8. INVESTMENTS

Ambac’s invested assets are primarily comprised of fixed income securities classified as available-for-sale. Beginning the first quarter of 2013, Ambac’s long-term portfolio also included equity interests in pooled investment funds. Such equity interests in the form of common stock or in-substance common stock are classified as trading securities. Equity interests in pooled funds organized as limited liability companies are recorded under the fair value option. Investments classified either as trading or fair value option securities are reported as Other investments on the Consolidated Balance Sheet at fair value with changes in fair value reported through Net investment income on the Statement of Comprehensive Income. Ambac’s investments in pooled funds as of March 31, 2013 are part of the company’s long-term financial guarantee investment strategy. These investments are accumulating funds, meaning that regular distributions of earnings are not anticipated but will be reflected in the NAV reported by the respective fund managers. These securities have been classified as trading or fair value option securities so that undistributed earnings of the funds may be reflected in Net investment income as they occur.

The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments, at March 31, 2013 and December 31, 2012 were as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Non-credit other- than-temporary Impairments⁽¹⁾
March 31, 2013
Fixed income securities:
Municipal obligations	$	1,606,136	$	188,861	$	642	$	1,794,355	$	—
Corporate obligations		986,866		89,231		7,024		1,069,073		—
Foreign obligations		10,796		1,082		—		11,878		—
U.S. government obligations		96,526		1,786		—		98,312		—
U.S. agency obligations		51,255		2,720		—		53,975		—
Residential mortgage-backed securities		1,085,177		466,111		14,399		1,536,889		6,590
Collateralized debt obligations		26,598		983		224		27,357		—
Other asset-backed securities		793,742		61,285		44,576		810,451		—

		4,657,096		812,059		66,865		5,402,290		6,590
Short-term		767,919		13		—		767,932		—

		5,425,015		812,072		66,865		6,170,222		6,590

Fixed income securities pledged as collateral:
U.S. government obligations		228,066		162		—		228,228		—

Total collateralized investments		228,066		162		—		228,228		—

Total available-for-sale investments	$	5,653,081	$	812,234	$	66,865	$	6,398,450	$	6,590

December 31, 2012
Fixed income securities:
Municipal obligations	$	1,662,124	$	187,191	$	383	$	1,848,932	$	—
Corporate obligations		999,554		87,535		9,117		1,077,972		—
Foreign obligations		67,347		2,765		—		70,112		—
U.S. government obligations		127,037		872		626		127,283		—
U.S. agency obligations		79,295		3,240		—		82,535		—
Residential mortgage-backed securities		1,096,202		379,935		20,555		1,455,582		6,892
Collateralized debt obligations		32,855		1,015		528		33,342		—
Other asset-backed securities		687,410		65,733		46,506		706,637		—

		4,751,824		728,286		77,715		5,402,395		6,892
Short-term		661,219		439		—		661,658		—

		5,413,043		728,725		77,715		6,064,053		6,892

Fixed income securities pledged as collateral:
U.S. government obligations		265,517		262		—		265,779		—

Total collateralized investments		265,517		262		—		265,779		—

Total available-for-sale investments	$	5,678,560	$	728,987	$	77,715	$	6,329,832	$	6,892

(1)	Represents the amount of non-credit other-than-temporary impairment losses remaining in accumulated other comprehensive loss on securities that also had a credit impairment. These losses are included in gross unrealized losses as of March 31, 2013 and December 31, 2012.

The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments, at March 31, 2013, by contractual maturity, were as follows:


	Amortized Cost		Estimated Fair Value
Due in one year or less	$	906,835	$	910,005
Due after one year through five years		916,863		979,204
Due after five years through ten years		1,035,633		1,156,493
Due after ten years		888,233		978,051

		3,747,564		4,023,753
Residential mortgage-backed securities		1,085,177		1,536,889
Collateralized debt obligations		26,598		27,357
Other asset-backed securities		793,742		810,451

	$	5,653,081	$	6,398,450

Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Unrealized Losses:

