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 March 31, 2017
¨
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, smaller reporting company or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”and"emerging growth company" in Rule 12b-2 of the Exchange Act): (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected nto to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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 May 5, 2017 , 45,228,945 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.     Unaudited Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
 
March 31,
 
December 31,
(Dollars in thousands, except share data) (March 31, 2017 (Unaudited))
2017
 
2016
Assets:
 
 
 
Investments:
 
 
 
Fixed income securities, at fair value (amortized cost of $5,303,723 and $5,435,385)
$
5,443,999

 
$
5,554,215

Fixed income securities pledged as collateral, at fair value (amortized cost of $64,889 and $64,833)
64,908

 
64,905

Short-term investments, at fair value (amortized cost of $347,152 and $430,827)
347,055

 
430,788

Other investments (includes $447,487 and $420,304 at fair value)
478,688

 
450,307

Total investments
6,334,650

 
6,500,215

Cash and cash equivalents
118,772

 
91,025

Receivable for securities
2,815

 
2,090

Investment income due and accrued
27,288

 
26,023

Premium receivables
652,677

 
661,337

Reinsurance recoverable on paid and unpaid losses
34,273

 
30,418

Deferred ceded premium
63,336

 
69,624

Subrogation recoverable
679,974

 
684,731

Loans
4,237

 
4,160

Derivative assets
74,397

 
77,742

Insurance intangible asset
931,159

 
962,080

Other assets
77,294

 
158,423

Variable interest entity assets:
 
 
 
Fixed income securities, at fair value
2,663,719

 
2,622,566

Restricted cash
5,005

 
4,873

Loans, at fair value
11,015,305

 
10,658,963

Derivative assets
75,459

 
80,407

Other assets
3,200

 
1,025

Total assets
$
22,763,560

 
$
22,635,702

Liabilities and Stockholders’ Equity:
 
 
 
Liabilities:
 
 
 
Unearned premiums
$
924,686

 
$
967,258

Loss and loss expense reserves
4,510,329

 
4,380,769

Ceded premiums payable
40,201

 
42,529

Obligations under investment agreements

 
82,358

Deferred taxes
1,746

 
1,720

Current taxes
25,936

 
14,280

Long-term debt
1,015,526

 
1,114,405

Accrued interest payable
396,924

 
421,975

Derivative liabilities
244,235

 
319,286

Other liabilities
67,881

 
76,589

Payable for securities purchased
15,983

 
1,084

Variable interest entity liabilities:
 
 
 
Accrued interest payable
3,006

 
859

Long-term debt, at fair value
11,564,054

 
11,155,936

Derivative liabilities
2,064,105

 
2,078,601

Other liabilities
32

 
29

Total liabilities
20,874,644

 
20,657,678

Commitments and contingencies (See Note 11)
 
 
 
Stockholders’ equity:
 
 
 
Preferred stock, par value $0.01 per share; 20,000,000 shares authorized shares; issued and outstanding shares—none

 

Common stock, par value $0.01 per share; 130,000,000 shares authorized; issued and outstanding shares: 45,275,982 and 45,194,954
453

 
452

Additional paid-in capital
196,788

 
195,267

Accumulated other comprehensive income (loss)
(2,775
)
 
(38,990
)
Retained earnings
1,431,397

 
1,557,681

Treasury stock, shares at cost: 47,037 and 22,458
(1,057
)
 
(496
)
Total Ambac Financial Group, Inc. stockholders’ equity
1,624,806

 
1,713,914

Noncontrolling interest
264,110

 
264,110

Total stockholders’ equity
1,888,916

 
1,978,024

Total liabilities and stockholders’ equity
$
22,763,560

 
$
22,635,702

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 1 2017 First Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Total Comprehensive Income (Loss) (Unaudited)
 
 
Three Months Ended March 31,
(Dollars in thousands, except share data)
 
2017
 
2016
Revenues:
 
 
 
 
Net premiums earned
 
$
47,613

 
$
52,800

Net investment income:
 
 
 
 
Securities available-for-sale and short-term
 
73,150

 
57,982

Other investments
 
8,409

 
2,839

Total net investment income
 
81,559

 
60,821

Other-than-temporary impairment losses:
 
 
 
 
Total other-than-temporary impairment losses
 
(21,154
)
 
(48,070
)
Portion of other-than-temporary impairment recognized in other comprehensive income
 
17,212

 
38,736

Net other-than-temporary impairment losses recognized in earnings
 
(3,942
)
 
(9,334
)
Net realized investment gains (losses)
 
(4,896
)
 
1,102

Change in fair value of credit derivatives:
 
 
 
 
Realized gains and other settlements
 
199

 
252

Unrealized gains (losses)
 
853

 
12,614

Net change in fair value of credit derivatives
 
1,052

 
12,866

Net gains (losses) on interest rate derivatives
 
(1,514
)
 
(83,424
)
Net realized gains (losses) on extinguishment of debt
 
2,741

 
1,235

Other income (expense)
 
(86
)
 
7,999

Income (loss) on variable interest entities
 
3,701

 
(27,163
)
Total revenues
 
126,228

 
16,902

Expenses:
 
 
 
 
Losses and loss expenses (benefit)
 
135,011

 
(105,281
)
Insurance intangible amortization
 
37,525

 
50,890

Operating expenses
 
27,980

 
28,009

Interest expense
 
31,572

 
30,430

Total expenses
 
232,088

 
4,048

Pre-tax income (loss)
 
(105,860
)
 
12,854

Provision for income taxes
 
19,581

 
3,439

Net income (loss)
 
(125,441
)
 
9,415

Less: net gain (loss) attributable to noncontrolling interest
 

 

Net income (loss) attributable to common shareholders
 
$
(125,441
)
 
$
9,415

Other comprehensive income (loss), after tax:
 
 
 
 
Net income (loss)
 
$
(125,441
)
 
$
9,415

Unrealized gains (losses) on securities, net of deferred income taxes of $0
 
21,335

 
59,791

Gains (losses) on foreign currency translation, net of deferred income taxes of $0
 
12,593

 
(17,781
)
Changes to postretirement benefit, net of tax of $0
 
2,287

 
787

Total other comprehensive income (loss), net of tax
 
36,215

 
42,797

Total comprehensive income (loss) attributable to Ambac Financial Group, Inc.
 
