Quarterly Report




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
 
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2016
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
 
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-10777
Ambac Financial Group, Inc.
(Exact name of Registrant as specified in its charter)
Delaware
 
13-3621676
(State of incorporation)
 
(I.R.S. employer identification no.)
 
 
 
One State Street Plaza, New York, New York
 
10004
(Address of principal executive offices)
 
(Zip code)
212-658-7470
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ( § 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes   x     No   ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act): (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   ¨     No   x
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes   x     No   ¨
As of November 2, 2016 , 45,121,788 shares of common stock, par value $0.01 per share, of the Registrant were outstanding.



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
PAGE
PART I.
FINANCIAL INFORMATION
 
 
Item 1.
Unaudited Consolidated Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
 
Item 4.
 
 
 
 
 
PART II.
OTHER INFORMATION
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 3.
 
 
Item 4.
 
Item 5.
 
Item 6.
 
 
 
 
 
 




PART I.    FINANCIAL INFORMATION
Item 1.     Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
 
September 30,
 
December 31,
(Dollars in thousands, except share data) (September 30, 2016 (Unaudited))
2016
 
2015
Assets:
 
 
 
Investments:
 
 
 
Fixed income securities, available for sale, at fair value (amortized cost: $5,806,949 and $4,992,756)
$
5,990,397

 
$
5,043,776

Fixed income securities pledged as collateral, available for sale, at fair value (amortized cost: $64,777 and $64,612)
64,972

 
64,555

Short-term investments, available for sale, at fair value (amortized cost: $130,732 and $225,789)
130,732

 
225,789

Other investments (includes $391,075 and $285,261 at fair value)
419,885

 
310,600

Total investments
6,605,986

 
5,644,720

Cash and cash equivalents
21,218

 
35,744

Receivable for securities
98,406

 
44,030

Investment income due and accrued
25,456

 
25,264

Premium receivables
706,228

 
831,575

Reinsurance recoverable on paid and unpaid losses
24,441

 
43,999

Deferred ceded premium
74,630

 
96,758

Subrogation recoverable
703,621

 
1,229,293

Loans
4,513

 
5,206

Derivative assets
103,373

 
84,995

Insurance intangible asset
1,022,865

 
1,212,112

Other assets
239,663

 
185,877

Variable interest entity assets:
 
 
 
Fixed income securities, at fair value
2,828,685

 
2,588,556

Restricted cash
5,477

 
5,822

Loans, at fair value
11,476,766

 
11,690,324

Derivative assets
68,676

 

Other assets
5,625

 
3,795

Total assets
$
24,015,629

 
$
23,728,070

Liabilities and Stockholders’ Equity:
 
 
 
Liabilities:
 
 
 
Unearned premiums
$
1,048,754

 
$
1,280,282

Loss and loss expense reserves
4,207,535

 
4,088,106

Ceded premiums payable
43,511

 
53,494

Obligations under investment agreements
82,358

 
100,358

Deferred taxes
1,736

 
2,205

Current taxes
16,750

 
5,835

Long-term debt
1,109,814

 
1,124,950

Accrued interest payable
400,737

 
355,536

Derivative liabilities
435,410

 
353,358

Other liabilities
52,177

 
61,134

Payable for securities purchased
201,980

 
84,690

Variable interest entity liabilities:
 
 
 
Accrued interest payable
3,121

 
3,230

Long-term debt, at fair value
11,930,434

 
12,327,960

Derivative liabilities
2,304,789

 
1,928,403

Other liabilities
149

 
183

Total liabilities
21,839,255

 
21,769,724

Commitments and contingencies (see Note 11)
 
 
 
Stockholders’ equity:

 

Preferred stock, par value $0.01 per share; 20,000,000 shares authorized; issued and outstanding shares—none

 

Common stock, par value $0.01 per share; 130,000,000 shares authorized; issued and outstanding shares: 45,121,788 and 45,044,222
451

 
450

Additional paid-in capital
194,383

 
190,813

Accumulated other comprehensive income
61,917

 
15,215

Retained earnings
1,652,846

 
1,478,439

Treasury stock, shares at cost: 0 and 8,202

 
(118
)
Total Ambac Financial Group, Inc. stockholders’ equity
1,909,597

 
1,684,799

Noncontrolling interest
266,777

 
273,547

Total stockholders’ equity
2,176,374

 
1,958,346

Total liabilities and stockholders’ equity
$
24,015,629

 
$
23,728,070

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 1 2016 Third Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Total Comprehensive Income (Loss) (Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(Dollars in thousands, except share data)
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Net premiums earned
$
53,218

 
$
71,535

 
$
147,420

 
198,132

Net investment income:
 
 
 
 
 
 
 
Securities available-for-sale and short-term
79,530

 
65,619

 
201,880

 
191,229

Other investments
11,387

 
(1,424
)
 
20,616

 
10,702

Total net investment income
90,917

 
64,195

 
222,496

 
201,931

Other-than-temporary impairment losses:
 
 
 
 
 
 
 
Total other-than-temporary impairment losses
(15,906
)
 
(31,743
)
 
(82,856
)
 
(43,495
)
Portion of other-than-temporary impairment recognized in other comprehensive income
13,053

 
22,593

 
63,228

 
30,206

Net other-than-temporary impairment losses recognized in earnings
(2,853
)
 
(9,150
)
 
(19,628
)
 
(13,289
)
Net realized investment gains (losses)
11,749

 
2,106

 
27,748

 
50,854

Change in fair value of credit derivatives:
 
 
 
 
 
 
 
Realized gains and other settlements
226

 
1,693

 
711

 
2,519

Unrealized gains (losses)
1,507

 
35,259

 
17,843

 
42,227

Net change in fair value of credit derivatives
1,733

 
36,952

 
18,554

 
44,746

Derivative products
(14,510
)
 
(65,083
)
 
(134,265
)
 
(51,858
)
Net realized gains (losses) on extinguishment of debt
24

 
1,420

 
4,845

 
81

Other income (expense)
2,693

 
7,150

 
17,611

 
5,206

Income (loss) on variable interest entities
2,057

 
(21,435
)
 
(16,119
)
 
38,130

Total revenues
145,028

 
87,690

 
268,662

 
473,933

Expenses:
 
 
 
 
 
 
 
Losses and loss expense (benefit)
(69,204
)
 
(133,213
)
 
(226,981
)
 
(431,642
)
Insurance intangible amortization
44,553

 
39,680

 
134,456

 
115,200

Operating expenses
21,466

 
25,006

 
77,470

 
75,402

Interest expense
31,493

 
29,899

 
92,632

 
85,980

Goodwill impairment

 
514,511

 

 
514,511

Total expenses (benefit)
28,308

 
475,883

 
77,577

 
359,451

Pre-tax income (loss)
116,720

 
(388,193
)
 
191,085

 
114,482

Provision for income taxes
15,282

 
2,838

 
21,877

 
8,464

Net income (loss)
101,438

 
(391,031
)
 
169,208

 
106,018

Less: net (gain) loss attributable to noncontrolling interest
(36
)
 
(44
)
 
(328
)
 
(401
)
Net income (loss) attributable to common stockholders
$
101,474

 
$
(390,987
)
 
$
169,536

 
$
106,419

Other comprehensive income (loss), after tax:
 
 
 
 
 
 
 
Net income (loss)
$
101,438

 
$
(391,031
)
 
$
169,208

 
$
106,018

Unrealized gains (losses) on securities, net of deferred income taxes of $0
24,719

 
8,382

 
132,680

 
(122,905
)
Gains (losses) on foreign currency translation, net of deferred income taxes of $0
(13,323
)
 
(30,909
)
 
(86,256
)
 
(24,224
)
Changes to postretirement benefit, net of tax of $0
(254
)
 
(220
)
 
278

 
(467
)
Total other comprehensive income (loss), net of tax
11,142

 
(22,747
)
 
46,702

 
(147,596
)
Total comprehensive income (loss)
112,580

 
(413,778
)
 
215,910

 
(41,578
)
Less: comprehensive (gain) loss attributable to the noncontrolling interest:
 
 
 
 
 
 
 
Net (gain) loss
(36
)
 
(44
)
 
(328
)
 
(401
)
Currency translation adjustments

 
(272
)
 

 
(200
)
Total comprehensive income (loss) attributable to Ambac Financial Group, Inc.
$
112,616

 
$
(413,462
)
 
$
216,238

 
$
(40,977
)
Net income (loss) per share attributable to Ambac Financial Group, Inc. common stockholders
 
 
 
 
 
 
 
Basic
$
2.24

 
$
(8.66
)
 
$
3.75

 
$
2.36

Diluted
$
2.22

 
$
(8.66
)
 
$
3.74

 
$
2.30

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 2 2016 Third Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders’ Equity (Unaudited)
 
 
 
Ambac Financial Group, Inc.
 