The following table shows gross unrealized losses and fair values of Ambac’s available-for-sale investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at March 31, 2013 and December 31, 2012:


	Less Than 12 Months				12 Months or More				Total
	Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss
March 31, 2013:
Fixed income securities:
Municipal obligations	$	42,336	$	627	$	3,958	$	15	$	46,294	$	642
Corporate obligations		16,506		156		85,494		6,868		102,000		7,024
U.S. government obligations		—		—		—		—		—		—
Residential mortgage-backed securities		43,511		4,071		111,909		10,328		155,420		14,399
Collateralized debt obligations		860		152		3,905		72		4,765		224
Other asset-backed securities		118,080		150		149,809		44,426		267,889		44,576

		221,293		5,156		355,075		61,709		576,368		66,865
Short-term		2,003		—		—		—		2,003		—

Total temporarily impaired securities	$	223,296	$	5,156	$	355,075	$	61,709	$	578,371	$	66,865

December 31, 2012:
Fixed income securities:
Municipal obligations	$	42,503	$	354	$	4,303	$	29	$	46,806	$	383
Corporate obligations		69,727		1,081		132,916		8,036		202,643		9,117
U.S. government obligations		26,081		626		—		—		26,081		626
Residential mortgage-backed securities		88,504		5,319		116,146		15,236		204,650		20,555
Collateralized debt obligations		253		168		13,429		360		13,682		528
Other asset-backed securities		180		3		188,832		46,503		189,012		46,506

		227,248		7,551		455,626		70,164		682,874		77,715
Short-term		1,194		—		—		—		1,194		—

Total temporarily impaired securities	$	228,442	$	7,551	$	455,626	$	70,164	$	684,068	$	77,715

Management has determined that the unrealized losses reflected in the tables above are temporary in nature as of March 31, 2013 and December 31, 2012 based upon (i) no unexpected principal and interest payment defaults on these securities; (ii) analysis of the creditworthiness of the issuer and financial guarantor, as applicable, and analysis of projected defaults on the underlying collateral; (iii) management has no intent to sell these investments in debt securities; and (iv) it is not more likely than not that Ambac will be required to sell these debt securities before the anticipated recovery of its amortized cost basis. The assessment under (iv) is based on a comparison of future available liquidity from the investment portfolio against the projected net cash outflow from operating activities and debt service. For purposes of this assessment, available liquidity from the investment portfolio is comprised of the fair value of securities for which management has asserted its intent to sell plus the scheduled maturities and interest payments from the remaining securities in the portfolio. To the extent that securities that management intends to sell are in an unrealized loss position, they would have already been considered other-than-temporarily impaired with the amortized cost written down to fair value. As of March 31, 2013 and December 31, 2012, management has not asserted an intent to sell any securities in an unrealized loss position. Because the above-described assessment indicates that future available liquidity exceeds projected net cash outflow, it is not more likely than not that we would be required to sell securities before the recovery of their amortized cost basis. In the liquidity assessment described above, principal payments on securities pledged as collateral are not considered to be available for other liquidity needs until the collateralized positions are projected to be settled. Projected interest receipts on securities pledged as collateral generally belong to Ambac and are considered to be sources of available liquidity from the investment portfolio. As of March 31, 2013, for securities that have indications of possible other-than-temporary impairment but which management does not intend to sell and will not more likely than not be required to sell, management compared the present value of cash flows expected to be collected to the amortized cost basis of the securities to assess whether the amortized cost will be recovered. Cash flows were discounted at the effective interest rate implicit in the security at the date of acquisition or for debt securities that are beneficial interests in securitized financial assets, at a rate equal to the current yield used to accrete the beneficial interest. For floating rate securities, future cash flows and the discount rate used were both adjusted to reflect changes in the index rate applicable to each security as of the evaluation date. Of the securities that were in a gross unrealized loss position at March 31, 2013, $143,145 of the total fair value and $38,994 of the unrealized loss related to below investment grade securities and non-rated securities. Of the securities that were in a gross unrealized loss position at December 31, 2012, $192,190 of the total fair value and $43,934 of the unrealized loss related to below investment grade securities and non-rated securities. With respect to Ambac-wrapped securities guaranteed under policies that have been allocated to the Segregated Account, future cash flows used to measure credit impairment represents the sum of (i) the bond’s intrinsic cash flows and (ii) the estimated fair value of Ambac claim payments. The Segregated Account has been making interim cash payments in amounts equal to 25% of permitted Segregated Account policy claims since September 2012. No final decision has been announced by the Rehabilitator with respect to effectuating or amending the Segregated Account Rehabilitation Plan although the Rehabilitator may seek (a) to amend the Segregated Account Rehabilitation Plan to provide for Deferred Amounts to be established, rather than surplus notes to be issued, with respect to the unpaid portion of permitted policy claims and (b) approval from the Rehabilitation Court to make Supplemental Payments with respect to certain insured securities, as described in Note 1. Possible modifications to the Segregated Account Rehabilitation Plan, or additional orders from the Rehabilitation Court, with respect to the form, amount and timing of satisfying permitted policy claims could have a material effect on the recognition of other-than-temporary impairment for, and the fair value of, Ambac-wrapped securities.

