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Background and Business Description | 6 Months Ended
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Jun. 30, 2017
Accounting Policies [Abstract] |
Background and Business Description | 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 provides financial guarantee insurance policies through its principal operating subsidiary, Ambac Assurance Corporation (“Ambac Assurance" or ”AAC") 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 also has another wholly-owned 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 Assurance and Ambac UK from being able to write new business. The 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 also provides other financial products through subsidiaries of Ambac Assurance. These products consist of interest rate swaps, funding conduits, and investment agreements (until the first quarter of 2017) that were provided principally to clients that were also provided financial guarantee policies. These financial products have been in active run-off since 2007. Prior to the second quarter of 2017, Ambac had two reportable business segments: i) the financial guarantee segment, which consisted of financial guarantee insurance policies and credit derivative contracts and ii) the financial services segment which consisted of the other financial products discussed above. With respect to the financial services segment, there were significant swap commutations in June 2017. The remaining interest rate swaps, along with other interest rate derivatives, are managed to economically hedge interest rate risk in the financial guarantee and investment portfolios. The last remaining investment agreement matured in March 2017 and the remaining conduit transactions are not material. The significant wind-down of these financial products, along with the appointment of a new Chief Executive Officer effective January 1, 2017, has resulted in a change in how the Company manages its business. Management now reviews financial information, allocates resources and measures financial performance on a consolidated basis. As a result, beginning with the second quarter of 2017, the Company has a single reportable segment. All prior period amounts and disclosures have been adjusted to reflect the reportable segment change. 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.
Although we are exploring selective business transactions for Ambac, no assurance can be given that we will be able to execute the acquisition or development of any new businesses or assets. In addition, there can be no assurance that we will be able to obtain the financial and other resources that may be required to finance the acquisition or development of new businesses or assets that may permit utilization of Ambac’s tax net operating loss carry-forwards. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of our securities is speculative. The execution of Ambac’s strategy to increase the value of its investment in Ambac Assurance remains 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. As a result of uncertainties associated with the oversight by the Rehabilitator of the Segregated Account as noted herein, management has concluded that there is substantial doubt about Ambac's ability to continue as a going concern. Ambac’s financial statements as of and for the three and six months ended June 30, 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. The Segregated Account 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 June 30, 2017 for policies allocated to the Segregated Account was $10,772,572. Policy obligations not allocated to the Segregated Account remain in the General Account of Ambac Assurance, and such policies in the General Account are not subject to and, therefore, are not directly impacted by the Segregated Account Rehabilitation Plan. To pay claims and other liabilities, the Segregated Account has the ability to demand payment from time to time under an aggregate excess of loss reinsurance agreement provided by Ambac Assurance (the “Reinsurance Agreement”). In addition, certain operating and administrative costs and expenses of the Segregated Account are reimbursable by Ambac Assurance pursuant to the Cooperation Agreement, dated as of March 24, 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 June 30, 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. Rehabilitation Exit Support Agreement On July 19, 2017, Ambac Assurance and Ambac entered into an agreement (the “Rehabilitation Exit Support Agreement”) with holders or beneficial owners (the “Supporting Holders”) of surplus notes issued by Ambac Assurance and beneficial interests in Deferred Amounts (as defined in the Segregated Account Rehabilitation Plan) of the Segregated Account with respect to a transaction which, subject to the conditions precedent set forth in the Rehabilitation Exit Support Agreement, and