 
(Dollars in thousands)
Total
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Preferred
Stock
 
Common
Stock
 
Additional Paid-in
Capital
 
Common
Stock Held
in Treasury,
at Cost
 
Noncontrolling
Interest
Balance at January 1, 2016
$
1,958,346

 
$
1,478,439

 
$
15,215

 
$

 
$
450

 
$
190,813

 
$
(118
)
 
$
273,547

Total comprehensive income (loss)
215,910

 
169,536

 
46,702

 

 

 

 

 
(328
)
Adjustment to initially apply ASU 2014-13

 
6,442

 

 

 

 

 

 
(6,442
)
Stock-based compensation
4,228

 

 

 

 

 
4,228

 

 

Cost of shares (acquired) issued under equity plan
(9
)
 
(127
)
 

 

 

 

 
118

 

Cost of warrants acquired
(2,104
)
 
(1,444
)
 

 

 

 
(660
)
 

 

Issuance of common stock
1

 

 

 

 
1

 

 

 

Warrants exercised
2

 

 

 

 

 
2

 

 

Balance at September 30, 2016
$
2,176,374

 
$
1,652,846

 
$
61,917

 
$

 
$
451

 
$
194,383

 
$

 
$
266,777

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2015
1,673,735

 
989,290

 
220,283

 

 
450

 
189,138

 
(56
)
 
274,630

Total comprehensive income (loss)
(41,578
)
 
106,419

 
(147,396
)
 

 

 

 

 
(601
)
Stock-based compensation
2,150

 

 

 

 

 
2,150

 

 

Cost of shares (acquired) issued under equity plan
(256
)
 
(56
)
 

 

 

 

 
(200
)
 

Cost of warrants acquired
(5,017
)
 
(3,707
)
 

 

 

 
(1,310
)
 

 

Warrants exercised
3

 

 

 

 

 
3

 

 

Balance at September 30, 2015
$
1,629,037

 
$
1,091,946

 
$
72,887

 
$

 
$
450

 
$
189,981

 
$
(256
)
 
$
274,029

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 3 2016 Third Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
 
 
Nine Months Ended September 30,
(Dollars in thousands)
 
2016
 
2015
Cash flows from operating activities:
 
 
 
 
Net income attributable to common stockholders
 
$
169,536

 
$
106,419

Noncontrolling interest in subsidiaries’ earnings
 
(328
)
 
(401
)
Net income
 
169,208

 
106,018

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
920

 
2,137

Impairment of goodwill
 

 
514,511

Amortization of bond premium and discount
 
(102,956
)
 
(99,534
)
Share-based compensation
 
4,228

 
2,150

Deferred income taxes
 
(469
)
 
(122
)
Current income taxes
 
11,848

 
(6,686
)
Unearned premiums, net
 
(210,722
)
 
(229,251
)
Losses and loss expenses, net
 
666,196

 
(424,334
)
Ceded premiums payable
 
(9,983
)
 
(2,785
)
Investment income due and accrued
 
(145
)
 
(91
)
Premium receivables
 
126,047

 
106,521

Accrued interest payable
 
45,201

 
30,860

Amortization of insurance intangible assets
 
134,456

 
115,200

Net mark-to-market (gains) losses
 
(17,843
)
 
(42,227
)
Net realized investment gains
 
(27,748
)
 
(50,854
)
Other-than-temporary impairment charges
 
19,628

 
13,289

Net realized (gains) losses on extinguishment of debt
 
(4,845
)
 
(81
)
Variable interest entity activities
 
16,119

 
(38,130
)
Other, net
 
6,392

 
85,450

Net cash provided by operating activities
 
825,532

 
82,041

Cash flows from investing activities:
 
 
 
 
Proceeds from sales of bonds
 
457,423

 
795,855

Proceeds from matured bonds
 
940,948

 
695,879

Purchases of bonds
 
(2,085,939
)
 
(1,696,643
)
Proceeds from sales of other invested assets
 
132,437

 
147,731

Purchases of other invested assets
 
(250,727
)
 
(101,913
)
Change in short-term investments
 
94,651

 
(4,477
)
Loans
 
693

 
215

Change in swap collateral receivable
 
(51,986
)
 
(17,032
)
Other, net
 
(10,714
)
 
(2,287
)
Net cash (used in) investing activities
 
(773,214
)
 
(182,672
)
Cash flows from financing activities:
 
 
 
 
Proceeds received from a secured borrowing
 

 
144,189

Paydowns of a secured borrowing
 
(25,306
)
 
(7,355
)
Payments for investment agreement draws
 
(17,964
)
 
(63,872
)
Payments for extinguishment of long-term debt
 
(19,550
)
 
(13,752
)
Proceeds from warrant exercises
 
2

 
3

Cost of warrants acquired
 
(2,104
)
 
(5,017
)
Net cash provided by (used in) financing activities
 
(64,922
)
 
54,196

Effect of foreign exchange rate changes on cash and cash equivalents
 
(1,922
)
 
(369
)
Net cash flow
 
(14,526
)
 
(46,804
)
Cash and cash equivalents at beginning of period
 
35,744

 
73,903

Cash and cash equivalents end of period
 
$
21,218

 
$
27,099

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
Income taxes
 
$
10,098

 
$
15,176

Interest on secured borrowing
 
3,314

 
449

Interest on investment agreements
 
435

 
261

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 4 2016 Third Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)
1. BACKGROUND AND BUSINESS DESCRIPTION
Ambac Financial Group, Inc. (“Ambac” or the “Company”), headquartered in New York City, is a financial services holding company incorporated in the state of Delaware on April 29, 1991 .
Ambac has two reportable business segments: Financial Guarantee and Financial Services.
Ambac’s financial guarantee business segment is conducted through its primary operating subsidiary, Ambac Assurance Corporation (“Ambac Assurance”), and its wholly owned subsidiary, Ambac Assurance UK Limited (“Ambac UK”). Insurance policies issued by Ambac Assurance and Ambac UK generally guarantee payment when due of the principal and interest on the obligations guaranteed. Ambac Assurance also has another wholly-owned financial guarantee subsidiary, Everspan Financial Guarantee Corp. (“Everspan”), which has been in runoff since its acquisition in 1997. The deterioration of Ambac Assurance’s financial condition resulting from losses in its insured portfolio since 2007 has prevented Ambac's subsidiaries from being able to write new business. An inability to write new business has and will continue to negatively impact Ambac’s future operations and financial results. Ambac Assurance’s ability to pay dividends and, as a result, Ambac’s liquidity, have been significantly restricted by the deterioration of Ambac Assurance’s financial condition, by the rehabilitation of the Segregated Account (as defined below) and by the terms of the Settlement Agreement, dated as of June 7, 2010 (the "Settlement Agreement"), by and among Ambac Assurance, Ambac Credit Products LLC (“ACP”), Ambac and certain counterparties to credit default swaps with ACP that were guaranteed by Ambac Assurance. Ambac Assurance is also restricted in its ability to pay dividends pursuant to regulatory restrictions, the terms of its Auction Market Preferred Shares and the terms of agreements entered into with the Segregated Account. It is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future.
Ambac’s financial services business segment is conducted through subsidiaries of Ambac Assurance, which provide financial products, including investment agreements, funding conduits and interest rate swaps, principally to the clients of its financial guarantee business. Ambac Assurance insured all of the obligations of its financial services subsidiaries. These businesses are in active runoff, which is being effectuated by transaction terminations, settlements and scheduled amortization of contracts. The Financial Services business also maintains interest rate derivatives to mitigate exposure to floating rate insured obligations in the Financial Guarantee segment.
Ambac’s primary goal is to maximize stockholder value by executing the following key strategies:
Active runoff of Ambac Assurance and its subsidiaries through accretive transaction terminations, policy commutations, settlements and restructurings, and maximizing the risk-adjusted return on invested assets;
Loss recovery through litigation and exercise of contractual and legal rights;
Improved cost effectiveness and efficiency of the operating platform;
Rationalization of Ambac Assurance's capital and liability structures, enabling simplification of corporate governance and facilitating the successful rehabilitation of the Segregated Account; and
Selective business transactions offering attractive risk-adjusted returns that, among other things, may permit utilization of Ambac’s tax net operating loss carry-forwards.
In March 2010, Ambac Assurance established a Segregated Account pursuant to Wisc. Stat. §611.24 (2) (the “Segregated Account”) to segregate certain segments of Ambac Assurance’s liabilities, and the Office of the Commissioner of Insurance for the State of Wisconsin (“OCI” (which term shall be understood to refer to such office as regulator of Ambac Assurance and to refer to the Commissioner of Insurance for the State of Wisconsin as rehabilitator of the Segregated Account (the “Rehabilitator”), as the context requires)) commenced rehabilitation proceedings in the Dane County, Wisconsin Circuit Court (the “Rehabilitation Court”) with respect to the Segregated Account (the “Segregated Account Rehabilitation Proceedings”) in order to permit OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account pursuant to the provisions of the Wisconsin Insurers Rehabilitation and Liquidation Act. On October 8, 2010, OCI filed a plan of rehabilitation for the Segregated Account (the “Segregated Account Rehabilitation Plan”) in the Rehabilitation Court. The Rehabilitation Court confirmed the Segregated Account Rehabilitation Plan on January 24, 2011. On June 11, 2014, the Rehabilitation Court approved amendments to the Segregated Account Rehabilitation Plan and the Segregated Account Rehabilitation Plan, as amended, became effective on June 12, 2014. Net par exposure as of September 30, 2016 for policies allocated to the Segregated Account was $12,469,965 . Policy obligations not allocated to the Segregated Account remain in the General Account of Ambac Assurance, and such policies in the General Account are not subject to and, therefore, are not directly impacted by the Segregated Account Rehabilitation Plan.
To pay claims and other liabilities, the Segregated Account has the ability to demand payment from time to time under an aggregate excess of loss reinsurance agreement provided by Ambac Assurance (the “Reinsurance Agreement”). In addition, certain operating and administrative costs and expenses of the Segregated Account are reimbursable by Ambac Assurance pursuant to the Cooperation Agreement, dated as of March 24,