Corporate Obligations

The gross unrealized losses on corporate obligations as of March 31, 2013 is primarily the result of an increase in credit spreads on life insurers. Of the $6,868 of unrealized losses on corporate obligations greater than 12 months, one security comprises $3,431 of the total. This security, which was purchased in multiple lots, is a closed-block life insurance issuance that is insured by Assured Guaranty Municipal Corporation, has been in an unrealized loss position for 45-63 months. Another security comprises $2,375 of the total. This security, which is an issuance by a large diversified financial services company that has a credit support agreement from its AA-rated parent, has been in an unrealized loss position for 69 months. The unrealized losses on these securities are the result of general credit spread widening since the date of purchase. Given the investment grade ratings, management believes that timely receipt of all principal and interest is probable.

Residential mortgage-backed securities

The gross unrealized loss on mortgage-backed securities as of March 31, 2013 is primarily related to Alt-A residential mortgage-backed securities. The $10,328 of unrealized losses on mortgage-backed securities for greater than 12 months is attributable to 15 individual Alt-A securities. These individual securities have been in an unrealized loss position for 63 months. All of these Alt-A securities have very similar characteristics such as vintage of the underlying collateral (2004-2007) and placement in the structure (generally class-A tranche rated triple-A at issuance). The declines in fair value relate to the effects of declining U.S. housing prices, the recession and weak economic conditions in general on the performance of collateral underlying residential mortgage backed securities. This has been reflected in decreased liquidity for RMBS securities and increased risk premiums demanded by investors resulting in a required return on investment that is significantly higher than at the time the securities were purchased. As part of the quarterly impairment review process, management estimates expected future cash flows from residential mortgage-backed securities, considering the likelihood of a wide dispersion of possible outcomes to develop cash flow scenarios. Management has contracted consultants to model each of the securities in our portfolio. This approach includes the utilization of market accepted software models in conjunction with detailed data of the historical performance of the collateral pools, which assists in the determination of assumptions such as defaults, severity and voluntary prepayment rates that are largely driven by home price forecasts as well as other macro-economic factors. These assumptions are used to project various future cash flow scenarios for each security. The expected future cash flows used to assess impairment are derived by probability-weighting the various cash flow scenarios. Management considered this analysis in making our determination that non-receipt of contractual cash flows is not probable on these transactions.

Other asset-backed securities

The gross unrealized losses on other asset-backed securities as of March 31, 2013 is the result of limited market demand for illiquid positions in the secondary market. Of the $44,426 of unrealized losses on other asset-backed securities greater than 12 months, one security comprises $28,912 of the total. This security, which is secured by lease payments on an IRS facility and is insured by Ambac Assurance, has been in an unrealized loss position for 63 months. The unrealized loss on this security is largely due to the illiquid nature of this structured transaction which does not trade in the secondary market. Management believes that the timely receipt of all principal and interest on this position as well as on other asset-backed securities is probable.

