INVESTMENTS

Ambac’s invested assets are primarily comprised of fixed income securities classified as available-for-sale and 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.

The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments, at March 31, 2014 and December 31, 2013 were as follows:



	Amortized		Gross Unrealized		Gross Unrealized		Estimated		Non-credit other- than-temporary
	Cost		Gains		Losses		Fair Value		Impairments⁽¹⁾
Successor Ambac - March 31, 2014
Fixed income securities:
Municipal obligations	$	1,189,334	$	12,932	$	16,978	$	1,185,288	$	—
Corporate obligations	1,652,302		9,535		14,253		1,647,584		—
Foreign obligations	146,189		673		4,818		142,044		—
U.S. government obligations	108,546		75		1,663		106,958		—
U.S. agency obligations	31,887		3		65		31,825		—
Residential mortgage-backed securities	1,578,205		97,861		20,408		1,655,658		834
Collateralized debt obligations	177,780		202		643		177,339		—
Other asset-backed securities	1,237,667		8,944		24,618		1,221,993		—
	6,121,910		130,225		83,446		6,168,689		834
Short-term	215,103		—		—		215,103		—
	6,337,013		130,225		83,446		6,383,792		834
Fixed income securities pledged as collateral:
U.S. government obligations	125,090		33		—		125,123		—
Total collateralized investments	125,090		33		—		125,123		—
Total available-for-sale investments	$	6,462,103	$	130,258	$	83,446	$	6,508,915	$	834
Successor Ambac - December 31, 2013
Fixed income securities:
Municipal obligations	$	1,405,293	$	857	$	28,427	$	1,377,723	$	—
Corporate obligations	1,508,377		4,886		23,894		1,489,369		—
Foreign obligations	131,709		69		6,901		124,877		—
U.S. government obligations	128,415		9		2,176		126,248		—
U.S. agency obligations	32,214		10		70		32,154		—
Residential mortgage-backed securities	1,516,877		59,853		18,105		1,558,625		852
Collateralized debt obligations	184,118		217		463		183,872		—
Other asset-backed securities	1,020,251		8,795		36,598		992,448		—
	5,927,254		74,696		116,634		5,885,316		852
Short-term	271,118		1		—		271,119		—
	6,198,372		74,697		116,634		6,156,435		852
Fixed income securities pledged as collateral:
U.S. government obligations	126,196		27		—		126,223		—
Total collateralized investments	126,196		27		—		126,223		—
Total available-for-sale investments	$	6,324,568	$	74,724	$	116,634	$	6,282,658	$	852


(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, 2014 and December 31, 2013.

The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments, at March 31, 2014, by contractual maturity, were as follows:



	Amortized Cost		Estimated Fair Value
Due in one year or less	$	512,768	$	512,927
Due after one year through five years	1,127,009		1,124,957
Due after five years through ten years	1,326,425		1,310,305
Due after ten years	502,249		505,736
	3,468,451		3,453,925
Residential mortgage-backed securities	1,578,205		1,655,658
Collateralized debt obligations	177,780		177,339
Other asset-backed securities	1,237,667		1,221,993
	$	6,462,103	$	6,508,915

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 March 31, 2014 and December 31, 2013:



	Less Than 12 Months ⁽¹⁾
	Fair Value		Gross Unrealized Loss
Successor Ambac - March 31, 2014
Fixed income securities:
Municipal obligations	$	415,721	$	16,978
Corporate obligations	738,842		14,253
Foreign government obligations	104,908		4,818
U.S. government obligations	29,753		1,663
U.S. agency obligations	31,619		65
Residential mortgage-backed securities	441,506		20,408
Collateralized debt obligations	128,956		643
Other asset-backed securities	440,749		24,618
	2,332,054		83,446
Short-term	1,702		—
Total temporarily impaired securities	$	2,333,756	$	83,446



	Less Than 12 Months⁽¹⁾
	Fair Value		Gross Unrealized Loss
Successor Ambac - December 31, 2013
Fixed income securities:
Municipal obligations	$	437,683	$	28,427
Corporate obligations	877,356		23,894
Foreign government obligations	117,905		6,901
U.S. government obligations	70,044		2,176
U.S. agency obligations	5,834		70
Residential mortgage-backed securities	644,502		18,105
Collateralized debt obligations	137,685		463
Other asset-backed securities	629,957		36,598
	2,920,966		116,634
Short-term	—		—
Total temporarily impaired securities	$	2,920,966	$	116,634


(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.