| Ambac Financial Group, Inc. 5 2016 Third Quarter FORM 10-Q |


2010, by and between the Segregated Account and Ambac Assurance, as amended (the “Cooperation Agreement”). Ambac Assurance is not obligated to make payments under the Reinsurance Agreement or Cooperation Agreement if its surplus as regards to policyholders is less than $100,000 (the “Minimum Surplus Amount”). As long as the surplus as regards to policyholders is not less than the Minimum Surplus Amount, payments by Ambac Assurance to the Segregated Account under the Reinsurance Agreement and Cooperation Agreement are not capped. At September 30, 2016 , Ambac Assurance’s surplus as regards to policyholders of $921,873 exceeded the Minimum Surplus Amount. In the event that Ambac Assurance does not maintain surplus in excess of the Minimum Surplus Amount, the Segregated Account would experience a shortfall in funds available to pay its liabilities. Any such shortfall would be a consideration for the Rehabilitator in the determination of whether any changes to the Segregated Account Rehabilitation Plan and/or the amount of partial policy claim payments are necessary or appropriate or whether to institute general rehabilitation proceedings against Ambac Assurance.
Ambac Assurance is evaluating possibilities for concluding the Segregated Account Rehabilitation Proceedings. In pursuing this objective, Ambac Assurance is considering the possibility of entering into transactions whereby it would monetize certain assets and/or restructure or exchange certain outstanding debt and insurance obligations. Towards this objective, Ambac Assurance is discussing with OCI potential options for addressing outstanding Segregated Account obligations.
On July 12, 2016, the Special Deputy Commissioner ("SDC") for the Segregated Account met with policy beneficiaries and holders of surplus notes of Ambac Assurance and the Segregated Account during which the SDC stated (i) that at present, the Rehabilitator does not have any plans to increase the interim payment percentage (“IPP”) on Segregated Account policy claims, commenting that the Rehabilitator and his advisors would need to feel highly confident that any change to the IPP would be sustainable and fair to all policyholders; (ii) that the Rehabilitator reserves the right to amend the Segregated Account Rehabilitation Plan or take such other action as he deems necessary or appropriate to adjust the rate of accretion on Deferred Amounts from time to time based on such factors as he considers relevant and, as such, the accretion rate remains under review; and (iii) his objective of seeking an exit of the Segregated Account from rehabilitation, and further stated that although his preferred goal would be to achieve an exit from rehabilitation through a consensual plan, he would advise the Rehabilitator to use all tools available to accomplish a successful and durable exit that enhances Ambac Assurance's long-term claims-paying ability.
While the terms, conditions, and timing of a potential conclusion of the Segregated Account Rehabilitation Proceedings are in the sole discretion of the OCI, and subject to the approval of the Rehabilitation Court, from time to time Ambac Assurance has discussed with several counterparty creditors a potential exchange pursuant to which outstanding Deferred Amounts, including accrued interest, and surplus notes (other than junior surplus notes) would be exchanged for new securities and cash. As of the date of this filing, Ambac Assurance has not reached any agreement on the terms of a potential transaction, and we cannot provide assurance that any such transaction will be entered into by Ambac Assurance in the future, or if it is, as to the timing, terms or conditions of any such transaction. Any such transaction would remain subject to the prior approval of the board of Ambac Assurance, OCI and the Rehabilitation Court.
The execution of Ambac’s strategy to increase the value of its investment in Ambac Assurance is subject to the authority of the Rehabilitator to control the management of the Segregated Account. In exercising such authority, the Rehabilitator will act for the benefit of policyholders, and will not take into account the interests of Ambac. The Rehabilitator's authority includes, but is not limited to, sole discretion over the rate at which the Segregated Account pays claims and the accretion rate on Deferred Amounts. Similarly, by operation of the contracts executed in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the Rehabilitator retains rights to oversee and approve certain actions taken by or in respect of Ambac Assurance. Opportunities for remediating losses on poorly performing insured transactions also depend on market conditions, including the perception of Ambac Assurance’s creditworthiness, the structure of the underlying risk and associated policy as well as other counterparty specific factors. Oversight by the Rehabilitator could impair Ambac’s ability to execute certain of its strategies. Ambac Assurance's ability to commute policies or purchase certain investments may also be limited by available liquidity.
Although we are exploring selective business transactions for Ambac, no assurance can be given that we will be able to execute the acquisition or development of any new businesses or assets. In addition, there can be no assurance that we will be able to obtain the financial and other resources that may be required to finance the acquisition or development of new businesses or assets that may permit utilization of Ambac’s tax net operating loss carry-forwards. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of our securities is speculative.
As a result of uncertainties associated with the aforementioned oversight by the Rehabilitator of the Segregated Account, management has concluded that there is substantial doubt about Ambac's ability to continue as a going concern. Ambac’s financial statements as of and for the three and nine months ended September 30, 2016 and the year ended December 31, 2015 , are prepared assuming Ambac continues as a going concern and do not include any adjustment that might result from its inability to continue as a going concern.
United Kingdom Referendum
In a non-binding referendum on the United Kingdom’s (“UK”) membership in the European Union in June 2016, a majority of those who voted approved the UK’s withdrawal from the European Union (“EU”). A withdrawal by the UK from the European Union (“Brexit”) would occur after, or possibly concurrently with, a process of negotiation regarding the future terms of the UK’s relationship with the EU, which could result in the UK losing access to certain aspects of the single EU market and the global trade deals negotiated by the EU on behalf of its members. The Brexit vote and the perceptions as to the impact of the withdrawal of the UK may adversely affect business activity, political stability and economic conditions in the UK, the Eurozone, the EU and elsewhere. The economic outlook could be further adversely affected by (i) the risk that one or more other EU countries could come under increasing pressure to leave the EU, (ii) the risk of a greater demand for independence by Scottish nationalists or for unification in Ireland, or (iii) the risk that the Euro as the single currency of the Eurozone could cease to exist. Any of these


| Ambac Financial Group, Inc. 6 2016 Third Quarter FORM 10-Q |


developments, or the perception that any of these developments are likely to occur, could have a material adverse effect on economic growth or business activity in the UK, the Eurozone, or the EU, and could result in the relocation of businesses, cause business interruptions, lead to economic recession or depression, and impact the stability of the financial markets, the availability of credit, political systems or financial institutions and the financial and monetary system. Consequently the medium and longer term impact on the UK generally, and Ambac Assurance UK Limited ("Ambac UK") specifically, is uncertain.  The immediate impact on the UK included a decline in the value of the British Pound against major currencies, a decline in the value of certain UK assets, such as real-estate, and greater asset volatility.
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company has disclosed its significant accounting policies in Note 2. Significant Accounting Policies in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2015 . The following significant accounting policies provide an update to those included in the Company’s Annual Report on Form 10-K/A.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by GAAP for annual periods. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K/A for the year ended December 31, 2015 . The accompanying consolidated financial statements have not been audited by an independent registered public accounting firm in accordance with the standards of the Public Company Accounting Oversight Board (U.S.), but in the opinion of management such financial statements include all adjustments necessary for the fair presentation of the Company’s consolidated financial position and results of operations. All intercompany balances and transactions have been eliminated. The results of operations for the three and nine months ended September 30, 2016 may not be indicative of the results that may be expected for the year ending December 31, 2016 . The December 31, 2015 consolidated balance sheet was derived from audited financial statements.
The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As additional information becomes available or actual amounts become determinable, the recorded estimates are revised and reflected in operating results.
Goodwill:
At the Fresh Start Reporting Date, we revalued our assets and liabilities to current estimated fair value. The excess reorganization value which could not be attributed to the fair value of specific identified tangible and intangible assets ("fair value of net assets") was recorded as goodwill. Pursuant to the Intangibles - Goodwill and Other Topic of the ASC, goodwill is not amortized but is subject to annual impairment testing. We test goodwill for impairment as of October 1 st of each year. Goodwill is also tested more frequently if indicators of impairment exist for each reporting unit. Refer to Note 2. Basis of Presentation and Significant Accounting Policies in the Notes to the Consolidated Financial Statements included in Part II, Item 8 in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 for further discussion on the two-step approach for goodwill impairment testing and how we assigned all goodwill to the Financial Guarantee reporting unit.
During the September 30, 2015 reporting period, Ambac determined sufficient indicators of potential impairment existed to perform an interim goodwill impairment evaluation for the Financial Guarantee reporting unit. Those indicators included the trading values of Ambac stock and changes in Ambac credit spreads. In conducting the goodwill impairment analysis as of September 30, 2015, we performed step one of the goodwill impairment test for the Financial Guarantee reporting unit. We estimated the fair value of the Financial Guarantee reporting unit using a market approach, which was derived using: i) Ambac’s common stock and warrant market capitalization, ii) fair value estimates of Ambac Assurance preferred shares (reported as noncontrolling interests on Ambac's balance sheet) and iii) an estimated control premium. Step one of the impairment test indicated the Financial Guarantee reporting unit's carrying value exceeded its fair value.
Accordingly, the Company performed step two of the impairment test as of September 30, 2015, which indicated the implied fair value of goodwill was zero. This was the result of substantial decreases in the Financial Guarantee reporting unit's fair value and substantial increases in the fair value of its net assets. The fair value of the Financial Guarantee reporting unit decreased significantly due to a material decrease in Ambac's market capitalization components (described above). The Financial Guarantee reporting unit's fair value of net assets increased significantly primarily as a result of a decrease in the estimated fair value of financial guarantee liabilities and, to a lesser extent, a decrease in the fair value of long-term debt. The fair value decrease in financial guarantee liabilities, which is a Level 3 estimate, was primarily driven by wider Ambac credit spreads and positive loss and loss expense reserves development. Please refer to Note 7. Fair Value Measurements for further discussion on the fair value model for financial guarantee liabilities. The fair value decrease in long-term debt was driven by lower market pricing on surplus notes and junior surplus notes.
As a result, the Company recorded a full non-cash, non-tax deductible goodwill impairment charge of $514,511 at September 30, 2015.


| Ambac Financial Group, Inc. 7 2016 Third Quarter FORM 10-Q |



The following is a summary of activity in goodwill for the Financial Guarantee reporting unit:
 