if consummated, would generally involve (i) the exchange of certain surplus notes held by holders of surplus notes that elect to participate in a voluntary exchange transaction and (ii) the satisfaction and discharge of all Deferred Amounts, in each case for an effective consideration package comprised of cash and new Secured Notes (as defined below) and certain existing surplus notes and (iii) the exit from rehabilitation of the Segregated Account (the “Rehabilitation Exit Transactions”). The settlement of the Deferred Amounts and the Segregated Account’s exit from rehabilitation are expected to be realized through the amendment (the “Rehabilitation Plan Amendment”) of the Segregated Account Rehabilitation Plan to be pursued by the Rehabilitator, and a series of transactions which would provide to holders of beneficial interests in Deferred Amounts (other than Ambac, but including Ambac Assurance) a total effective consideration package, in full satisfaction and discharge of each $1.00 of Deferred Amounts (including accretion), of (i) $0.40 in cash, (ii) $0.41 in principal amount of new Secured Notes (as defined below) and (iii) from certain holders of surplus notes, $0.125 currently outstanding surplus notes. Such consideration package would thereby provide a discount of $0.065 (set first against accretion of Deferred Amounts). Ambac would receive $0.91 in principal amount of Secured Notes for each $1.00 of Deferred Amounts (including accretion) that it holds, and would provide a $0.09 discount in full satisfaction and discharge of its Deferred Amount claims. It is anticipated that the Rehabilitator will file a motion in the Rehabilitation Court by no later than October 2, 2017 seeking entry of an order approving the Rehabilitation Plan Amendment. The Rehabilitator has reserved December 12, 2017 through December 14, 2017 for a confirmation hearing on the Rehabilitation Plan Amendment, and November 30, 2017 for a pre-trial hearing. The Rehabilitation Exit Support Agreement calls for a series of interrelated transactions involving the exchange of certain surplus notes (collectively, the “Exchange Offers”), pursuant to which, for each $1.00 of principal amount outstanding and accrued and unpaid interest thereon, holders effectively would (i) receive $0.40 in cash, (ii) receive $0.41 in principal amount of Secured Notes, (iii) retain $0.125 in principal amount and accrued and unpaid interest thereon of surplus notes and (iv) provide a discount of $0.065 in principal amount and accrued and unpaid interest thereon. Ambac will not participate in the Exchange Offers and will hold surplus notes issued by the Segregated Account and Ambac Assurance until the Rehabilitation Exit Transactions are consummated and a certain amount of such surplus notes for a time after such transactions are completed, as described below. As part of the Rehabilitation Exit Transactions, Ambac and Ambac Assurance will seek consents from holders of surplus notes to a waiver and amendment (the “BSA Waiver and Amendment”) of certain provisions of the Settlement Agreement, such consents to be executed by holders of more than 50% in aggregate principal amount of the surplus notes. Holders who participate in the Exchange Offers will be required to deliver their consent to the BSA Waiver and Amendment. As contemplated by the Rehabilitation Exit Support Agreement and as a portion of the consideration received by holders of beneficial interests in Deferred Amounts (including Ambac Assurance) in satisfaction and discharge of their claims pursuant to the Rehabilitation Plan Amendment and by holders of surplus notes pursuant to the Exchange Offers (as specified above), a newly formed special purpose entity will issue new secured notes (the “Secured Notes”), secured by all assets of the special purpose entity, which include a note issued by Ambac Assurance to the special purpose entity, which note is secured by a pledge of Ambac Assurance’s right, title and interest in up to the first $1,400,000 of proceeds (net of reinsurance) from certain litigations in which Ambac Assurance and the Segregated Account seek redress for breaches of representations and warranties and/or fraud related to residential mortgage-backed securitizations (the “RMBS Litigations”). In addition, the note issued by Ambac Assurance to the special purpose entity will be secured by RMBS securities having a market value of not less than $350,000 on the date that is not more than five business days prior to the closing date of the Rehabilitation Exit Transactions. Ambac Assurance will also pledge for the benefit of the holders of Secured Notes (other than Ambac Assurance) the proceeds of any Secured Notes held by AAC from time to time, and will issue a financial guaranty insurance policy to a trustee for the benefit of holders of Secured Notes irrevocably guarantying all principal and interest payments in respect