9. 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 are part of the company’s long-term financial guarantee investment strategy. The majority of such 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. Investments in pooled funds have been classified as trading or fair value option securities so that any 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 September 30, 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⁾
Successor Ambac – September 30, 2013
Fixed income securities:
Municipal obligations	$	1,470,363	$	152	$	26,157	$	1,444,358	$	—
Corporate obligations		1,367,029		1,981		24,324		1,344,686		—
Foreign obligations		127,649		56		5,206		122,499		—
U.S. government obligations		106,605		36		1,381		105,260		—
U.S. agency obligations		35,562		4		77		35,489		—
Residential mortgage-backed securities		1,523,755		52,896		21,039		1,555,612		947
Collateralized debt obligations		91,023		256		224		91,055		—
Other asset-backed securities		1,073,838		9,208		23,340		1,059,706		—

		5,795,824		64,589		101,748		5,758,665		947
Short-term		549,233		1		5		549,229		—

		6,345,057		64,590		101,753		6,307,894		947

Fixed income securities pledged as collateral:
U.S. government obligations		140,216		57		—		140,273		—

Total collateralized investments		140,216		57		—		140,273		—

Total available-for-sale investments	$	6,485,273	$	64,647	$	101,753	$	6,448,167	$	947


Predecessor Ambac – 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 September 30, 2013 and December 31, 2012.

The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments held by Successor Ambac, at September 30, 2013, by contractual maturity, were as follows:


	Amortized Cost		Estimated Fair Value
Due in one year or less	$	549,519	$	549,500
Due after one year through five years		76,880		74,832
Due after five years through ten years		116,964		109,788
Due after ten years		3,053,294		3,007,674

		3,796,657		3,741,794
Residential mortgage-backed securities		1,523,755		1,555,612
Collateralized debt obligations		91,023		91,055
Other asset-backed securities		1,073,838		1,059,706

	$	6,485,273	$	6,448,167

Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay certain 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 September 30, 2013 and December 31, 2012:


	Less Than 12 Months ⁽¹⁾
	Fair Value		Gross Unrealized Loss
Successor Ambac – September 30, 2013:
Fixed income securities:
Municipal obligations	$	455,719	$	26,157
Corporate obligations		962,892		24,324
Foreign government obligations		114,986		5,206
U.S. government obligations		33,653		1,381
U.S. agency obligations		4,554		77
Residential mortgage-backed securities		580,747		21,039
Collateralized debt obligations		37,018		224
Other asset-backed securities		743,499		23,340

		2,933,068		101,748
Short-term		1,298		5

Total temporarily impaired securities	$	2,934,366	$	101,753

(1)

As a result of the implementation of Fresh Start, amortized cost for available for sale securities were set to equal fair value on April 30, 2013. Accordingly, Successor Ambac does not have any gross unrealized losses that have been in a continuous unrealized loss position for greater than 12 months.


	Less Than 12 Months				12 Months or More				Total
	Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss
Predecessor Ambac – 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 September 30, 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. 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 September 30, 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 Fresh Start Reporting Date of April 30, 2013 for securities purchased prior to that date) 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 September 30, 2013, $810,835 of the total fair value and $37,209 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 (plus, in certain cases, Supplemental Payments as described in Note 1). 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 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 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.

Municipal and corporate obligations

The gross unrealized losses on municipal and corporate obligations as of September 30, 2013 are primarily the result of the increase in interest rates since April 30, 2013. These securities are primarily fixed-rate securities with an investment grade credit rating. Management believes that the timely receipt of all principal and interest on these positions is probable.

Residential mortgage-backed securities

Of the $21,039 of unrealized losses on residential mortgage-backed securities, $18,369 is attributable to Ambac-wrapped securities. The unrealized loss on these securities is primarily related to credit spread widening since April 30, 2013. As part of the quarterly impairment review process, management estimates expected future cash flows from residential mortgage-backed securities. 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 future cash flows for each security. 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

Of the $23,340 of unrealized losses on other asset-backed securities as of September 30, 2013, $22,876 is attributable to 6 military housing, fixed-rate securities. The unrealized loss on these securities is largely due to the increase in interest rates since April 30, 2013. Management believes that the timely receipt of all principal and interest on these positions 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 (losses) gains and other-than-temporary impairments included in earnings for the affected periods:


	Successor Ambac – Three Months Ended September 30, 2013			Predecessor Ambac – Three Months Ended September 30, 2012
Gross realized gains on securities	$	3,906		$	3,492
Gross realized losses on securities		(7,239	)		(72	)
Foreign exchange losses		(6,977	)		(258	)

Net realized (losses) gains	$	(10,310	)	$	3,162

Net other-than-temporary impairments⁽¹⁾	$	(38,037	)	$	(354	)


	Successor Ambac – Five Months Ended September 30, 2013			Predecessor Ambac – Four Months Ended April 30, 2013			Predecessor Ambac – Nine Months Ended September 30, 2012
Gross realized gains on securities	$	20,518		$	47,448		$	71,997
Gross realized losses on securities		(8,831	)		(320	)		(963	)
Foreign exchange (losses) gains		(3,525	)		6,177			(413	)

Net realized gains	$	8,162		$	53,305		$	70,621

Net other-than-temporary impairments⁽¹⁾	$	(40,039	)	$	(467	)	$	(5,753	)

(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 received cash recoveries of $1,216 in the three and five months ended September 30, 2013 and $39,978 in the four months ended April 30, 2013. These amounts were recorded within gross realized gains on securities.