$
(89,226
)
 
$
52,212

Net income (loss) per share attributable to Ambac Financial Group, Inc. common stockholders
 
 
 
 
Basic
 
$
(2.77
)
 
$
0.21

Diluted
 
$
(2.77
)
 
$
0.21

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 2 2017 First 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, 2017
$
1,978,024

 
$
1,557,681

 
$
(38,990
)
 
$

 
$
452

 
$
195,267

 
$
(496
)
 
$
264,110

Total comprehensive income
(89,226
)
 
(125,441
)
 
36,215

 

 

 

 

 

Adjustment to initially apply ASU 2016-09
(137
)
 
(137
)
 

 

 

 

 

 

Stock-based compensation
1,521

 

 

 

 

 
1,521

 

 

Cost of shares (acquired) issued under equity plan
(1,267
)
 
(706
)
 

 

 

 

 
(561
)
 

Balance at March 31, 2017
$
1,888,916

 
$
1,431,397

 
$
(2,775
)
 
$

 
$
453

 
$
196,788

 
$
(1,057
)
 
$
264,110

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2016
$
1,958,346

 
$
1,478,439

 
$
15,215

 
$

 
$
450

 
$
190,813

 
$
(118
)
 
$
273,547

Total comprehensive income
52,212

 
9,415

 
42,797

 

 

 

 

 

Adjustment to initially apply ASU 2014-13

 
6,442

 

 

 

 

 

 
(6,442
)
Stock-based compensation
1,082

 

 

 

 

 
1,082

 

 

Cost of shares (acquired) issued under equity plan
(9
)
 
(115
)
 

 

 

 

 
106

 

Balance at March 31, 2016
$
2,011,631

 
$
1,494,181

 
$
58,012

 
$

 
$
450

 
$
191,895

 
$
(12
)
 
$
267,105

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 3 2017 First Quarter FORM 10-Q |



AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
 
 
Three Months Ended March 31,
(Dollars in thousands)
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income (loss)
 
$
(125,441
)
 
$
9,415

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
270

 
303

Amortization of bond premium and discount
 
(36,178
)
 
(26,336
)
Share-based compensation
 
1,521

 
1,082

Deferred income taxes
 
26

 
(446
)
Current income taxes
 
11,550

 
(2,479
)
Unearned premiums, net
 
(36,272
)
 
(77,229
)
Losses and loss expenses, net
 
131,188

 
800,823

Ceded premiums payable
 
(2,328
)
 
(6,156
)
Investment income due and accrued
 
(1,250
)
 
(124
)
Premium receivables
 
8,630

 
49,507

Accrued interest payable
 
4,866

 
16,152

Amortization of insurance intangible assets
 
37,525

 
50,890

Net mark-to-market (gains) losses
 
(853
)
 
(12,614
)
Net realized investment gains
 
4,896

 
(1,102
)
Other-than-temporary impairment charges
 
3,942

 
9,334

(Gain) loss on extinguishment of debt
 
(2,741
)
 
(1,235
)
Variable interest entity activities
 
(3,701
)
 
27,163

Other, net
 
1,704

 
(8,872
)
Net cash provided by (used in) operating activities
 
(2,646
)
 
828,076

Cash flows from investing activities:
 
 
 
 
Proceeds from sales of bonds
 
305,541

 
136,175

Proceeds from matured bonds
 
227,741

 
297,619

Purchases of bonds
 
(439,473
)
 
(1,002,314
)
Proceeds from sales of other invested assets
 
121,353

 
3,061

Purchases of other invested assets
 
(139,561
)
 
(15,690
)
Change in short-term investments
 
83,550

 
(211,036
)
Loans, net
 
(77
)
 
97

Change in cash collateral receivable
 
9,615

 
(29,788
)
Other, net
 
(1,112
)
 
8,001

Net cash provided by (used in) investing activities
 
167,577

 
(813,875
)
Cash flows from financing activities:
 
 
 
 
Paydowns of a secured borrowing
 
(10,355
)
 
(8,871
)
Payments for investment agreement draws
 
(82,358
)
 

Payments for extinguishment of long-term debt
 
(43,666
)
 
(11,453
)
Tax payments related to shares withheld for share-based compensation plans
 
(1,268
)
 
(10
)
Net cash used in financing activities
 
(137,647
)
 
(20,334
)
Effect of foreign exchange on cash and cash equivalents
 
463

 
(469
)
Net cash flow
 
27,747

 
(6,602
)
Cash and cash equivalents at beginning of period
 
91,025

 
35,744

Cash and cash equivalents end of period
 
$
118,772

 
$
29,142

 
 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
Income taxes
 
$
8,295

 
$
6,477

Interest on long-term debt and investment agreements
 
28,791

 
7,995

Non-cash financing activities:
 
 
 
 
Decrease in long-term debt as a result of an exchange for investment securities
 
$
55,426

 
$

See accompanying Notes to Unaudited Consolidated Financial Statements


| Ambac Financial Group, Inc. 4 2017 First 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 last remaining investment agreement matured in March 2017. The Financial Services business also maintains interest rate derivatives to mitigate interest rate risk in the insured and investment portfolios of 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 transaction terminations, policy commutations, settlements and restructurings that we believe will improve our risk profile, 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's and its subsidiaries' capital and liability structures, enabling simplification of corporate governance and facilitating the successful rehabilitation of the Segregated Account (as defined below); 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 March 31, 2017 for policies allocated to the Segregated Account was $11,274,275 . 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


| Ambac Financial Group, Inc. 5 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