Realized Gains and Losses and Other-Than-Temporary Impairments:

The following table details amounts included in net realized gains and other-than-temporary impairments included in earnings for the three month period ended March 31, 2013 and 2012:


	Three months ended March 31,
	2013			2012
Gross realized gains on securities	$	41,578		$	824
Gross realized losses on securities		(318	)		(321	)
Foreign exchange gains		4,800			(111	)

Net realized gains	$	46,060		$	392

Net other–than-temporary impairments⁽¹⁾	$	—		$	(3,071	)

(1)

Other-than-temporary impairments exclude impairment amounts recorded in other comprehensive income under ASC Paragraph 320-10-65-1, which comprise non-credit related amounts on securities that are credit impaired but which management does not intend to sell and it is not more likely than not that the company will be required to sell before recovery of the amortized cost basis.

During 2002 and 2003 Ambac recognized investment realized losses of $150,201 relating to its $174,500 investment in asset-backed notes issued by National Century Financial Enterprises, Inc. (“NCFE”). These notes, which were backed by health care receivables and rated triple-A until October 25, 2002, defaulted and NCFE filed for protection under Chapter 11 of the U.S. Bankruptcy Code in November 2002. In connection with a full and final settlement of a lawsuit brought by NCFE bondholders against Credit Suisse Securities LLC, a subsidiary of Ambac Assurance recorded cash recoveries of $39,978 in the three months ended March 31, 2013.

Since commencement of the Segregated Account Rehabilitation Proceedings, changes in the estimated timing of claim payments have resulted in adverse changes in projected cash flows on certain impaired Ambac-wrapped securities. Such changes in estimated claim payments on Ambac-wrapped securities contributed to net other-than-temporary impairments for the three months ended March 31, 2012. Further changes to estimated claim payments could result in additional other-than-temporary impairment charges in the future. Additionally, the three months ended March 31, 2012 included credit impairments on certain other non-agency RMBS securities. As of March 31, 2013, management has not asserted an intent to sell any securities in an unrealized loss position from its portfolio. Future changes in our estimated liquidity needs could result in a determination that Ambac no longer has the ability to hold such securities, which could result in additional other-than-temporary impairment charges.

The following table presents a roll-forward of Ambac’s cumulative credit impairments that were recognized in earnings on securities held as of March 31, 2013 and 2012:


	Credit Impairment
	2013			2012
Balance as of January 1	$	183,300		$	201,317
Additions for credit impairments recognized on:
Securities not previously impaired		—			2,609
Securities previously impaired		—			462
Reductions for credit impairments previously recognized on:
Securities that matured or were sold during the period		(9	)		—

Balance as of March 31	$	183,291		$	204,388

Counterparty Collateral, Deposits with Regulators and Other Restrictions:

Ambac routinely pledges and receives collateral related to certain business lines and/or transactions. The following is a description of those arrangements by collateral source:

(1)

Cash and securities held in Ambac’s investment portfolio—Ambac pledges assets it holds in its investment portfolio to investment and repurchase agreement and derivative counterparties. Securities pledged to investment agreement counterparties may not then be re-pledged to another entity. Ambac’s counterparties under derivative agreements have the right to pledge or rehypothecate the securities and as such, pledged securities are separately classified on the Consolidated Balance Sheets as “Fixed income securities pledged as collateral, at fair value”.

(2)	Cash and securities pledged to Ambac under derivative agreements—Ambac may re-pledge securities it holds from certain derivative counterparties to other derivative counterparties in accordance with its rights and obligations under those agreements.

The following table presents (i) the sources of collateral either received from various counterparties where Ambac is permitted to sell or re-pledge or held directly in the investment portfolio and (ii) how that collateral was pledged to various investment agreement, derivative and repurchase agreement counterparties at March 31, 2013 and December 31, 2012:


	Fair Value of Cash and Underlying Securities		Fair Value of Cash and Securities Pledged to Investment and Repurchase Agreement Counterparties		Fair Value of Cash and Securities Pledged to Derivative Counterparties
March 31, 2013:
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio	$	609,439	$	376,014	$	233,425
Cash and securities pledged from derivative counterparties		—		—		—
December 31, 2012:
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio	$	646,663	$	375,412	$	271,251
Cash and securities pledged from derivative counterparties		—		—		—

Securities carried at $6,929 and $6,945 at March 31, 2013 and December 31, 2012, respectively, were deposited by Ambac Assurance and Everspan with governmental authorities or designated custodian banks as required by laws affecting insurance companies.