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 periods presented in the table above. Further changes to estimated claim payments could result in additional other-than-temporary impairment charges in the future. Successor Ambac’s net other-than-temporary impairments relate to the company’s intent to sell certain securities that were in an unrealized loss position as of September 30, 2013. The three and nine months ended September 30, 2012 included credit impairments on certain other non-agency RMBS securities. 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 losses on debt securities held as of September 30, 2013 and 2012 for which a portion of an other-than-temporary impairment was recognized in other comprehensive income:


	Credit Impairment
Successor Ambac:
Balance as of May 1, 2013	$	—
Additions for credit impairments recognized on:
Securities not previously impaired		1,032
Securities previously impaired		—
Reductions for credit impairments previously recognized on:
Securities that matured or were sold during the period		(3	)
Securities that no longer have a portion of other-than-temporary impairment in other comprehensive income because of the company’s intent to sell such securities		—

Balance as of September 30, 2013	$	1,029


Predecessor Ambac:
Balance as of January 1, 2013	$	183,300
Additions for credit impairments recognized on:
Securities not previously impaired		—
Securities previously impaired		—
Reductions for credit impairments previously recognized on:
Securities that matured or were sold during the period ⁽¹⁾		(183,300	)

Balance as of April 30, 2013	$	—


	Credit Impairment
Predecessor Ambac:
Balance as of January 1, 2012	$	201,317
Additions for credit impairments recognized on:
Securities not previously impaired		820
Securities previously impaired		4,933
Reductions for credit impairments previously recognized on:
Securities that matured or were sold during the period		(24,007	)

Balance as of September 30, 2012	$	183,063

(1)

Includes reduction made in connection with Fresh Start, under which the cost basis of all invested assets have been set to fair value as of the Fresh Start Reporting Date of April 30, 2013. As described in Note 2, adopting Fresh Start results in a new reporting entity with no beginning retained earnings or accumulated deficit. Therefore cumulative credit impairments for Successor Ambac on May 1, 2013 are $0.

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 agreement, 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 the collateral or collateral held directly in the investment portfolio and (ii) how that collateral was pledged to various investment agreement, derivative and repurchase agreement counterparties at September 30, 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
Successor Ambac – September 30, 2013:
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio	$	513,285	$	373,012	$	140,273
Cash and securities pledged from derivative counterparties		—		—		—

Predecessor Ambac – 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 $6,863 and $6,945 at September 30, 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 $230,049 and $201,329 at September 30, 2013 and December 31, 2012, respectively, were held by a bankruptcy remote trust to collateralize and fund repayment of debt issued through a re-securitization 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 4, 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 September 30, 2013 and December 31, 2012, respectively:


	Municipal obligations		Corporate obligations		Mortgage and asset- backed securities		Short-term		Total		Weighted Average Underlying Rating⁽¹⁾
Successor Ambac – September 30, 2013:
Ambac Assurance Corporation ⁽²⁾	$	66,324	$	—	$	1,713,578	$	—	$	1,779,902		CCC+
National Public Finance Guarantee Corporation		543,112		39,247		—		—		582,359		AA-
Assured Guaranty Municipal Corporation		406,181		168,195		—		—		574,376		A
MBIA Insurance Corporation		—		18,418		—		—		18,418		BBB-
Assured Guaranty Corporation		—		—		16,775		—		16,775		D
Financial Guarantee Insurance Corporation		—		—		2,988		—		2,988		D

Total	$	1,015,617	$	225,860	$	1,733,341	$	—	$	2,974,818		BB


Predecessor Ambac – 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
MBIA Insurance Corporation		—		19,733		2,143		—		21,876		BBB-
Assured Guaranty Corporation		—		—		14,743		—		14,743		D
Financial Guarantee Insurance Corporation		17,599		—		4,182		—		21,781		A-

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 asset-backed securities with a fair value of $51,714 and $45,630 at September 30, 2013 and December 31, 2012, respectively, insured by Ambac UK.

Investment Income:

Net investment income was comprised of the following for the affected periods:


	Successor Ambac – Three Months Ended September 30, 2013			Predecessor Ambac – Three Months Ended September 30, 2012
Fixed income securities	$	53,301		$	85,364
Short-term investments		626			431
Loans		109			137
Investment expense		(2,260	)		(1,854	)

Securities available-for-sale and short-term		51,776			84,078
Other investments		350			—

Total net investment income	$	52,126		$	84,078


	Successor Ambac – Five Months Ended September 30, 2013			Predecessor Ambac – Four Months Ended April 30, 2013			Predecessor Ambac – Nine Months Ended September 30, 2012
Fixed income securities	$	83,732		$	118,097		$	292,483
Short-term investments		788			677			1,188
Loans		193			146			558
Investment expense		(3,726	)		(2,549	)		(4,198	)

Securities available-for-sale and short-term		80,987			116,371			290,031
Other investments		(2,665	)		369			—

Total net investment income	$	78,322		$	116,740		$	290,031

Net investment income from Other investments represents changes in fair value on securities classified as trading or under the fair value option. Successor Ambac gains and (losses) for the three and five months ended September 30, 2013 on securities still held at the reporting date was $1,577 and ($784), respectively. Predecessor Ambac gains for the four months ended April 30, 2013 on securities still held at September 30, 2013 were ($78). There were no such investments held during 2012.