costs and expenses of the Segregated Account are reimbursable by Ambac Assurance pursuant to the Cooperation Agreement, dated as of March 24, 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 March 31, 2017 , Ambac Assurance’s surplus as regards to policyholders 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 the possibility of entering into, and may seek to enter into, one or more transactions to improve the financial condition of Ambac Assurance which may, subject to OCI approval, lead to the conclusion of the Segregated Account Rehabilitation Proceedings. In pursuing this objective, Ambac Assurance may seek to monetize certain assets, restructure, purchase, modify or exchange certain outstanding obligations, extinguish or modify certain contractual restrictions, and/or commute or reduce insured exposures, and is also discussing with OCI potential options for addressing outstanding Segregated Account and other obligations. Separately from or in connection with any such transaction we may seek to further optimize our capital and corporate structure to unlock shareholder value.
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, Ambac Assurance has discussed, and is currently actively engaged in discussions, with counterparty creditors and OCI concerning a potential transaction pursuant to which outstanding Deferred Amounts and surplus notes, in each case including accrued interest, would be exchanged for or satisfied with cash, securities, or other instruments, assets or means. No assurance can be given that an agreement with respect to any such potential transaction will be reached or consummated.
On April 10, 2017, the Rehabilitator issued a statement indicating that the Special Deputy Commissioner ("SDC") has engaged in discussions with Ambac Assurance, policy beneficiaries, and other stakeholders to advance the goal of achieving a durable exit from Rehabilitation by the Segregated Account and, as a result, the SDC has recommended to the Rehabilitator that Ambac Assurance be allowed to further engage with stakeholders in an effort to reach a comprehensive consensual agreement for a durable plan of exit from Rehabilitation by the Segregated Account. According to the statement, the Rehabilitator agreed with such recommendation, recognizing that any such plan is subject to further review and that it will need to be approved by the Rehabilitator as well as the Rehabilitation Court. In his April 10th statement, the Rehabilitator also indicated that if a consensual plan acceptable to the Rehabilitator is not developed within sixty days from that time, the Rehabilitator may pursue a plan that he believes will provide for a durable exit and that is protective of policyholders. OCI has not specified a course of action to address Segregated Account or other obligations or to conclude the Segregated Account Rehabilitation Proceedings.
The Rehabilitator further indicated in the April 10, 2017 statement that he and the SDC are supportive of Ambac Assurance’s efforts to continue, over sixty days from that time, to work diligently to reach an agreement for a durable plan which will enable the Segregated Account to exit from Rehabilitation. The SDC is continuing to monitor this process closely and the Rehabilitator reserves the right to take all actions allowed or required under applicable law with respect to the Segregated Account, including the pursuit of the Rehabilitator's own aforementioned exit plan.
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 within the timeframe allowed by OCI, or if it is, as to the ultimate timing, terms or conditions of any such transaction, or as to whether it could lead to the conclusion of the Segregated Account Rehabilitation Proceedings. Any such transaction would remain subject to the prior approval of the board of Ambac Assurance, OCI and the Rehabilitation Court and may require third party consents, which may not be obtained. OCI retains the authority, subject to the approval of the Rehabilitation Court, to address Segregated Account obligations without the agreement of Ambac Assurance or its board of directors. Moreover, even if the Segregated Account Rehabilitation Proceedings could be brought to a successful conclusion, there can be no assurance that any level of capital deemed sufficient by OCI to permit such conclusion will be sufficient to cover all future losses, whether currently anticipated or unanticipated.
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


| Ambac Financial Group, Inc. 6 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

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 months ended March 31, 2017 and the year ended December 31, 2016 , 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.
Ballantyne Litigation
On March 25, 2017, Ambac UK agreed in principle to a confidential settlement of litigation brought by Ambac UK in the name of Ballantyne Re plc ("Ballantyne") against J.P. Morgan Investment Management Inc. ("JPMIM") relating to the management of Ballantyne’s investment accounts, which were funded with the proceeds of notes issued in 2006 in connection with a structured reinsurance transaction and guaranteed in part by Ambac UK. On April 11, 2017, Ambac UK, Ballantyne and JPMIM signed a settlement agreement. Pursuant to the settlement, Ballantyne received a payment of $325,600 from JPMIM in return for releases of all claims by Ballantyne and Ambac UK. As a result of the settlement, Ambac recognized an incremental benefit through a reduction losses and loss expenses of approximately $91,600 in the first quarter of 2017. The full benefit was partially offset by approximately $18,300 of losses related to other changes in assumptions, resulting in a net benefit of approximately $73,300 . Ambac had previously included an estimated benefit through a reduction of loss and loss expense reserves of approximately $53,000 related to our probability weighted estimate of the value of the litigation. The total $144,600 benefit recognized from the settlement of the litigation will reduce the ultimate Ballantyne claims Ambac UK is expecting to pay and not result in a direct cash payment to Ambac UK.
Puerto Rico
On March 13, 2017, the Financial Management and Oversight Board for Puerto Rico (the "Oversight Board") certified the 10-year Fiscal and Economic Growth Plan ("FEGP") for the Commonwealth of Puerto Rico (the “Commonwealth"). The certified FEGP, among other things, was intended to provide Commonwealth creditors a base from which to progress consensual negotiations under Title VI of the P uerto Rico Oversight, Management and Economic Stability Act ("PROMESA"). However, the certified FEGP implied a 77% discount to all debt service due to be paid by the Commonwealth and its instrumentalities covered by the FEGP over the ten-years of the plan (FY2017-2026). The FEGP did not provide details regarding its underlying assumptions and data, expense definitions, cause of expense growth or accounting adjustments and did not include any restructuring proposals. These deficiencies of the FEGP, when combined with the absence of sufficient projected cash flows for debt service, increased the uncertainty of whether successful consensual negotiations can be reached.
On April 28, 2017, the Fiscal Agency and Financial Advisory Authority of Puerto Rico (“FAFAA”) released a restructuring proposal covering General Obligation (“GO”), GO‐guaranteed, Puerto Rico Sales Tax Financing Corporations ("COFINA"), Puerto Rico Highway and Transportation Authority ("HTA"), Puerto Rico Infrastructure Financing Authority ("PRIFA") and Puerto Rico Convention Center District Authority ("CCDA") bonds. Under the proposal, bondholders would receive a “senior bond” based on amounts expected to be available for debt service under the FEGP and a “cash flow bond” that would allow for additional payments if amounts available for debt service exceeded FEGP forecasts. FAFAA’s proposal further provides that GO and GO‐guaranteed bondholders would receive a maximum recovery of 77% (52% senior bond, 25% cash flow bond), COFINA bondholders would receive a maximum recovery of 58% (39% senior bond, 19% cash flow bond), and HTA, CCDA, PRIFA, and Metropolitan Bus Authority bondholders would receive a maximum recovery of 30% (0% senior bond, 30% cash flow bond). Recoveries relating to the cash flow bond component could be lower depending upon future surpluses at the General Fund and future new money GO bond issuances. The proposal was premised only on the cash available for debt service included in the certified FEGP, despite challenges from creditors and repeated calls for a review and adjustment of the assumptions underlying such Plan. Among other infirmities, the proposal lacks any textured narrative or economic or financial logic for treating Senior and Junior tranches within the COFINA structure as pari passu obligations and fails to explain how the allocation of cashflow between GO and GO‐guaranteed bonds and COFINA bonds was derived. The proposal was summarily rejected by affected bondholders.