 
Nine Months Ended September 30, 2015
Beginning balance
 
$
514,511

Impairment loss
 
(514,511
)
Ending balance
 
$

Foreign Currency:
Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with the Foreign Currency Matters Topic of the ASC. The functional currencies of Ambac's subsidiaries are the local currencies of the country where the respective subsidiaries are based, which are also the primary operating environments in which the subsidiaries operate.
Foreign currency translation : Functional currency assets and liabilities of Ambac’s foreign subsidiaries are translated into U.S. dollars using exchange rates in effect at the balance sheet dates and the related translation adjustments, net of deferred taxes, are included as a component of Accumulated Other Comprehensive Income in Stockholders' Equity. Consolidated Statements of Total Comprehensive Income accounts expressed in functional currencies are translated using average exchange rates.
Foreign currency transactions : The impact of non-functional currency transactions and the remeasurement of non-functional currency assets and liabilities into the respective subsidiaries' functional currency (collectively "foreign currency transactions gains/(losses)") are $(26,741) and $(6,734) for the nine months ended September 30, 2016 and 2015 . Foreign currency transactions gains/(losses) are primarily the result of remeasuring Ambac UK's assets and liabilities denominated in currencies other than its functional currency, primarily the U.S. dollar and the Euro. The significant components of foreign currency transaction gains/(losses), including the respective classifications in the Consolidated Statement of Total Comprehensive Income, are as follows:
Remeasurement of loss reserves, classified in Loss and loss expenses, in the amount of $(56,910) and $(13,347) for the nine months ended September 30, 2016 and 2015 , respectively;
Sales of investment securities and the unrealized gains (losses) of trading and short-term investment securities, classified in Net realized investment gains, in the amount of $22,030 and $3,801 for the nine months ended September 30, 2016 and 2015 , respectively;
Remeasurement of premium receivables, classified in Other income, in the amount of $8,264 and $(3,234) for the nine months ended September 30, 2016 and 2015 , respectively;
Remeasurement of credit derivative liabilities, classified in Net change in fair value of credit derivative, in the amount of $(929) and $4,895 for the nine months ended September 30, 2016 and 2015 , respectively; and
Remeasurement of cash held, classified in Other income, in the amount of $457 and $1,140 for the nine months ended September 30, 2016 and 2015 , respectively.
Reclassifications
Certain reclassifications have been made to prior years' amounts to conform to the current year's presentation.
Recently Adopted and Recently Issued Accounting Standards
Adopted:
Effective January 1, 2016, Ambac adopted the following accounting standards:
ASU 2014-12, Compensation - Stock Compensation (Topics 718) - Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period . Generally, share-based payment awards that require a specific performance target to be met also require an employee to render service until the performance target is achieved. However, in some cases, the terms of an award may provide that the performance target could be achieved after the employee completes the requisite service period. Under previous U.S. GAAP, there was no explicit guidance on how to account for share-based payment awards with performance targets that could be achieved after the requisite service period. This ASU is intended to resolve diversity in practice with respect to how the performance target is considered in the grant-date fair value of the award, which impacts the amount of compensation cost recognized over time. The ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. As a result, the performance target would not be reflected in estimating the fair value of the award at the grant date. As Ambac previously followed the guidance in ASU 2014-12 for its share-based awards which have performance targets, the adoption of this ASU had no impact on Ambac's financial statements.
ASU 2014-13, Consolidation (Topic 810): Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity . A collateralized financing entity ("CFE") is a variable interest entity with nominal or no equity that holds financial assets and


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issues beneficial interests in those financial assets. The beneficial interests, which are financial liabilities of the CFE, have contractual recourse only to the related assets of the CFE. Currently, a reporting entity that is required to consolidate a CFE may elect to measure the financial assets and financial liabilities of the CFE at fair value. Under the ASU, a reporting entity may elect to measure such assets and liabilities using either: i) the measurement principles in the Fair Value Measurement Topic of the ASC or ii) an alternative measurement approach specified in the ASU. The alternative measurement approach uses the more observable of either the fair value of the financial assets or financial liabilities to measure both. However, a reporting entity may not use the alternative measurement approach if it guarantees all or a portion of the CFE's beneficial interests. Furthermore, entities that do not (or may not) use the alternative measurement approach may not attribute any of the CFE's earnings to noncontrolling interests. The ASU is intended to address diversity in practice in accounting for the measurement difference between financial assets and financial liabilities of CFEs. Most of the CFEs consolidated by Ambac are the result of Ambac’s guarantee of the CFEs' respective beneficial interests. As a result, we may not apply the measurement alternative in this ASU to those CFEs.  Previously, Ambac had one consolidated CFE where we elected to measure the financial assets and financial liabilities at fair value and where a portion of the CFEs earnings were attributed to noncontrolling interests. As a result, we have elected to use a modified retrospective approach in adopting this ASU and have reclassified $6,442 related to this CFE from noncontrolling interest to retained earnings on the balance sheet effective January 1, 2016. There was no impact on the Statement of Comprehensive Income.
ASU 2014-16, Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity. The objective of this ASU is to eliminate the existing diversity in practice in accounting for hybrid financial instruments issued in the form of a share. A hybrid financial instrument consists of a “host contract” into which one or more derivative terms have been embedded. The ASU requires an entity to consider the terms and features of the entire financial instrument, including the embedded derivative features, in order to determine whether the nature of the host contract is more akin to debt or to equity. Adoption of this ASU did not affect Ambac’s financial statements.
ASU 2015-01, Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. Extraordinary items are defined as both unusual in nature and infrequent in occurrence. Under previous guidance, a reporting entity was required to separately present and disclose extraordinary items. This ASU eliminates from current U.S. GAAP the concept of extraordinary items. However, the ASU retains the presentation and disclosure guidance for items that are unusual in nature or occur infrequently. Items that meet either or both of these criteria must be presented as a separate component on the face of the income statement or, alternatively, disclosed in the notes to the financial statements. Adoption of this ASU did not affect Ambac’s financial statements.
ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis . This ASU makes changes to the variable interest ("VIE") model and voting interest ("VOE") model consolidation guidance. The main provisions of the ASU include the following: i) adding a requirement that limited partnerships and similar legal entities must provide partners with either substantive kick-out rights or substantive participating rights over the general partner to qualify as a VOE rather than a VIE; ii) eliminating the presumption that the general partner should consolidate a limited partnership; iii) eliminating certain conditions that need to be met when evaluating whether fees paid to a decision maker or service provider are considered a variable interest; iv) excluding certain fees paid to decision makers or service providers when evaluating which party is the primary beneficiary of a VIE; and v) revising how related parties are evaluated under the VIE guidance. Lastly, the ASU eliminates the indefinite deferral of FAS 167, which allowed reporting entities with interests in certain investment funds to follow previous guidance in FIN 46 (R). However, the ASU permanently exempts reporting entities from consolidating registered money market funds that operate in accordance with Rule 2a-7 of the Investment Company Act of 1940. Adoption of this ASU did not affect Ambac’s financial statements.
ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30) . This ASU simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts, rather than as a deferred asset. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The ASU requires retrospective application to all prior periods presented. Adoption of this ASU did not have a material effect on Ambac’s financial statements.
ASU 2015-07, Fair Value Measurement (Topic 820) - Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) . Reporting entities are permitted to use net asset value ("NAV") as a practical expedient to measure the fair value of certain investments. Under previous GAAP, investments that use the NAV practical expedient to measure fair value were categorized within the fair value hierarchy as level 2 or level 3 investments depending on their redemption attributes, which has led to diversity in practice. This ASU will remove the requirement to categorize within the fair value hierarchy all investments that use the NAV practical expedient for fair value measurement purposes. Furthermore, the ASU will remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the NAV practical expedient. Upon adoption Ambac applied this ASU retrospectively to all prior periods presented, which was not material to Ambac's financial statements. Disclosures that were impacted by adoption of this ASU are shown in Note 7 - Fair Value Measurements .
Issued:
In March 2016, the FASB issued ASU 2016-06, Derivatives and Hedging (Topic 815) - Contingent Put and Call Options in Debt Instruments . Current accounting rules require that embedded derivatives be separated from the host contract in a financial instrument and accounted for separately as derivatives if certain criteria are met. One of these criteria is that the economic characteristics and risks of the embedded derivatives are not "clearly and closely related" to the host contract. The objective of the ASU is to resolve diversity in practice in assessing embedded contingent put and call options. The ASU clarifies what steps are required when assessing whether the economic characteristics and risk of put and call options are clearly and closely related to their debt host contracts. The ASU is effective for fiscal years beginning after December 15,