of the Secured Notes as and when such payments become due and owing. Should Ambac Assurance settle any of the RMBS Litigations before the closing of the Rehabilitation Exit Transactions, any proceeds received by Ambac Assurance from any settlement which would have secured the Secured Notes will replace Secured Notes having a face amount equal to the amount of proceeds received that would otherwise be issued. Following the consummation of the Rehabilitation Exit Transactions and until the earlier of (i) June 8, 2020 and (ii) the date on which at least 25% of the principal amount of Remaining Senior Surplus Notes (as defined the Rehabilitation Exit Support Agreement) are no longer outstanding, Ambac shall hold and not sell Remaining Senior Surplus Notes which, as of June 30, 2017, have an aggregate of $60,000 of principal amount and accrued and unpaid interest outstanding. The Company may terminate the Rehabilitation Exit Support Agreement upon the occurrence of certain events, including if the Rehabilitation Exit Transactions have not been consummated within 365 days of the signing date of the Rehabilitation Exit Support Agreement. Supporting Holders that, in the aggregate, beneficially own at least 66 2/3% of the principal amount outstanding under the surplus notes and 66 2/3% of the principal amount of the Deferred Amounts, held by the Supporting Holders as a whole may terminate the Rehabilitation Exit Support Agreement upon the occurrence of certain events, including if (i) within 75 days of signing date of the Rehabilitation Exit Support Agreement, the Rehabilitator has not filed a motion in the Rehabilitation Court seeking entry of the approval order; (ii) the confirmation hearing has not commenced within 180 days of the signing date of the Rehabilitation Exit Support Agreement; and (iii) the Rehabilitation Exit Transactions have not been consummated within 270 days of the Signing Date. In addition if the Rehabilitation Exit Transactions have not been consummated within 365 days of the signing date of the Rehabilitation Exit Support Agreement, each Supporting Holder shall have the right to terminate the Agreement with respect to itself. Ambac can provide no assurance that any of the termination events described above or in the Rehabilitation Exit Support Agreement will not arise. The Exchange Offers will be subject to a number of conditions precedent, including, among others, (i) approval by the OCI; (ii) the effectiveness of the Rehabilitation Plan Amendment concurrent with the closing of the Exchange Offers; (iii) participation by 85% of the outstanding principal amount owned by holders of surplus notes (including Ambac and Ambac Assurance) in the Exchange Offers; (iv) receipt of consents of at least a majority of the outstanding aggregate principal amount of the surplus notes (other than surplus notes beneficially owned by Ambac or Ambac Assurance or any of their affiliates) to the BSA Waiver and Amendment; and (v) subject to the approval of the OCI, a one-time current interest payment of approximately $12,500 on the surplus notes outstanding immediately following the effective date of the Rehabilitation Plan Amendment. The Rehabilitation Plan Amendment is subject to a number of conditions precedent having been satisfied or waived by the Rehabilitator, in his sole discretion, including, among others, (i) the Rehabilitation Plan Amendment will have been approved by the Rehabilitation Court, and such order will have become a final order; (ii) as of the effective date, Ambac Assurance will have sufficient capital and claims-paying resources to effect all of the Rehabilitation Exit Transactions and to exit rehabilitation; (iii) the conditions to consummation of the Exchange Offers will have been satisfied or waived in full in accordance with the terms thereof; and (iv) Ambac will have received from the Internal Revenue Service a ruling, in form and substance reasonably satisfactory to the Rehabilitator, Ambac Assurance, and Ambac. Ambac can provide no assurances that these approvals or consents will be obtained or that the other conditions precedent will be satisfied or waived in a timely manner or at all. Even if the Rehabilitation Exit Transactions are consummated, OCI may impose on Ambac and Ambac Assurance reporting requirements and restrictions on transactions or other activities, which may create additional challenges or obstacles with respect to Ambac Assurance's ability to deliver value to Ambac and Ambac's ability to deliver value to its stockholders. Tier 2 Commitment On July 19, 2017, Ambac Assurance also entered into a commitment letter (the “Commitment Letter”) with certain investors (the “Investors”), with respect to the issuance of an aggregate principal amount of $240,000 of senior notes (the “Tier 2 Notes”) secured by Ambac Assurance’s rights, title and interest in the cash and non-cash proceeds (net of reinsurance) above $1,600,000 received in connection with the RMBS Litigations. The Commitment Letter will terminate upon the earliest occurrence of: (i) 365 days from the execution of the Rehabilitation Exit Support Agreement, and (ii) the date on which the Tier 2 Notes are issued. In addition, Ambac Assurance and the Investors have the option to terminate the Commitment Letter following (i) the resolution of Ambac Assurance Corp. et al. v. Countrywide Home Loans, Inc. et al., Index No. 651612/2010 (N.Y. Sup. Ct. N.Y. Cnty.) (Bransten, J.) or (ii) the termination of the Rehabilitation Exit Support Agreement. The issuance of the Tier 2 Notes is subject to a number of conditions precedent including, among others, satisfaction or waiver of the conditions to effectiveness set forth in the Plan Amendment. The terms, conditions, and timing of the conclusion of the Segregated Account Rehabilitation Proceedings are in the sole discretion of the OCI, and subject to the approval of the Rehabilitation Court. No assurance can be given that Rehabilitation Exit Transactions or issuance of the Tier 2 Notes will be consummated. 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. Ambac Assurance will seek to further improve its financial condition by continuing to pursue asset monetizations; loss recoveries; restructurings, purchases, modifications or exchanges of certain outstanding obligations; extinguishment or modification of certain contractual restrictions; and/or commuting or reducing insured exposures Separately from or in connection with the actions described above, we may seek to further optimize our capital and corporate structure to unlock shareholder value. Augusta Funding Limited IV ("Augusta") Commutation On June 27, 2017, Ambac entered into a termination agreement with various parties, including Augusta, in connection with the commutation of interest rate swaps between Augusta and Ambac's wholly-owned subsidiary, Ambac Financial Services. During the second quarter, Ambac had net settlement payments of approximately $103,592, including $94,407 under the termination agreement. At March 31, 2017, Ambac had recorded a mark-to-market liability under this swap transaction of $147,035, resulting in a gain of approximately $43,443 and $42,157 during the three and six months ended June 30, 2017, respectively. In July 2017, Augusta redeemed its outstanding Ambac-insured debt and accordingly Ambac will recognize approximately $2,600 in accelerated earnings in the third quarter of 2017 relating to this redemption. 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 in losses and loss expenses of approximately $91,600 in the first quarter of 2017. 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 Highways and Transportation Authority ("PRHTA"), 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 be offered 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 PRHTA, 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 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 not accepted 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. 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 states that because COFINA does not generate surpluses, the dispositions of Chapter 4 are not applicable to COFINA. The Explicative Declaration further 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. The statements in the Explicative Declaration appear to contradict the statutory language of Articles 4.01, 4.02 and 4.03, resulting in uncertainty about how the 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 limit or restrict the right granted by the Resolution or COFINA’s rights 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 pledge of the Dedicated Sales Tax to COFINA and the rights of COFINA’s bondholders under the Resolution against all claims and demands; 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 holders of more than 25% of the senior COFINA bonds, sent a letter to BNY demanding immediate acceleration of all senior bonds issued by COFINA. On May 16, 2017, BNY filed an interpleader action in COFINA’s Title III case against COFINA and certain creditors of COFINA, including Ambac Assurance, that have made competing claims of entitlement to funds held by BNY. This action will resolve the parties’ respective entitlements to the funds, including a determination of whether an Event of Default have occurred under the COFINA resolution. On May 2, 2017, the Oversight Board certified a ten-year fiscal plan (the “PRHTA Fiscal Plan”) for the Puerto Rico Highways and Transportation Authority (“PRHTA”). The PRHTA Fiscal Plan reflects an expectation that the Puerto Rico Treasury and PRHTA will temporarily cease funding debt service payments in July of 2017. The PRHTA Fiscal Plan states that as a result of the “clawback” of certain revenues pledged to PRHTA, PRHTA has insufficient cash flow to service debt. It is currently unclear when the funding