On April 29, 2017, the Commonwealth enacted the Fiscal Plan Compliance Act, also known as Act No. 26 (the “Fiscal Plan Compliance Act” or “Act 26-2017”). Articles 4.01 and 4.02 of Chapter 4 of the Fiscal Plan Compliance Act order all public corporations, agencies and instrumentalities of the Government of Puerto Rico to transfer their revenue surplus to the Commonwealth Treasury, after covering operational expenses and obligations, as per the expense budget recommended by the Office of Management and Budget of Puerto Rico for each fiscal year. Article 4.01 further states that such funds would be considered “available resources” for the Commonwealth and would be deposited in the Commonwealth’s General Fund to meet the liquidity requirements contemplated in the FEGP. Article 4.02 empowers a committee composed of the Executive Director of the Fiscal Agency and Financial Advisory Authority of Puerto Rico, the Secretary of the Puerto Rico Treasury Department and the Executive Director of the Office of Management and Budget of Puerto Rico to determine the amount each public corporation and instrumentality would contribute. Such committee is also empowered to revise the sources of revenue of the public corporations, agencies and instrumentalities and adjust, increase or reduce any of their charges, fees, tariffs and similar revenues, with the objective of complying with the metrics stated in the FEGP.



| Ambac Financial Group, Inc. 7 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

Article 4.03 of Chapter 4 of Act 26-2017, “Exclusions”, explicitly excludes certain entities from coverage of Articles 4.01 and 4.02, including the University of Puerto Rico, the Public Corporation for the Supervision and Insurance of Cooperatives (COSSEC), and funds from public corporations and entities received by private entities for community-related objectives.

While Article 4.03 does not explicitly exclude COFINA from coverage of such Articles 4.01 and 4.02, as it does with other entities, it does state that the Executive Branch shall be authorized to use the COFINA funds, occasionally, solely as a last alternative, and subject to the filing of a sworn certification before the Legislative Assembly. Such sworn certification, which, according to Article 4.03 shall not be interpreted to give the Executive Branch indefinite use of the COFINA funds, must establish the need, term and amount of funds that will be used to cover significant occasional cash flow deficits to comply with the FEGP. An Explicative Declaration of Act 26-2017 signed by the Governor of Puerto Rico on April 29, 2017, however, states that because COFINA does not generate surpluses, the dispositions of Chapter 4 are not applicable to COFINA. Moreover, the Explicative Declaration states that the Fiscal Plan Compliance Act does not refer to other revenues from public corporations except for those determined by fee adjustments of the corporations specifically included in the FEGP. Given that the statements in the Explicative Declaration seem to contradict the statutory language of Articles 4.01, 4.02 and 4.03, it is not clear how some of the provisions of Fiscal Plan Compliance Act will be implemented.

In its Chapter 6, the Fiscal Plan Compliance Act also requires that, commencing July 1, 2017, all special funds and other revenues of dependencies and public corporations must be deposited with the Puerto Rico Treasury. The Puerto Rico Secretary of Treasury is authorized to establish the order of priority for the disbursement of payments chargeable to the special funds and other revenues, in accordance with the approved budget and the Fiscal Plan.

On May 1, 2017, Ambac Assurance sent COFINA a notice of failures to comply with covenants and events of default under COFINA’s bond resolution and enabling legislation. Among other things, Ambac Assurance stated that the Commonwealth had violated its covenant not to interfere with COFINA’s ability to meet its obligations to its bondholders by enacting the Fiscal Plan Compliance Act; that COFINA had violated its covenant to defend, preserve, and protect the COFINA structure and the rights of COFINA’s bondholders; and that both covenant violations were incurable and therefore constituted immediate Events of Default under the COFINA resolution. Also on May 1, 2017, the COFINA trustee, Bank of New York Mellon (“BNY”), sent a letter to COFINA and the Puerto Rico Fiscal Agency and Financial Advisory Authority stating that the Fiscal Plan Compliance Act was inconsistent with COFINA’s and the Commonwealth’s covenants under COFINA’s resolution and enabling legislation, and seeking a response detailing any curative action either intended to take. On May 4, 2017, BNY sent COFINA a notice of default arising out of the Fiscal Plan Compliance Act, and stated that the defaults by COFINA and the Commonwealth would be deemed Events of Default under the COFINA resolution if left uncured within 30 days of Ambac’s May 1, 2017 letter noticing the defaults. Later on May 4, 2017, Ambac Assurance, together with certain holders of senior COFINA bonds, sent a letter to BNY demanding immediate acceleration of all senior bonds issued by COFINA.
In response to letter requests from Governor Rossello, the Oversight Board commenced a Title III proceeding for the Commonwealth of Puerto Rico on May 3, 2017 and for COFINA on May 5, 2017. It is currently unclear which additional Commonwealth entities and instrumentalities, if any, will pursue a plan of adjustment of their debts under Title III or continue to pursue consensual debt restructuring pursuant to Title VI of PROMESA. As part of the Title III filings for the Commonwealth and COFINA, the Oversight Board noted that the Oversight Board and the Commonwealth intend to continue pursuing consensual negotiations under the protection of the Title III automatic stay. No assurances can be given that consensual resolutions will be achieved with respect to the Commonwealth’s or COFINA’s obligations or those of any other Puerto Rico instrumentality. In addition, given that the Title III filings are the first two under PROMESA, Ambac is uncertain how the Title III process will be implemented and to what extent the rights of Ambac Assurance will be respected as part of that process.
Ambac Assurance is party to seven litigations related to its Puerto Rico exposures, including two litigations challenging the constitutionality and legality of the FEGP and the Fiscal Plan Compliance Act, discussed below under Note 11. Commitments and Contingencies .” Ambac Assurance filed several of those cases to protect and assert its rights under transaction documents and applicable law. Ambac Assurance has also intervened in the Lex Claims litigation to defend the COFINA structure against a challenge by certain GO bondholders. Some or all of the claims asserted in the cases against the Commonwealth or its officials or instrumentalities may be stayed under Title III of PROMESA. Accordingly, Ambac is unable to predict when and how the issues raised in those cases will be resolved. If we are unsuccessful with any of these challenges, Ambac’s financial condition, including liquidity, loss reserves and capital resources may suffer a material negative impact.
Ambac has considered these developments and other factors in evaluating its Puerto Rico loss reserves. Primarily as a result of the continued uncertainty and volatility of the situation in Puerto Rico, Ambac incurred through losses and loss expenses a $169,400 expense associated with its Public Finance insured portfolio in the three months ended March 31, 2017 . The majority of this incurred expense is attributable to increasing reserves for potential future losses, including estimated payments to commute certain exposures and expenses associated with mitigating and remediating such potential losses. While management believes its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance that Ambac may not incur additional losses in the future, particularly given the developing economic, political, and legal circumstances in Puerto Rico. Such additional losses may have a material adverse effect on Ambac’s results of operations and financial condition. For public finance credits, including Puerto Rico as well as other issuers, for which Ambac has an estimate of expected loss at March 31, 2017, the possible increase in loss reserves under stress or other adverse conditions and circumstances was estimated to be approximately $1.6 billion . However, there can be no assurance that losses may not exceed such amount.