Securities with fair value of $218,735 and $201,329 at March 31, 2013 and December 31, 2012, respectively, were held by a bankruptcy remote trust to collateralize and fund repayment of debt issued through a resecuritization transaction. The securities may not be sold or repledged by the trust. These assets are held and the secured debt is issued by entities that qualify as VIEs and are consolidated in Ambac’s unaudited consolidated financial statements. Refer to Note 3, Special Purpose Entities, Including Variable Interest Entities for a further description of this transaction.

Guaranteed Securities:

Ambac’s fixed income portfolio includes securities covered by guarantees issued by Ambac Assurance and other financial guarantors (“insured securities”). The published rating agency ratings on these securities reflect the higher of the financial strength rating of the financial guarantor or the rating of the underlying issuer. Rating agencies do not always publish separate underlying ratings (those ratings excluding the insurance by the financial guarantor) because the insurance cannot be legally separated from the underlying security by the insurer. Ambac obtains underlying ratings through ongoing dialogue with rating agencies and other sources. In the event these underlying ratings are not available from the rating agencies, Ambac will assign an internal rating. The following table represents the fair value, including the value of the financial guarantee, and weighted-average underlying rating, excluding the financial guarantee, of the insured securities at March 31, 2013 and December 31, 2012, respectively:


	Municipal obligations		Corporate obligations		Mortgage and asset- backed securities		Short-term		Total		Weighted Average Underlying Rating⁽¹⁾
March 31, 2013:
Ambac Assurance Corporation ⁽²⁾	$	70,201	$	4,672	$	1,426,787	$	—	$	1,501,660		B
National Public Finance Guarantee Corporation		672,420		43,111		—		—		715,531		AA-
Assured Guaranty Municipal Corporation		452,147		169,004		2,833		—		623,984		A
Financial Guarantee Insurance Corporation		17,378		—		3,264		—		20,642		A-
MBIA Insurance Corporation		—		18,366		1,072		—		19,438		BBB-
Assured Guaranty Corporation		—		—		14,641		—		14,641		D

Total	$	1,212,146	$	235,153	$	1,448,597	$	—	$	2,895,896		BBB-

December 31, 2012:
Ambac Assurance Corporation ⁽²⁾	$	66,270	$	4,717	$	1,344,289	$	—	$	1,415,276		B
National Public Finance Guarantee Corporation		720,904		43,010		—		—		763,914		AA-
Assured Guaranty Municipal Corporation		448,241		169,245		4,923		—		622,409		A
Financial Guarantee Insurance Corporation		17,599		—		4,182		—		21,781		A-
MBIA Insurance Corporation		—		19,733		2,143		—		21,876		BBB-
Assured Guaranty Corporation		—		—		14,743		—		14,743		D

Total	$	1,253,014	$	236,705	$	1,370,280	$	—	$	2,859,999		BBB-

(1)	Ratings are based on the lower of Standard & Poor’s or Moody’s rating. If unavailable, Ambac’s internal rating is used.

(2)	Includes securities insured by Ambac Assurance and Ambac Assurance UK Limited.

Investment Income:

Net investment income was comprised of the following:


	March 31,
	2013			2012
Fixed income securities	$	86,331		$	112,652
Short-term investments		595			313
Loans		108			216
Investment expense		(1,422	)		(1,064	)

Securities available-for-sale and short-term		85,612			112,117
Other investments		(543	)		—

Total net investment income	$	85,069		$	112,117

Net investment income from Other investments represents changes in fair value on securities classified as trading or under the fair value option. The amount of loss for the three months ended March 31, 2013 on securities still held at the reporting date is $543.