| Ambac Financial Group, Inc. 9 2016 Third Quarter FORM 10-Q |



2016 and interim periods within those fiscal years, with early adoption permitted. The ASU must be applied on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are effective. Ambac will adopt this ASU on January 1, 2017. Adoption of this ASU is not expected to have a material impact on Ambac's financial statements.
In March 2016, the FASB issued ASU 2016-07, Investments-Equity Method and Joint Ventures (Topic 323) - Simplifying the Transition to the Equity Method of Accounting . This ASU eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively as if the equity method had been in effect during all previous periods that the investment had been owned. The ASU will now require that at the date an available-for-sale equity security becomes qualified for the equity method of accounting, the reporting entity will recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income. The ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. The amendments should be applied prospectively upon adoption. Ambac may choose to early adopt this ASU to the extent we hold an available-for-sale equity security that becomes qualified for the equity method of accounting. Adoption of this ASU is not expected to have a material impact on Ambac's financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting . The objective of this ASU is to improve and simplify the accounting for employee share-based payment accounting. The amendments are as follows: (i) recognizing excess tax benefits and tax deficiencies as income tax expense, (ii) recognizing excess tax benefits regardless of whether it reduces taxes payable in the current period, (iii) classifying excess tax benefits related to share-based payments along with other income tax cash flows as an operating activity on the statement of cash flows, (iv) allowing companies to make an accounting policy election to either estimate forfeitures or account for forfeitures as they occur, for purposes of accruing compensation cost, (v) to qualify for equity classification treatment, permitting tax withholding by employees up to the maximum statutory tax rate and (vi) classifying cash paid by an employer to a taxing authority when directly withholding shares as a financing activity on the statement of cash flows. The ASU is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted. Depending on the amendment, application will be prospective, retrospective or using a modified retrospective approach. Ambac has not determined whether it will early adopt this ASU and we are currently evaluating its impact on Ambac's financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments . This ASU significantly affects how reporting entities will measure credit losses for financial assets that are not accounted for at fair value through net income, which include loans, debt securities, trade receivables, net investments in leases, and certain off-balance sheet credit exposures. For financial assets measured at amortized cost, the ASU replaces the "incurred loss" model, which generally delayed recognition of the full amount of credit losses until the loss was probable of occurring, with an "expected loss" model, which reflects an entity's current estimate of all expected credit losses. Expected credit losses for amortized cost assets will be recorded as a valuation allowance, with subsequent increases or decreases in the allowance reflected in the income statement each period. For available-for-sale debt securities, credit losses under the ASU will be measured similarly to current GAAP. However, under the ASU, credit losses for available-for-sale securities will be recorded as a valuation allowance (similar to the amortized cost assets approach described above), rather than as a direct write-down of the security as is required under current GAAP. As a result, improvements to estimated credit losses for available-for-sale debt securities will be recognized immediately in the income statement rather than as interest income over time. The ASU is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted as of the fiscal year beginning after December 15, 2018. Ambac has not determined whether it will early adopt this ASU and we are currently evaluating its impact on Ambac's financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments . The ASU resolves diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. Transactions addressed in the ASU that may impact Ambac are as follows:
Debt prepayment or debt extinguishment costs - Such payments will be classified as a financing cash outflow.
Settlement of zero-coupon debt or other debt with coupon rates that are insignificant in relation to the effective interest rate of the borrowing - The portion of the cash payment attributable to accreted interest will be classified as an operating cash outflow and the portion attributable to the principal will be classified as a financing cash outflow.
Distributions from equity-method investees - An entity will elect one of the two following approaches. Under the "cumulative earnings approach": i) distributions received up to the amount of cumulative earnings recognized will be treated as returns on investments and classified as cash inflows from operating activities and ii) distributions received in excess of earnings recognized will be treated as returns of investments and classified as cash inflows from investing activities. Under the "nature of the distribution" approach, distributions received will be classified based on the nature of the activity that generated the distribution (i.e. classified as a return on investment or return of investment), when such information is available to the investor.
Beneficial interests in securitization transactions - Any beneficial interests obtained in financial assets transferred to an unconsolidated securitization entity will be disclosed as a non-cash investing activity. Subsequent cash receipts from the beneficial interests in previously transferred trade receivables will be classified as cash inflows from investing activities.


| Ambac Financial Group, Inc. 10 2016 Third Quarter FORM 10-Q |



ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted, including adoptions within an interim period. Adoption of this ASU is not expected to have a material impact on Ambac's financial statements.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory . Current GAAP prohibits the recognition of current and deferred income taxes for intercompany transfers of assets until the asset has been sold to an outside party. The ASU will require companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory, as income tax expense (or benefit) in the period in which the transfer occurs. ASU 2016-16 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years. Early adoption is permitted as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued. Ambac has not determined whether it will early adopt this ASU and we are currently evaluating its impact on Ambac's financial statements.
In October 2016, the FASB issued ASU 2016-17, Consolidation (Topic 810) - Interests Held through Related Parties That Are under Common Control . The new guidance changes how a reporting entity that is a single decision maker for a VIE will consider its indirect interests in that VIE when determining whether the reporting entity is the primary beneficiary and should consolidate the VIE. Under current GAAP, a single decision maker in a VIE is required to consider an indirect interest held by a related party under common control in its entirety. Under the new ASU, the single decision maker will consider the indirect interest on a proportionate basis. ASU 2016-17 is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal periods. Early adoption is permitted, including adoption in an interim period. Adoption of this ASU is not expected to have a material impact on Ambac's financial statements.
3. SPECIAL PURPOSE ENTITIES, INCLUDING VARIABLE INTEREST ENTITIES ("VIEs")
Ambac, with its subsidiaries, has engaged in transactions with special purpose entities, including VIEs, in various capacities. Ambac most commonly provides financial guarantees, including credit derivative contracts, for various debt obligations issued by special purpose entities, including VIEs. Ambac has also sponsored certain special purpose entities to fund the purchase of certain financial assets. Ambac is also an investor in collateralized debt obligations, mortgage-backed and other asset-backed securities issued by VIEs and its ownership interest is generally insignificant to the VIE and/or Ambac does not have rights that direct the activities that are most significant to such VIE.
Financial Guarantees
Ambac’s subsidiaries provide financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs. Ambac’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structures provide certain financial protection to Ambac. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread. In the case of over-collateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the debt obligations guaranteed), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the debt obligations that have been guaranteed by Ambac’s subsidiaries. In the case of first loss, the financial guarantee insurance policy or credit derivative contract only covers a senior layer of losses on assets held or debt issued by special purpose entities, including VIEs. The first loss with respect to the assets is either retained by the asset seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the securitized assets contributed to special purpose entities, including VIEs, generate interest cash flows that are in excess of the interest payments on the related debt; such excess cash flow is applied to redeem debt, thus creating over-collateralization. Generally, upon deterioration in the performance of a transaction or upon an event of default as specified in the transaction legal documents, Ambac will obtain certain loss remediation rights. These rights may enable Ambac to direct the activities of the entity that most significantly impact the entity’s economic performance.
We determined that Ambac’s subsidiaries generally have the obligation to absorb a VIE's expected losses given that they have issued financial guarantees supporting the liabilities (and in certain cases assets). As further described below, we consolidated certain VIEs because: (i) we determined for certain transactions that experienced the aforementioned performance deterioration, that Ambac’s subsidiaries had the power, through voting rights or similar rights, to direct the activities of certain VIEs that most significantly impact the VIE’s economic performance because certain triggers had been breached in these transactions resulting in their ability to exercise certain loss remediation activities, or (ii) due to the passive nature of the VIEs’ activities, Ambac’s subsidiaries’ contingent loss remediation rights upon a breach of certain triggers in the future is considered to be the power to direct the activities that most significantly impact the VIEs’ economic performance. With respect to VIEs involving Ambac financial guarantees, Ambac is required to consolidate a VIE in the period that applicable triggers result in Ambac having control over the VIE’s most significant economic activities. A VIE is deconsolidated in the period that Ambac no longer has such control, which could occur in connection with insurance policies that are allocated to the Segregated Account, execution of remediation activities on the transaction or amortization of insured exposure, any of which may reduce the degree of Ambac’s control over a VIE. Assets and liabilities of VIEs that are consolidated as a result of Ambac's variable interest arising from financial guarantees written by Ambac's subsidiaries are reported within Variable interest entity assets or Variable interest entity liabilities on the Consolidated Balance Sheets. Results from such VIEs are reported within Income (loss) on variable interest entities in the Consolidated Statements of Total Comprehensive Income (Loss).
Ambac Sponsored VIEs
A subsidiary of Ambac transferred financial assets to two special purpose entities. The business purpose of these entities was to provide certain financial guarantee clients with funding for their debt obligations. These special purpose entities were established as separate legal entities, demonstrably distinct from Ambac and that Ambac, its affiliates or its agents could not unilaterally dissolve. The permitted activities of these entities were contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchase, executing derivative hedges and