| Ambac Financial Group, Inc. 8 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company has disclosed its significant accounting policies in Note 2. Basis of Presentation and Significant Accounting Policies in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 . The following significant accounting policies provide an update to those included in the Company’s Annual Report on Form 10-K.
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 for the year ended December 31, 2016 . 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 months ended March 31, 2017 may not be indicative of the results that may be expected for the year ending December 31, 2017 . The December 31, 2016 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.
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 (Loss) 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 $6,465 and $(6,241) for the three months ended March 31, 2017 and 2016 . 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 $5,827 and $(10,081) for the three months ended March 31, 2017 and 2016 , 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 $1,916 and $2,783 for the three months ended March 31, 2017 and 2016 , respectively;
Remeasurement of premium receivables, classified in Other income, in the amount of $(560) and $2,709 for the three months ended March 31, 2017 and 2016 , respectively;
Remeasurement of credit derivative liabilities, classified in Net change in fair value of credit derivative, in the amount of $(706) and $(1,024) for the three months ended March 31, 2017 and 2016 , respectively; and
Remeasurement of cash held, classified in Other income, in the amount of $(12) and $(628) for the three months ended March 31, 2017 and 2016 , respectively.
Reclassifications:
Certain reclassifications may have been made to prior years' amounts to conform to the current year's presentation.
Recently Adopted Accounting Standards:
Effective January 1, 2017, Ambac adopted the following accounting standards:


| Ambac Financial Group, Inc. 9 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

Consolidation of Variable Interest Entities - Decision Makers
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 previous 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. Adoption of this ASU did not have an impact on Ambac's financial statements.
Improvements to Employee Share-Based Payment Accounting
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) for purposes of accruing compensation costs, allowing companies to make an accounting policy election to either: a) estimate forfeitures or b) account for forfeitures as they occur, which Ambac elected to do upon adoption, (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. Adoption of this ASU did not have a material impact on Ambac's financial statements.
Equity Method of Accounting
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. Adoption of this ASU did not have an impact on Ambac's financial statements.
Contingent Put and Call Options in Debt Instruments
In March 2016, the FASB issued ASU 2016-06, Derivatives and Hedging (Topic 815) - Contingent Put and Call Options in Debt Instruments . Previous accounting rules required 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. Adoption of this ASU did not have an impact on Ambac's financial statements.
Future Application of Accounting Standards:
Premium Amortization on Callable Debt Securities
In March 2017, the FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20) - Premium Amortization on Purchased Callable Debt Securities . The ASU shortens the amortization period for the premium on callable debt securities to the earliest call date. Under current GAAP, a reporting entity generally amortizes the premium as yield adjustment over the contractual life (i.e. maturity) of the debt security and if that debt security is called, the entity would record a loss equal to the unamortized premium. The ASU does not change the accounting for callable debt securities held at a discount, which will continue to be amortized to maturity. ASU 2017-08 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The ASU must be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We have not determined whether Ambac will early adopt this ASU and are evaluating the impact on Ambac's financial statements.
Net Periodic Pension and Postretirement Costs
In March 2017, the FASB issued ASU 2017-07, Compensation-Retirement Benefits (Topic 715) - Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost . The objective of the ASU is to increase transparency in the reporting of net pension cost and net postretirement cost (collectively "net benefit cost"). The ASU requires that the service cost component of net benefit cost be reported on the same line item as other compensation costs arising from services rendered by employees. It further requires that the other components of net benefit costs (i.e. interest costs, amortization of prior service cost, etc.) be presented separately from the service cost component and outside the subtotal of income from operations, if one is presented. ASU 2017-09 is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, with early adoption permitted. Ambac will adopt this ASU on January 1, 2018. The adoption of this ASU is not expected to have a consequential impact on Ambac's financial statements.



| Ambac Financial Group, Inc. 10 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

3. SPECIAL PURPOSE ENTITIES, INCLUDING VARIABLE INTEREST ENTITIES
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 ("FG VIEs").
Ambac sponsors special purpose entities that issued medium-term notes to fund the purchase of certain financial assets.
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 is 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.
FG VIEs:
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 FG 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 FG 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 that most significantly impact the VIE’s economic performance because certain triggers had been breached in these transactions resulting in Ambac's subsidiaries' 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 existing VIEs involving Ambac financial guarantees, Ambac is generally 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 FG VIEs that are consolidated are reported within Variable interest entity assets or Variable interest entity liabilities on the Consolidated Balance Sheets. The net results from such FG VIEs are reported within Income (loss) on variable interest entities in the Consolidated Statements of Total Comprehensive Income (Loss).
Upon initial consolidation of a FG VIE, we recognize a gain or loss in earnings for the difference between: (i) the fair value of the consideration paid, 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 FG VIE, we recognize a gain or loss for the difference between: (i) the fair value of any consideration received, 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 impact of consolidating such FG VIEs on Ambac’s balance sheet is the elimination of transactions between the consolidated FG VIEs and Ambac’s operating subsidiaries and the inclusion of the FG 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


| Ambac Financial Group, Inc. 11 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

payable and insurance intangible assets. For investment securities owned by Ambac that are debt instruments issued by the VIE, the investment securities balance is eliminated upon consolidation.
As of March 31, 2017 consolidated FG VIE assets and liabilities relating to 12 consolidated entities were $13,762,688 and $13,631,197 , respectively. As of December 31, 2016 , consolidated FG VIE assets and liabilities relating to 12 consolidated entities were $13,367,834 and $13,235,425 , respectively. As of March 31, 2017 , eight and four consolidated FG VIEs related to transaction insured by Ambac UK and Ambac Assurance and eight and four as of December 31, 2016 . As of March 31, 2017 , FG VIE assets and liabilities of $13,362,738 and $13,244,407 and as of December 31, 2016 , FG VIE assets and liabilities of $12,950,009 and $12,833,466 related to transactions guaranteed by Ambac UK. The remaining balance of consolidated FG 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 FG VIEs are attributable to Ambac’s interests through financial guarantee premium and loss payments with the VIE.
Below is a schedule detailing the change in fair value of the various financial instruments within the consolidated FG VIEs, along with gains (losses) from consolidating and deconsolidating FG VIEs, that together comprise Income (loss) on variable interest entities for for the affected periods:
Three Months Ended March 31,
 
2017
 
2016
Income (loss) on changes related to:
 
 
 
 
Net fair value of VIE assets and liabilities
 
$
3,701

 
$
(27,163
)
Consolidation / Deconsolidation
 

 