of PRHTA debt service payments with pledged revenues will resume. The Governor signed into law Act No. 1 of 2017, on January 11, 2017, which amended the Commonwealth’s Public-Private Partnership Act (Act No. 29 of 2009) ("P3 Act") authorizing the Public-Private Partnerships Authority (“P3A”) to facilitate privatization agreements between Partnering Government Entities (as such term is defined in the P3 Act) and private entities. The 2017 amendments allow the P3A to receive and consider unsolicited or voluntary proposals from proponents that meet the minimum criteria set forth in the P3 Act, whereas prior to the 2017 amendments, proposals could only be received in response to a P3A request for proposals. Direct negotiations with proponents of unsolicited or voluntary proposals may be conducted without a request for qualifications or a request for proposals process if the P3A determines that certain criteria have been met. The 2017 amendments also permit the use of the initial and/or periodical payments received from any partnership for contributions to the retirement systems of the Government of Puerto Rico, in addition to other uses provided for by the P3 Act, including the payment of debts of Partnering Government Entities. It is unclear how Puerto Rico will make use of the law and to what extent it will impact the obligations that we insure. In response to letter requests from Governor Rosselló, 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. Subsequently, the Oversight Board commenced a Title III proceeding for the Employees Retirement System and PRHTA on May 21, 2017, and for the Puerto Rico Electric Power Authority on July 2, 2017. Ambac Assurance has not issued any financial guaranty policies with respect to obligations of the Employees Retirement System or the Puerto Rico Electric Power Authority. 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. On June 14, 2017, Judge Laura Taylor Swain entered an order appointing a team of mediators to facilitate confidential mediation discussions in order to facilitate consensual resolution of certain issues arising in the context of these Title III cases. The mediation team is led by Chief Judge Barbara Houser of the United States Bankruptcy Court for the Northern District of Texas, and consists of Circuit Judge Thomas Ambro of the United States Court of Appeals for the Third Circuit, Senior District Judge Nancy Atlas of the United States District Court for the Southern District of Texas, Bankruptcy Judge Christopher Klein of the United States Bankruptcy Court for the Eastern District of California, and Senior District Judge Victor Marrero of the United States District Court for the Southern District of New York. The mediators held an introductory mediation session, primarily for scheduling and housekeeping matters, on July 12, 2017. The mediators requested initial, confidential mediation statements identifying the issues to be discussed in the mediation(s) and the order in which the issues presented are to be taken up by July 24, 2017. The substantive mediation process is not expected to get underway until September. 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, 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. On June 30, 2017, the Oversight Board certified the Commonwealth’s fiscal year 2018 budget, which is largely compliant with the FEGP. The budget does not allocate funds for debt service, stating only that it will do so after a Title III plan of adjustment or Title VI agreement is approved by the Court. Ambac Assurance is party to nine litigations related to its Puerto Rico exposures. These include three litigations challenging the constitutionality and legality of the FEGP and the Fiscal Plan Compliance Act, discussed below under Note 11. Commitments and Contingencies, one of which is an adversary proceeding actively pending in PRHTA’s Title III proceedings. Ambac Assurance filed several of those cases to protect and assert its rights under transaction documents and applicable law. Six of these litigations are stayed under Title III of PROMESA, and one has been stayed by order of the United States District Court for the District of Puerto Rico pending resolution of an interpleader action related to COFINA funds (to which interpleader action Ambac is also a party). Accordingly, Ambac is unable to predict when and how the issues raised in those cases will be resolved. If Ambac Assurance is 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. During the six months ended June 30, 2017, Ambac had incurred losses associated with its Domestic Public Finance insured portfolio of $221,604, which was significantly impacted by the continued uncertainty and volatility of the situation in Puerto Rico. 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 June 30, 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.

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