| Ambac Financial Group, Inc. 11 2016 Third Quarter FORM 10-Q |



obtaining financial guarantee policies with respect to indebtedness incurred. Effective February 17, 2015, one of the special purpose entities was liquidated as it no longer had any outstanding liabilities. Ambac has not consolidated these entities because Ambac Assurance’s policies issued to these entities were allocated to the Segregated Account, thereby limiting Ambac’s control over the entities’ most significant economic activities. Ambac elected to account for its equity interest in these entities at fair value under the fair value option in accordance with the Financial Instruments Topic of the ASC. We believe that the fair value of the investments in these entities provides for greater transparency for recording profit or loss as compared to the equity method under the Investments – Equity Method and Joint Ventures Topic of the ASC. Refer to Note 7. Fair Value Measurements for further information on the valuation technique and inputs used to measure the fair value of Ambac’s equity interest in these entities. At September 30, 2016 and December 31, 2015 the fair value of the remaining entity was $7,729 and $8,696 , respectively, and is reported within Other assets on the Consolidated Balance Sheets.
Since their inception, there have been 15 individual transactions with these entities, of which three transactions remain outstanding as of September 30, 2016 . In each case, Ambac sold assets to these entities. The purchase by these entities of financial assets was financed through the issuance of medium-term notes (“MTNs”), which are cross-collateralized by the purchased assets. The MTNs have the same expected weighted average life as the purchased assets. Derivative contracts (interest rate swaps) are used within the entities for economic hedging purposes only. Derivative positions were established at the time MTNs were issued to purchase financial assets. Total principal amount of MTN debt outstanding was $412,750 and $465,160 at September 30, 2016 and December 31, 2015 , respectively, the decline was due to changes in foreign exchange rates relative to the British Pound. The assets are composed of utility obligations with a weighted average rating of BBB+ at September 30, 2016 and weighted average life of 5.9 years . As of September 30, 2016 Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the entities.
Insurance premiums paid to Ambac Assurance by these entities are earned in a manner consistent with other insurance policies, over the risk period. Additionally, any losses incurred on such insurance policies are included in Ambac’s Consolidated Statements of Total Comprehensive Income (Loss). Under the terms of an Administrative Agency Agreement, Ambac provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.
In July 2015, Ambac Assurance entered into a secured borrowing transaction whereby it sold 17 Ambac insured residential mortgage-backed securities (the "Securities") and all rights associated therewith as of May 31, 2015, to a Delaware statutory trust (the "Trust") in exchange for an equity certificate in the Trust, all financial guarantee claim payments associated with the Securities and cash of $146,000 (prior to expenses associated with the transaction). The Securities had par and fair value of $342,294 and $369,127 as of September 30, 2016 , respectively. Although the Securities were legally sold to the Trust, the Securities will remain in Invested assets on the Consolidated Balance Sheets. Refer to Note 8. Investments for further discussion of the restrictions on the invested assets. At the same time, a second Delaware statutory trust (the "Issuer"), issued $146,000 of debt securities and used the proceeds, together with an equity certificate of the Issuer, to purchase from the Trust a certificate entitling the Issuer to, and secured by, all principal and interest payments (other than financial guarantee claim payments) on the Securities. Interest on the debt securities is payable monthly at an annual rate of one month LIBOR + 2.8% . Both the Trust and the Issuer are consolidated VIEs because Ambac Assurance was involved in their design and holds a significant amount of the beneficial interests issued by the VIEs or guaranteed the assets held by the VIEs. VIE debt outstanding to third parties under this secured borrowing transaction had a carrying value of $106,284 as of September 30, 2016 and is reported in Long-Term Debt on the Consolidated Balance Sheets.
Consolidation of VIEs
Upon initial consolidation of a VIE, we recognize a gain or loss in earnings for the difference between: (i) the fair value of the consideration paid (when applicable), the fair value of any non-controlling interests and the reported amount of any previously held interests and (ii) the net amount, as measured on a fair value basis, of the assets and liabilities consolidated. Upon deconsolidation of a VIE, we recognize a gain or loss for the difference between: (i) the fair value of any consideration received (when applicable), the fair value of any retained non-controlling investment in the VIE and the carrying amount of any non-controlling interest in the VIE and (ii) the carrying amount of the VIE’s assets and liabilities. Gains or losses from consolidation and deconsolidation that are reported in earnings are reported within Income (loss) on variable interest entities on the Consolidated Statements of Total Comprehensive Income (Loss).
The variable interest in a VIE generally involves one or more of the following: a financial guarantee policy issued to the VIE, a written credit derivative contract that references liabilities of the VIE or an investment in securities issued by the VIE. The impact of consolidating such VIEs on Ambac’s balance sheet is the elimination of transactions between the consolidated VIEs and Ambac’s operating subsidiaries and the inclusion of the VIE’s third party assets and liabilities. For a financial guarantee insurance policy issued to a consolidated VIE, Ambac does not reflect the financial guarantee insurance policy in accordance with the related insurance accounting rules under the Financial Services – Insurance Topic of the ASC. Consequently, upon consolidation, Ambac eliminates the insurance assets and liabilities associated with the policy from the Consolidated Balance Sheets. Such insurance assets and liabilities may include premium receivables, reinsurance recoverable, deferred ceded premium, subrogation recoverable, unearned premiums, loss and loss expense reserves, ceded premiums payable and insurance intangible assets. Furthermore, with respect to the consolidation or deconsolidation of VIEs related to financial guarantee insurance policies, there typically is no consideration paid or received by Ambac, and consequently has no impact on the above described gain or loss calculation. For investment securities owned by Ambac that are debt instruments issued by the VIE, the investment securities balance is eliminated upon consolidation. Ambac did not consolidate any VIEs solely as a result of purchases of the VIE’s debt instruments for any of the periods presented.
As of September 30, 2016 , consolidated VIE assets and liabilities relating to 13 consolidated entities were $14,385,229 and $14,238,493 , respectively. As of December 31, 2015 , consolidated VIE assets and liabilities relating to 13 consolidated entities were $14,288,497 and


| Ambac Financial Group, Inc. 12 2016 Third Quarter FORM 10-Q |



$14,259,776 , respectively. As of September 30, 2016 and December 31, 2015 , eight and seven consolidated VIEs related to transaction insured by Ambac UK and Ambac Assurance, respectively. As of September 30, 2016 VIE assets and liabilities of $13,939,377 and $13,813,682 and as of December 31, 2015 , VIE assets and liabilities of $13,769,985 and $13,636,628 related to transactions guaranteed by Ambac UK. The remaining balance of consolidated VIE assets and liabilities are related to transactions guaranteed by Ambac Assurance. Ambac is not primarily liable for, and generally does not guarantee all of the debt obligations issued by the VIEs. Ambac would only be required to make payments on the VIE debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due and such obligation is guaranteed by Ambac. Additionally, Ambac’s general creditors, other than those specific policy holders which own the VIE debt obligations, do not have rights with regard to the assets of the VIEs. Ambac evaluates the net income effects and earnings per share effects to determine attributions between Ambac and non-controlling interests as a result of consolidating a VIE. Ambac has determined that the net income and earnings per share effect of most consolidated VIEs are attributable to Ambac’s interests through financial guarantee premium and loss payments with the VIE.
The financial reports of certain VIEs are prepared by outside trustees and are not available within the time constraints Ambac requires to ensure the financial accuracy of the operating results. As such, the financial results of certain VIEs are consolidated on a time lag that is no longer than 90 days.
The table below provides the fair value of fixed income securities, by asset-type, held by consolidated VIEs as of September 30, 2016 and December 31, 2015
 
September 30,
2016
 
December 31,
2015
Investments:
 
 
 
Corporate obligations
$
2,828,685

 
$
2,588,556

Total variable interest entity assets: fixed income securities
$
2,828,685

 
$
2,588,556

The following table provides supplemental information about the loans held as assets and long-term debt associated with the VIEs for which the fair value option has been elected as of September 30, 2016 and December 31, 2015 :
 
Estimated fair value
 
Unpaid principal balance
September 30, 2016:
 
 
 
Loans
$
11,476,766

 
$
8,058,125

Long-term debt
11,930,434

 
9,327,859

December 31, 2015:
 
 
 
Loans
$
11,690,324

 
$
9,182,284

Long-term debt
12,327,960

 
10,803,729

For the nine months ended September 30, 2016 , Ambac did not consolidate or deconsolidate any VIEs. For the three months ended September 30, 2015 , Ambac deconsolidated one VIE as a result of the termination of the associated financial guarantee policy. There was a gain of $572 reported in Income (loss) on variable interest entities on the Consolidated Statement of Total Comprehensive Income (loss). For the nine months ended September 30, 2015 , Ambac deconsolidated two VIEs; one as a result of the termination of the associated financial guarantee policy and one as a result of the associated financial guarantee maturing. There was a gain of $572 reported in Income (loss) on variable interest entities on the Consolidated Statement of Total Comprehensive Income (Loss) for the nine months ended September 30, 2015 .
Variable Interests in Non-Consolidated VIEs
On August 28, 2014, Ambac monetized its ownership of the junior surplus note issued to it by the Segregated Account by depositing the junior surplus note into a newly formed VIE trust in exchange for cash and an owner trust certificate, which represents Ambac's right to residual cash flows from the junior surplus note. Ambac does not consolidate the VIE. Ambac reports its interest in the VIE as an equity investment within Other investments on the Consolidated Balance Sheets with associated results from operations included within Net investment income: Other investments on the Consolidated Statements of Total Comprehensive Income (Loss). The equity investment had a carrying value of $28,810 and $25,339 as of September 30, 2016 and December 31, 2015 .


| Ambac Financial Group, Inc. 13 2016 Third Quarter FORM 10-Q |



The following table displays the carrying amount of the assets, liabilities and maximum exposure to loss of Ambac’s variable interests in non-consolidated VIEs resulting from financial guarantee and derivative contracts by major underlying asset classes, as of September 30, 2016 and December 31, 2015 :
 
Carrying Value of Assets and Liabilities
 
Maximum
Exposure
To Loss
(1)
 
Insurance
Assets
(2)
 
Insurance
Liabilities
(3)
 
Net Derivative
Assets (Liabilities) 
(4)
September 30, 2016:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
845,991

 
$
231

 
$
3,400

 
$
(184,838
)
Mortgage-backed—residential
15,412,198

 
744,303

 
3,040,292

 

Other consumer asset-backed
2,419,657

 
27,943

 
289,372

 

Other commercial asset-backed
1,768,494

 
71,686

 
68,884

 

Other
3,073,443

 
72,461

 
430,985

 
15,430

Total global structured finance
23,519,783

 
916,624

 
3,832,933

 
(169,408
)
Global public finance
26,485,274

 
354,769

 
380,103

 
(9,220
)
Total
$
50,005,057

 
$
1,271,393

 
$
4,213,036

 
$
(178,628
)
 
 
 
 
 
 
 
 
December 31, 2015:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
980,935

 
$
264

 
$
3,639

 
$
(129,525
)
Mortgage-backed—residential
17,081,002

 
1,279,650

 
2,680,739

 

Other consumer asset-backed
3,853,443

 
47,346

 
535,090

 

Other commercial asset-backed
2,393,805

 
104,033

 
94,191

 

Other
3,286,568

 
81,017

 
461,364

 
15,410

Total global structured finance
27,595,753

 
1,512,310

 
3,775,023

 
(114,115
)
Global public finance
28,586,582

 
377,412

 
427,299

 
(24,860
)
Total
$
56,182,335

 
$
1,889,722

 
$
4,202,322

 
$
(138,975
)
(1)
Maximum exposure to loss represents the maximum future payments of principal and interest on insured obligations and derivative contracts plus Deferred Amounts and accrued and unpaid interest thereon. Ambac’s maximum exposure to loss does not include the benefit of any financial instruments (such as reinsurance or hedge contracts) that Ambac may utilize to mitigate the risks associated with these variable interests.
(2)
Insurance assets represent the amount recorded in “Premium receivables” and “Subrogation recoverable” for financial guarantee contracts on Ambac’s Consolidated Balance Sheets.
(3)
Insurance liabilities represent the amount recorded in “Loss and loss expense reserves” and “Unearned premiums” for financial guarantee contracts on Ambac’s Consolidated Balance Sheets.
(4)
Net derivative assets (liabilities) represent the fair value recognized on credit derivative contracts and interest rate swaps on Ambac’s Consolidated Balance Sheets.


| Ambac Financial Group, Inc. 14 2016 Third Quarter FORM 10-Q |



4. COMPREHENSIVE INCOME
The following tables detail the changes in the balances of each component of accumulated other comprehensive income for the affected periods:
 
Unrealized Gains
(Losses) on
Available for
Sale Securities
(1)
 
Amortization of
Postretirement
Benefit
(1)
 
Gain (Loss) on
Foreign Currency
Translation
(1)
 