Income (loss) on Variable Interest Entities
 
$
3,701

 
$
(27,163
)
Ambac consolidated zero and deconsolidated zero VIEs for the three months ended March 31, 2017 and 2016 .
The table below provides the fair value of fixed income securities, by asset-type, held by consolidated VIEs as of March 31, 2017 and December 31, 2016 :
 
March 31,
2017
 
December 31,
2016
Investments:
 
 
 
Corporate obligations
$
2,663,719

 
$
2,622,566

Total variable interest entity assets: fixed income securities
$
2,663,719

 
$
2,622,566

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 March 31, 2017 and December 31, 2016 :
 
Estimated fair value
 
Unpaid principal balance
March 31, 2017:
 
 
 
Loans
$
11,015,305

 
$
7,726,235

Long-term debt
11,564,054

 
8,960,947

December 31, 2016:
 
 
 
Loans
$
10,658,963

 
$
7,641,756

Long-term debt
11,155,936

 
8,854,530

Ambac Sponsored VIEs:
A subsidiary of Ambac transferred financial assets to a special purpose entity. The business purpose of this entity was to provide certain financial guarantee clients with funding for their debt obligations. This special purpose entity was established as a separate legal entity, demonstrably distinct from Ambac and that Ambac, its affiliates or its agents could not unilaterally dissolve. The permitted activities of this entity was contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchases, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. Ambac has not consolidated this entity because Ambac Assurance’s policies issued to this entity were allocated to the Segregated Account, thereby limiting Ambac’s control over the entity's most significant economic activities. Ambac has elected to account for its equity interest in this entity at fair value under the fair value option in accordance with the Financial


| Ambac Financial Group, Inc. 12 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

Instruments Topic of the ASC. We believe that the fair value of the investments in this entity 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 this entity. At March 31, 2017 and December 31, 2016 the fair value of this entity was $7,039 and $7,382 , respectively, and is reported within Other assets on the Consolidated Balance Sheets.
Total principal amount of debt outstanding was $395,490 and $388,950 at March 31, 2017 and December 31, 2016 , respectively. In each case, Ambac sold assets to this entity. The assets are composed of utility obligations with a weighted average rating of BBB+ at March 31, 2017 and weighted average life of 4.9 years . The purchase by this entity 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 entity for economic hedging purposes only. Derivative positions were established at the time MTNs were issued to purchase financial assets. As of March 31, 2017 Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the entity.
Insurance premiums paid to Ambac Assurance by this entity is 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). 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 secured by and entitling the Issuer to 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 $92,311 and $102,403 as of March 31, 2017 and December 31, 2016 , respectively, and is reported in Long-Term Debt on the Consolidated Balance Sheets.
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 $31,201 and $30,003 as of March 31, 2017 and December 31, 2016 , respectively.


| Ambac Financial Group, Inc. 13 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

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 March 31, 2017 and December 31, 2016 :
 
Carrying Value of Assets and Liabilities
 
Maximum
Exposure
To Loss
(1)
 
Insurance
Assets
(2)
 
Insurance
Liabilities
(3)
 
Net Derivative
Assets (Liabilities) 
(4)
March 31, 2017:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
719,106

 
$
202

 
$
3,236

 
$
(147,064
)
Mortgage-backed—residential
14,325,870

 
717,384

 
3,151,852

 

Other consumer asset-backed
2,366,997

 
26,376

 
304,839

 

Other commercial asset-backed
1,599,921

 
62,885

 
63,865

 

Other
2,960,327

 
62,761

 
342,402

 
11,262

Total global structured finance
21,972,221

 
869,608

 
3,866,194

 
(135,802
)
Global public finance
25,512,967

 
343,033

 
362,261

 
(9,075
)
Total
$
47,485,188

 
$
1,212,641

 
$
4,228,455

 
$
(144,877
)
 
 
 
 
 
 
 
 
December 31, 2016:
 
 
 
 
 
 
 
Global structured finance:
 
 
 
 
 
 
 
Collateralized debt obligations
$
761,451

 
$
218

 
$
3,319

 
$
(145,402
)
Mortgage-backed—residential
14,859,909

 
725,106

 
3,118,892

 

Other consumer asset-backed
2,391,604

 
26,758

 
302,335

 

Other commercial asset-backed
1,686,256

 
66,277

 
64,961

 

Other
2,963,521

 
66,091

 
412,929

 
13,347

Total global structured finance
22,662,741

 
884,450

 
3,902,436

 
(132,055
)
Global public finance
25,608,471

 
338,587

 
359,142

 
(8,827
)
Total
$
48,271,212

 
$
1,223,037

 
$
4,261,578

 
$
(140,882
)
(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 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

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 March 31, 2017:
 
 
 
 
 
 
 
Beginning Balance
$
118,863

 
$
9,367

 
$
(167,220
)
 
$
(38,990
)
Other comprehensive income before reclassifications
12,500

 

 
12,593

 
25,093

Amounts reclassified from accumulated other comprehensive income
8,835

 
2,287

 

 
11,122

Net current period other comprehensive income (loss)
21,335

 
2,287

 
12,593

 
36,215

Balance at March 31, 2017
$
140,198

 
$
11,654

 
$
(154,627
)
 
$
(2,775
)
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2016:
 
 
 
 
 
 
 
Beginning Balance
$
50,963

 
$
9,344

 
$
(45,092
)
 
$
15,215

Other comprehensive income before reclassifications
51,562

 

 
(17,781
)
 
33,781

Amounts reclassified from accumulated other comprehensive income
8,229

 
787

 

 
9,016

Net current period other comprehensive income (loss)
59,791

 
787

 
(17,781
)
 
42,797

Balance at March 31, 2016
$
110,754

 
$
10,131

 
$
(62,873
)
 
$
58,012

(1)
All amounts are net of tax and noncontrolling interest. Amounts in parentheses indicate debits.
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:
Details about Accumulated Other
Comprehensive Income Components
 
Amount Reclassified from Accumulated
Other Comprehensive Income
(1)
 
Affected Line Item in the
Consolidated Statement of
Total Comprehensive Income (Loss)
 
Three Months Ended March 31,
 
 
2017
 
2016
 
Unrealized Gains (Losses) on Available-for-Sale Securities
 
 
 
 
 
 
 
 
$
8,835

 
$
8,229

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

 

 
Tax (expense) benefit
 
 
$
8,835

 
$
8,229

 
Net of tax and noncontrolling interest 
Amortization of Postretirement Benefit
 
 
 
 
 
 
Prior service cost
 
$
(241
)
 
$
(166
)
 