Total
Three Months Ended September 30, 2016:
 
 
 
 
 
 
 
Beginning Balance
$
158,924

 
$
9,876

 
$
(118,025
)
 
$
50,775

Other comprehensive income before reclassifications
33,625

 

 
(13,323
)
 
20,302

Amounts reclassified from accumulated other comprehensive income
(8,906
)
 
(254
)
 

 
(9,160
)
Net current period other comprehensive income (loss)
24,719

 
(254
)
 
(13,323
)
 
11,142

Balance at September 30, 2016
$
183,643

 
$
9,622

 
$
(131,348
)
 
$
61,917

 
 
 
 
 
 
 
 
Three Months Ended September 30, 2015:
 
 
 
 
 
 
 
Beginning Balance
$
79,406

 
$
9,784

 
$
6,172

 
$
95,362

Other comprehensive income before reclassifications
1,342

 

 
(30,637
)
 
(29,295
)
Amounts reclassified from accumulated other comprehensive income
7,040

 
(220
)
 

 
6,820

Net current period other comprehensive income (loss)
8,382

 
(220
)
 
(30,637
)
 
(22,475
)
Balance at September 30, 2015
$
87,788

 
$
9,564

 
$
(24,465
)
 
$
72,887

 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016:
 
 
 
 
 
 
 
Beginning Balance
$
50,963

 
$
9,344

 
$
(45,092
)
 
$
15,215

Other comprehensive income before reclassifications
140,810

 

 
(86,256
)
 
54,554

Amounts reclassified from accumulated other comprehensive income
(8,130
)
 
278

 

 
(7,852
)
Net current period other comprehensive income (loss)
132,680

 
278

 
(86,256
)
 
46,702

Balance at September 30, 2016
$
183,643

 
$
9,622

 
$
(131,348
)
 
$
61,917

 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2015:
 
 
 
 
 
 
 
Beginning Balance
$
210,693

 
$
10,031

 
$
(441
)
 
$
220,283

Other comprehensive income before reclassifications
(85,313
)
 

 
(24,024
)
 
(109,337
)
Amounts reclassified from accumulated other comprehensive income
(37,592
)
 
(467
)
 

 
(38,059
)
Net current period other comprehensive income (loss)
(122,905
)
 
(467
)
 
(24,024
)
 
(147,396
)
Balance at September 30, 2015
$
87,788

 
$
9,564

 
$
(24,465
)
 
$
72,887

(1)
All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate debits.


| Ambac Financial Group, Inc. 15 2016 Third Quarter FORM 10-Q |



The following table details the significant amounts reclassified from each component of accumulated other comprehensive income, shown in the above rollforward tables, for the affected periods:
 
 
Amount Reclassified from Accumulated
Other Comprehensive Income
(1)
 
Affected Line Item in the
Details about Accumulated Other
 
Three Months Ended September 30,
 
Consolidated Statement of
Comprehensive Income Components
 
2016
 
2015
 
Total Comprehensive Income (Loss)
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
(8,906
)
 
$
7,040

 
Net realized investment (losses) gains and other-than-temporary impairment losses
 
 

 

 
Tax (expense) benefit
 
 
$
(8,906
)
 
$
7,040

 
Net of tax and noncontrolling interest 
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(167
)
 
$
(167
)
 
Operating expenses  (2)
Actuarial (losses)
 
(87
)
 
(53
)
 
Operating expenses  (2)
 
 
(254
)
 
(220
)
 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
$
(254
)
 
$
(220
)
 
Net of tax and noncontrolling interest 
Total reclassifications for the period
 
$
(9,160
)
 
$
6,820

 
Net of tax and noncontrolling interest 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
 
 
2016
 
2015
 
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
(8,130
)
 
$
(37,592
)
 
Net realized investment (losses) gains and other-than-temporary impairment losses
 
 

 

 
Tax (expense) benefit
 
 
$
(8,130
)
 
$
(37,592
)
 
Net of tax and noncontrolling interest 
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(500
)
 
$
(500
)
 
Operating expenses  (2)
Actuarial gains
 
778

 
33

 
Operating expenses  (2)
 
 
278

 
(467
)
 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
$
278

 
$
(467
)
 
Net of tax and noncontrolling interest 
Total reclassifications for the period
 
$
(7,852
)
 
$
(38,059
)
 
Net of tax and noncontrolling interest 
(1)
Amounts in parentheses indicate debits to the Consolidated Statement of Total Comprehensive Income (Loss).
(2)
These accumulated other comprehensive income components are included in the computation of net periodic benefit cost.
5. NET INCOME PER SHARE
On May 1, 2013, pursuant to the Second Modified Fifth Amended Plan of Reorganization of Ambac (the "Reorganization Plan"), 45,000,000 shares of new common stock at par value of $0.01 per share and 5,047,138 of warrants were issued. Warrants entitled such holders to acquire up to 5,047,138 shares of new common stock at an exercise price of $16.67 per share at any time on or prior to April 30, 2023 . For the nine months ended September 30, 2016 and 2015 , 136 and 740 warrants were exercised, respectively, resulting in an issuance of 136 and 236 shares of common stock, respectively.
On June 30, 2015, the Board of Directors of Ambac authorized the establishment of a warrant repurchase program that permits the repurchase of up to $10,000 of warrants. For the nine months ended September 30, 2016 , Ambac repurchased 291,082 warrants at a cost of $2,104 . As of September 30, 2016 , Ambac has repurchased 922,682 warrants totaling $7,478 , (average cost of $8.10 per warrant) leaving 4,116,319 warrants outstanding. On November 3, 2016, the Board of Directors of Ambac authorized a $10,000 increase to the warrant repurchase program, bringing the remaining aggregate authorization at September 30, 2016 to $12,550 .
Basic net income per share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding and vested restricted stock units. Diluted net income per share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares used for basic earnings per share plus all potential dilutive common shares outstanding during the period. All potential dilutive common shares outstanding consider common stock deliverable pursuant to warrants issued


| Ambac Financial Group, Inc. 16 2016 Third Quarter FORM 10-Q |



under the Reorganization Plan, vested and unvested options, unvested restricted stock units and performance stock units granted under employee and director compensation plans.
The following table provides a reconciliation of the common shares used for basic net income per share to the diluted shares used for diluted net income per share:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Basic weighted average shares outstanding
45,229,570

 
45,174,521

 
45,206,429

 
45,173,671

Effect of potential dilutive shares:
 
 
 
 
 
 
 
Warrants
293,311

 

 

 
1,154,313

Stock options

 

 

 
7,083

Restricted stock units
156,023

 

 
105,794

 
14,418

Performance stock units
113,179

 

 
60,481

 
2,729

Diluted weighted average shares outstanding
45,792,083

 
45,174,521

 
45,372,704

 
46,352,214

Antidilutive securities for the three and nine months ended September 30, 2016 included stock options to purchase 143,334 shares of common stock, where the exercise price was greater than the average market price and 23,334 restricted stock units.
For the three months ended September 30, 2015 , Ambac incurred net losses and accordingly excluded all potentially dilutive securities from the determination of diluted loss per share as their impact was antidilutive. Antidilutive securities for the three months ended September 30, 2015 included stock options and warrants to purchase 176,668 and 4,461,637 shares of common stock, respectively, where the exercise price was greater than the average market price. 78,460 restricted stock units and 96,349 performance stock units at their target amounts. Antidilutive securities for the nine months ended September 30, 2015 included stock options to purchase 110,000 shares of common stock where the exercise price was greater than the average market price.
6. FINANCIAL GUARANTEE INSURANCE CONTRACTS
Amounts presented in this Note relate only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE.
Net Premiums Earned:
Gross premiums are received either upfront (typical of public finance obligations) or in installments (typical of structured finance and international obligations). For premiums received upfront, an unearned premium revenue (“UPR”) liability is established, which is initially recorded as the cash amount received. For installment premium transactions, a premium receivable asset and offsetting UPR liability is initially established in an amount equal to: (i) the present value of future contractual premiums due (the “contractual” method) or (ii) if the assets underlying the insured obligation are homogenous pools which are contractually prepayable, the present value of premiums to be collected over the expected life of the transaction (the “expected” method). An appropriate risk-free rate corresponding to the weighted average life of each policy and currency is used to discount the future premiums contractually due or expected to be collected. For example, U.S. dollar exposures are discounted using U.S. Treasury rates while exposures denominated in a foreign currency are discounted using the appropriate risk-free rate for the respective currency. The weighted average risk-free rate at September 30, 2016 and December 31, 2015 , was 2.4% and 2.7% , respectively, and the weighted average period of future premiums used to estimate the premium receivable at September 30, 2016 and December 31, 2015 , was 9.1 years and 9.2 years, respectively.
Insured obligations consisting of homogeneous pools for which Ambac uses expected future premiums to estimate the premium receivable and UPR include residential mortgage-backed securities. As prepayment assumptions change for homogenous pool transactions, or if there is an actual prepayment for a “contractual” method installment transaction, the related premium receivable and UPR are adjusted in equal and offsetting amounts with no immediate effect on earnings using new premium cash flows and the then current risk-free rate.
Generally, the priority for the payment of financial guarantee premiums to Ambac, as required by bond indentures of insured structured finance obligations, is senior in the waterfall. Additionally, in connection with the allocation of certain liabilities to the Segregated Account, trustees and other parties are required under the Segregated Account Rehabilitation Plan and related court orders to continue to pay installment premiums, notwithstanding the Segregated Account Rehabilitation Proceedings. In evaluating the credit quality of the premium receivables, management evaluates the transaction waterfall structures and the internal ratings of the transactions underlying the premium receivables. Uncollectable premiums are determined on a policy basis and utilize a combination of historical premium collection data in addition to cash flow analysis to determine if an impairment in the related policy's premium receivables exist. As of September 30, 2016 and December 31, 2015 , approximately 26% and 27% of the premium receivables related to transactions with non-investment grade internal ratings, comprised mainly of non-investment grade RMBS, structured insurance, lease securitizations and student loan transactions, which comprised 8% , 6% , 4% , and 3% , of the total premium receivables at September 30, 2016 and 8% , 5% , 5% , and 5% of the total premium receivables at December 31, 2015 , respectively. At September 30, 2016 and December 31, 2015 , $10,976 and $15,240 respectively, of premium receivables were deemed uncollectable. Past due premiums on policies insuring non-investment grade obligations amounted to less than $500 at September 30, 2016 .