Operating expenses  (2)
Actuarial (losses)
 
2,528

 
953

 
Operating expenses  (2)
 
 
2,287

 
787

 
Total before tax
 
 

 

 
Tax (expense) benefit
 
 
2,287

 
787

 
Net of tax and noncontrolling interest 
Total reclassifications for the period
 
$
11,122

 
$
9,016

 
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 three months ended March 31, 2017 and 2016 , 0 and 0 warrants were exercised, respectively, resulting in an issuance of 0 and 0 shares of common stock, respectively.


| Ambac Financial Group, Inc. 15 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

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 three months ended March 31, 2017 , Ambac repurchased 0 warrants at a cost of $0 . As of March 31, 2017 , Ambac has repurchased 985,331 warrants totaling $8,092 , (average cost of $8.21 per warrant) leaving 4,053,670 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 March 31, 2017 to $11,939 .
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 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 March 31,
 
 
2017
 
2016
Basic weighted average shares outstanding
 
45,292,253

 
45,176,978

Effect of potential dilutive shares (1) :
 
 
 
 
Restricted stock units
 

 
56,902

Performance stock units
 

 
10,117

Diluted weighted average shares outstanding
 
45,292,253

 
45,243,997

Anti-dilutive shares excluded from the above reconciliation:
 
 
 
 
Stock options
 
126.667

 
176,668

Warrants
 
4,053,670

 
4,407,537

Restricted stock units
 
94.204

 
51,992

Performance stock units (2)
 
342.456

 
263,988

(1)
For the three months ended March 31, 2017 , Ambac incurred net losses and accordingly excluded all potentially dilutive securities from the determination of diluted loss per share as their impact was antidilutive.
(2)
Performance stock units are reflected herein at their target issuance amounts. Vesting of these units are contingent upon meeting certain performance metrics. Although a portion of these performance metrics have been achieved as of the respective period end, it is possible that awards may no longer meet the metric at the end of the performance period.
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 or in installments. 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 March 31, 2017 and December 31, 2016 , was 2.6% and 2.6% , respectively, and the weighted average period of future premiums used to estimate the premium receivable at March 31, 2017 and December 31, 2016 , was 9.3 years and 9.0 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.
In structured finance transactions, the priority for the payment of financial guarantee premiums to Ambac, as required by bond indentures of insured structured finance obligations, is generally 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


| Ambac Financial Group, Inc. 16 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

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 March 31, 2017 and December 31, 2016 , approximately 22% and 25% 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 7% , 5% , 3% and 3% , of the total premium receivables at March 31, 2017 and 8% , 5% , 4% and 3% of the total premium receivables at December 31, 2016 , respectively. At March 31, 2017 and December 31, 2016 , $9,198 and $9,186 respectively, of premium receivables were deemed uncollectable. Past due premiums on policies insuring non-investment grade obligations amounted to less than $500 at March 31, 2017 .
Below is the gross premium receivable roll-forward for the affected periods:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Beginning premium receivable
 
$
661,337

 
$
831,575

Premium receipts
 
(17,978
)
 
(21,377
)
Adjustments for changes in expected and contractual cash flows
 
1,352

 
(35,029
)
Accretion of premium receivable discount
 
4,244

 
5,123

Changes to uncollectable premiums
 
(12
)
 
5,126

Other adjustments (including foreign exchange)
 
3,734

 
(3,340
)
Ending premium receivable  (1)
 
$
652,677

 
$
782,078

(1)
Gross premium receivable includes premiums to be received in foreign denominated currencies most notab ly in British Pounds and Euros. At March 31, 2017 and 2016 , premium receivables include British Pounds of $185,204 ( £147,726 ) and $220,662 ( £153,536 ), respectively, and Euros of $34,908 ( €32,671 ) and $47,245 ( €41,487 ), 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 early, typically due to an issuer call, 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, we offset the recognition of any remaining UPR 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 months ended March 31, 2017 and 2016 was $16,280 and $14,976 , 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 these 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 March 31, 2017
 
2017
 
2016
 
Written
 
Earned
 
Written
 
Earned
Direct
$
5,584

 
$
52,065

 
$
(24,780
)
 
$
56,990

Assumed

 
21

 

 
21

Ceded
(1,815
)
 
4,473

 
(6,045
)
 
4,211

Net premiums
$
7,399

 
$
47,613

 
$
(18,735
)
 
$
52,800



| Ambac Financial Group, Inc. 17 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

The table below summarizes the future gross undiscounted premiums to be collected and future premiums earned, net of reinsurance at March 31, 2017 :
 
Future premiums
to be collected
(1)
 
Future
premiums to
be earned net of
reinsurance
(1)
Three months ended:
 
 
 
June 30, 2017
$
15,490

 
$
26,449

September 30, 2017
16,958

 
23,676

December 31, 2017
14,583

 
20,442

Twelve months ended:
 
 
 
December 31, 2018
61,045

 
73,108

December 31, 2019
57,574

 
66,576

December 31, 2020
54,725

 
62,413

December 31, 2021
48,636

 
57,214

Five years ended:
 
 
 
December 31, 2026
215,417

 
233,977

December 31, 2031
172,005

 
157,264

December 31, 2036
101,505

 
88,021

December 31, 2041
35,221

 
30,593

December 31, 2046
16,921

 
14,783

December 31, 2051
5,250

 
6,148

December 31, 2056
239

 
686

Total
$
815,569

 
$
861,350

(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 Policies in the Notes to Consolidated Financial Statements included in Ambac's Annual Report on Form 10-K for the year ended December 31, 2016 . 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 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.


| Ambac Financial Group, Inc. 18 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

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 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 material 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 March 31, 2017 and December 31, 2016 :
 
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
March 31, 2017:
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense reserves
$
2,406,397

 
$
565,369

 
$
2,862,877

 
$
(1,182,839
)
 
$
(141,475
)
 
$
4,510,329

Subrogation recoverable
581,979

 
140,242

 
44,638

 
(1,446,833
)
 

 
(679,974
)
Totals
$
2,988,376

 
$
705,611

 
$
2,907,515

 
$
(2,629,672
)
 
$
(141,475
)
 
$
3,830,355

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016:
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense reserves
$
2,411,105

 
$
529,703

 
$
2,681,198

 
$
(1,098,096
)
 
$
(143,141
)
 
$
4,380,769

Subrogation recoverable
583,042

 
132,139

 
68,419

 
(1,468,331
)
 

 
(684,731
)
Totals
$
2,994,147

 
$
661,842

 
$
2,749,617

 
$
(2,566,427
)
 
$
(143,141
)
 
$
3,696,038

Below is the loss and loss expense reserve roll-forward, net of subrogation recoverable and reinsurance, for the affected periods:
 
Three Months Ended March 31,
 
2017
 
2016
Beginning gross loss and loss expense reserves
$
3,696,038

 
$
2,858,813

Reinsurance recoverable
30,767

 
44,059

Beginning balance of net loss and loss expense reserves
3,665,271

 
2,814,754

Losses and loss expenses (benefit):
 
 
 
Current year
1,543

 
768

Prior year
133,468

 
(106,049
)
Total (1) (2)
135,011

 
(105,281
)
Loss and loss expenses (recovered) paid:
 
 
 
Current year
696

 

Prior year
9,749

 
(916,206
)
Total
10,445

 
(916,206
)
Foreign exchange effect
5,827

 
(10,081
)
Ending net loss and loss expense reserves
3,795,664

 
3,615,598

Reinsurance recoverable (3)
34,691

 
27,478

Ending gross loss and loss expense reserves  (4)
$
3,830,355

 
$
3,643,076

(1)
Total losses and loss expenses (benefit) incurred includes $4,112 and $9,454 for the three months ended March 31, 2017 and 2016 , respectively, related to ceded reinsurance.
(2)
Ambac records the impact of estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties within losses and loss expenses (benefit). The losses and loss expense (benefit) incurred associated with changes in estimated representation and warranties for the three months ended March 31, 2017 and 2016 was $13,797 and $(20,319) , respectively.


| Ambac Financial Group, Inc. 19 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

(3)
Represents reinsurance recoverable on future loss and loss expenses. Additionally, the Balance Sheet line "Reinsurance recoverable on paid and unpaid losses" includes reinsurance recoverables (payables) of $(418) and $(162) as of March 31, 2017 and 2016 , respectively, related to previously presented loss and loss expenses and subrogation.
(4)
Includes Euro denominated gross loss and loss expense reserves of $20,984 ( €19,639 ) and $22,321 ( €19,600 ) at March 31, 2017 and 2016 , respectively.
For 2017 , the net negative development was primarily the result of negative development in certain public finance transactions and interest accrued on Deferred Amounts partially offset by positive development in certain Ambac UK transactions.
For 2016 , the net positive development was primarily the result of the impact of commutations in the student loan portfolio and reduced future claims for the RMBS portfolio partially offset by negative development in certain public finance and Ambac UK transactions and interest accrued on Deferred Amounts.
The tables below summarize information related to policies currently included in Ambac’s loss and loss expense reserves or subrogation recoverable at March 31, 2017 and December 31, 2016 . Gross par exposures include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bond. The weighted average risk-free rate used to discount loss reserves at March 31, 2017 and December 31, 2016 was 2.6% and 2.7% , respectively.
Surveillance Categories as of March 31, 2017
 
I/SL
 
IA
 
II
 
III
 
IV
 
V
 
Total
Number of policies
19

 
20

 
35

 
46

 
166

 
3

 
289

Remaining weighted-average contract period (in years) (1)
11

 
6

 
13

 
21

 
13

 
5

 
16

Gross insured contractual payments outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
Principal
$
925,810

 
$
345,593

 
$
1,656,293

 
$
2,588,384

 
$
7,581,597

 
$
49,247

 
$
13,146,924

Interest
334,340

 
74,931

 
738,349

 
7,631,485

 
2,291,449

 
14,182

 
11,084,736

Total
$
1,260,150

 
$
420,524

 
$
2,394,642

 
$
10,219,869

 
$
9,873,046

 
$
63,429

 
$
24,231,660

Gross undiscounted claim liability (2)
$
4,038

 
$
1,463

 
$
87,521

 
$
1,440,449

 
$
6,127,145

 
$
63,429

 
$
7,724,045

Discount, gross claim liability
(410
)
 
(86
)
 
(19,176
)
 
(525,964
)
 
(656,494
)
 
(5,515
)
 
(1,207,645
)
Gross claim liability before all subrogation and before reinsurance
3,628

 
1,377

 
68,345

 
914,485

 
5,470,651

 
57,914

 
6,516,400

Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross RMBS subrogation  (3)
$

 
$

 
$

 
$

 
$
(1,912,844
)
 
$

 
$
(1,912,844
)
Discount, RMBS subrogation

 

 

 

 
19,870

 

 
19,870

Discounted RMBS subrogation, before reinsurance

 

 

 

 
(1,892,974
)
 

 
(1,892,974
)
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross other subrogation  (4)

 

 
(17,848
)
 
(161,545
)
 
(630,230
)
 
(12,842
)
 
(822,465
)
Discount, other subrogation

 

 
8,826

 
14,160

 
59,010

 
3,771

 
85,767

Discounted other subrogation, before reinsurance

 

 
(9,022
)
 
(147,385
)
 
(571,220
)
 
(9,071
)
 
(736,698
)
Gross claim liability, net of all subrogation and discounts, before reinsurance
3,628

 
1,377

 
59,323

 
767,100

 
3,006,457

 
48,843

 
3,886,728

Less: Unearned premium revenue
(2,324
)
 
(625
)
 
(18,733
)
 
(62,228
)
 
(57,199
)
 
(366
)
 
(141,475
)
Plus: Loss expense reserves
10,013

 
203

 
521

 
16,206

 
58,159

 

 
85,102

Gross loss and loss expense reserves
$
11,317

 
$
955

 
$
41,111

 
$
721,078

 
$
3,007,417

 
$
48,477

 
$
3,830,355

Reinsurance recoverable reported on Balance Sheet (5)
$
150

 
$
3

 
$
8,865

 
$
42,314

 
$
(17,059
)
 
$

 
$
34,273

 
(1)
Remaining weighted-average contract period is weighted based on projected gross claims over the lives of the respective policies.
(2)
Gross undiscounted claim liability includes unpaid claims, including accrued interest on Deferred Amounts, on policies allocated to the Segregated Account and Ambac's estimate of expected future claims.
(3)
RMBS subrogation represents Ambac’s estimate of subrogation recoveries from RMBS transaction sponsors for representation and warranty ("R&W") breaches.
(4)
Other subrogation represents subrogation related to excess spread and other contractual cash flows on public finance and structured finance transactions, including RMBS.


| Ambac Financial Group, Inc. 20 2017 First Quarter FORM 10-Q |

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
(Dollar Amounts in Thousands, Except Share Amounts)

(5)
Reinsurance recoverable reported on Balance Sheet includes reinsurance recoverables of $34,691 related to future loss and loss expenses and $(418) related to presented loss and loss expenses and subrogation.