| Ambac Financial Group, Inc. 17 2016 Third Quarter FORM 10-Q |



Below is the gross premium receivable roll-forward for the affected periods:
 
 
Nine Months Ended September 30,
 
 
2016
 
2015
Beginning premium receivable
 
$
831,575

 
$
1,000,607

Premium receipts
 
(60,609
)
 
(70,940
)
Adjustments for changes in expected and contractual cash flows
 
(57,932
)
 
(39,613
)
Accretion of premium receivable discount
 
14,304

 
18,795

Changes to uncollectable premiums
 
4,264

 
1,978

Other adjustments (including foreign exchange)
 
(25,374
)
 
(15,381
)
Ending premium receivable  (1)
 
$
706,228

 
$
895,446

(1)
Gross premium receivable includes premiums to be received in foreign denominated currencies most notab ly in British Pounds and Euros. At September 30, 2016 and 2015 premium receivables include British Pounds of $195,187 ( £150,575 ) and $253,092 ( £167,367 ), respectively, and Euros of $38,284 ( €34,067 ) and $51,640 ( €46,251 ), respectively.
Similar to gross premiums, premiums ceded to reinsurers are paid either upfront or in installments. Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies.
When a bond issue insured by Ambac Assurance has been retired, including those retirements due to calls, any remaining UPR is recognized at that time to the extent the financial guarantee contract is legally extinguished, causing accelerated premium revenue. For installment premium paying transactions, the recognition of any remaining UPR is offset by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement), which may cause negative accelerated premium revenue. Ambac’s accelerated premium revenue for retired obligations for the three and nine months ended September 30, 2016 was $18,174 and $38,231 , and the three and nine months ended September 30, 2015 was $28,369 and $64,862 , respectively. Certain obligations insured by Ambac have been legally defeased whereby government securities are purchased by the issuer with the proceeds of a new bond issuance, or less frequently with other funds of the issuer, and held in escrow. The principal and interest received from the escrowed securities are then used to retire the Ambac-insured obligations at a future date either to their maturity date (a refunding) or a specified call date (a pre-refunding). Ambac has evaluated the provisions in policies issued on legally defeased obligations and determined those insurance policies have not been legally extinguished. For policies with refunding securities, premium revenue recognition is not impacted as the escrowed maturity date is the same as the previous legal maturity date. For policies with pre-refunding securities, the maturity date of the pre-refunded security has been shortened from its previous legal maturity. Although premium revenue recognition has not been accelerated in the period of the pre-refunding, it results in an increase in the rate at which the policy's remaining UPR is to be recognized.
The effect of reinsurance on premiums written and earned for the respective periods was as follows:
 
Three Months Ended September 30,
 
2016
 
2015
 
Written
 
Earned
 
Written
 
Earned
Direct
$
(10,543
)
 
$
59,096

 
$
(8,710
)
 
$
77,982

Assumed

 
21

 

 
22

Ceded
(1,526
)
 
5,899

 
(105
)
 
6,469

Net premiums
$
(9,017
)
 
$
53,218

 
$
(8,605
)
 
$
71,535

 
Nine Months Ended September 30,
 
2016
 
2015
 
Written
 
Earned
 
Written
 
Earned
Direct
$
(39,364
)
 
$
161,058

 
$
(18,840
)
 
$
214,787

Assumed

 
64

 

 
66

Ceded
(8,425
)
 
13,702

 
(882
)
 
16,721

Net premiums
$
(30,939
)
 
$
147,420

 
$
(17,958
)
 
$
198,132



| Ambac Financial Group, Inc. 18 2016 Third Quarter FORM 10-Q |



The table below summarizes the future gross undiscounted premiums to be collected and future premiums earned, net of reinsurance at September 30, 2016 :
 
Future premiums
to be collected
(1)
 
Future
premiums to
be earned net of
reinsurance
(1)
Three months ended:
 
 
 
December 31, 2016
$
17,213

 
$
29,942

Twelve months ended:
 
 
 
December 31, 2017
67,650

 
96,399

December 31, 2018
63,131

 
77,484

December 31, 2019
59,548

 
71,357

December 31, 2020
56,542

 
67,017

Five years ended:
 
 
 
December 31, 2025
231,529

 
269,853

December 31, 2030
186,809

 
186,311

December 31, 2035
121,623

 
109,372

December 31, 2040
41,618

 
40,087

December 31, 2045
18,852

 
17,219

December 31, 2050
7,151

 
7,785

December 31, 2055
601

 
1,298

Total
$
872,267

 
$
974,124

(1)
Future premiums to be collected are undiscounted and are used to derive the discounted premium receivable asset recorded on Ambac's balance sheet. Future premiums to be earned, net of reinsurance relate to the unearned premiums liability and deferred ceded premium asset recorded on Ambac’s balance sheet. The use of contractual lives for many bond types which do not have homogeneous pools of underlying collateral is required in the calculation of the premium receivable, as further described in Note 2. Basis of Presentation and Significant Accounting Principles in the Notes to Consolidated Financial Statements included in Ambac's Annual Report on Form 10-K/A for the year ended December 31, 2015 . This results in a different premium receivable balance than if expected lives were considered. If installment paying policies are retired or prepay early, premiums reflected in the premium receivable asset and amounts reported in the above table for such policies may not be collected. Future premiums to be earned also considers the use of contractual lives for many bond types which do not have homogeneous pools of underlying collateral, which may result in different unearned premium than if expected lives were considered. If those bonds types are retired early, premium earnings may be negative in the period of call or refinancing.
Loss and Loss Expense Reserves:
The loss and loss expense reserve (“loss reserve”) policy for financial guarantee insurance relates only to Ambac’s non-derivative insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. A loss reserve is recorded on the balance sheet on a policy-by-policy basis. Loss reserve components of an insurance policy include unpaid claims and the present value ("PV") of expected net cash flows required to be paid under an insurance contract, further described below:
Unpaid claims represent the sum of (i) claims presented and not yet paid for policies allocated to the Segregated Account, including Deferred Amounts and (ii) accrued interest on Deferred Amounts as required by the amended Segregated Account Rehabilitation Plan that became effective on June 12, 2014. Refer to Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in Ambac's Annual Report on Form 10-K/A for further discussion of the amended Segregated Account Rehabilitation Plan. Unpaid claims are measured based on the cost of settling the claims, which is principal plus accrued interest.
The PV of expected net cash flows represents the PV of expected cash outflows less the PV of expected cash inflows. The PV of expected net cash flows are impacted by: (i) expected future claims to be paid under an insurance contract, including the impact of potential settlement outcomes upon future installment premiums, (ii) expected recoveries from contractual breaches of RMBS representations and warranties by transaction sponsors, (iii) excess spread within the underlying transaction's cash flow structure, and (iv) other subrogation recoveries. Expected receipts from third parties within the underlying transaction's cash flow structure relating to contractual breaches in non-RMBS securitizations may also reduce expected future claims. Ambac’s approach to resolving disputes involving contractual breaches by transaction sponsors or other third parties has included negotiations and/or pursuing litigation. Ambac does not include potential recoveries attributed solely to fraudulent inducement claims in our estimate of subrogation recoveries, since any remedies under such claims would be non-contractual.
Net cash outflow policies represent contracts where the sum of unpaid claims plus the PV of expected cash outflows are greater than the PV of expected cash inflows. For such policies, a “Loss and loss expense reserves” liability is recorded for the sum of: (i) unpaid claims plus (ii) the excess of the PV of expected net cash outflows over the unearned premium revenue. Net cash inflow policies represent contracts where losses have been paid, but not yet recovered, such that the PV of expected cash inflows are greater than the sum of unpaid claims plus the PV of expected


| Ambac Financial Group, Inc. 19 2016 Third Quarter FORM 10-Q |



cash outflows. For such policies, a “Subrogation recoverable” asset is recorded for the difference between (i) the PV of expected net cash inflows and (ii) unpaid claims.
The approaches used to estimate expected future claims and expected future recoveries considers the likelihood of all possible outcomes. The evaluation process for determining expected losses is subject to certain estimates and judgments based on our assumptions regarding the probability of default by the issuer of the insured security, probability of settlement outcomes (which may include commutation settlements, refinancing and/or other settlement outcomes) and expected severity of credits for each insurance contract. Ambac’s loss reserves are based on management’s on-going review of the financial guarantee credit portfolio. Below are the components of the Loss and loss expense reserves liability and the Subrogation recoverable asset at September 30, 2016 and December 31, 2015 :
 
Unpaid Claims
 
Present Value of Expected
Net Cash Flows
 
 
 
 
Balance Sheet Line Item
Claims
 
Accrued
Interest
 
Claims and
Loss Expenses
 
Recoveries
 
Unearned
Premium
Revenue
 
Gross Loss and
Loss Expense
Reserves
September 30, 2016:
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense reserves
$
2,392,674

 
$
490,099

 
$
2,772,357

 
$
(1,290,553
)
 
$
(157,042
)
 
$
4,207,535

Subrogation recoverable
616,987

 
127,810

 
96,406

 
(1,544,824
)
 

 
(703,621
)
Totals
$
3,009,661

 
$
617,909

 
$
2,868,763

 
$
(2,835,377
)
 
$
(157,042
)
 
$
3,503,914

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015:
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense reserves
$
2,138,952

 
$
349,668

 
$
3,265,349

 
$
(1,476,276
)
 
$
(189,587
)
 
$
4,088,10