Management has determined that the unrealized losses reflected in the tables above are temporary in nature as of March 31, 2014 and December 31, 2013 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, the fair value of other securities that are available for sale and in an unrealized gain position, 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 in an unrealized loss position 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, 2014, 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 March 31, 2014, $595,247 of the total fair value and $33,433 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, 2013, $826,969 of the total fair value and $36,946 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 Ambac claim payments. The Segregated Account has been making Interim 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 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's 2013 Annual Report on Form 10-K). As described in Note 1 to the Unaudited Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q, if the proposed amendments to the Segregated Account Rehabilitation Plan sought by the Rehabilitator are approved, the Rehabilitator intends to increase the percentage of permitted policy claims to be paid from 25% to 45%, and to make certain payments on Deferred Amounts, together with interest thereon, and to early redeem a portion of the Segregated Account surplus notes (including accrued and unpaid interest thereon). The redemption of any Segregated Account surplus notes will result in a proportionate redemption of the General Account surplus notes (including accrued and unpaid interest thereon). Our evaluation of other-than-temporary impairments as of March 31, 2014, particularly with respect to Ambac's ability to hold securities that are in an unrealized loss position, considered the impact of increased cash outflow that would result in 2014 from the increased claim payment percentage, payment on Deferred Amounts and surplus note redemptions. Declines in the fair value of investment securities or changes in management's intent to sell securities to fund these increased cash payments could result in future recognition of other-than-temporary impairments. Additionally, modifications to the Segregated Account Rehabilitation Plan, or orders from the Rehabilitation Court or actions by the Rehabilitator, with respect to the form, amount and timing of satisfying permitted policy claims, or making payments on Deferred Amounts or surplus notes may have a material effect on the fair value of Ambac-wrapped securities and future recognition of other-than-temporary impairments.

Municipal and corporate obligations

The gross unrealized losses on municipal and corporate obligations as of March 31, 2014 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 $20,408 of unrealized losses on residential mortgage-backed securities, $16,258 is attributable to Ambac-wrapped securities. The unrealized loss on these securities is primarily the result of discount accretion, which has exceeded the increase in fair value since April 30, 2013. As part of the quarterly impairment review process, management estimates expected future cash flows from residential mortgage-backed securities. 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 a credit loss has not occurred at March 31, 2014 on these transactions.

Other asset-backed securities

Of the $24,618 of unrealized losses on other asset-backed securities as of March 31, 2014, $24,333 is attributable to 5 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 gains and other-than-temporary impairments included in earnings for the affected periods:



	Successor Ambac –			Predecessor Ambac –
	Three Months Ended March 31, 2014			Three Months Ended March 31, 2013
Gross realized gains on securities	$	19,576		$	41,578
Gross realized losses on securities	(1,128		)	(318		)
Foreign exchange losses	(2,159		)	4,800
Net realized gains	$	16,289		$	46,060
Net other-than-temporary impairments ⁽¹⁾	$	(10,392	)	$	—


(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 relating to its investment in asset-backed notes issued by National Century Financial Enterprises, Inc. (“NCFE”). These notes 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 $39,978 in the three months ended March 31, 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 the timing of 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 adverse changes in projected cash flows on certain Ambac-wrapped securities as well as the company’s intent to sell certain securities that were in an unrealized loss position as of March 31, 2014. 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 March 31, 2014 and 2013 for which a portion of an other-than-temporary impairment was recognized in other comprehensive income:



	Credit Impairment
Successor Ambac:
Balance as of January 1, 2014	$	1,182
Additions for credit impairments recognized on:
Securities not previously impaired	4,767
Securities previously impaired	—
Reductions for credit impairments previously recognized on:
Securities that matured or were sold during the period	—
Securities that no longer have a portion of other-than-temporary impairment in other comprehensive income because of Ambac's intent to sell such securities	—
Balance as of March 31, 2014	$	5,949
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	(9		)
Balance as of March 31, 2013	$	183,291

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 March 31, 2014 and December 31, 2013:



	Fair Value of Cash and Underlying Securities		Fair Value of Cash and Securities Pledged to Investment Agreement Counterparties		Fair Value of Cash and Securities Pledged to Derivative Counterparties
Successor Ambac - March 31, 2014
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio	$	497,802	$	372,679	$	125,123
Cash and securities pledged from derivative counterparties	$	—	$	—	$	—
Successor Ambac - December 31, 2013
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio	$	497,946	$	371,723	$	126,223
Cash and securities pledged from derivative counterparties	$	690	$	—	$	—

Securities carried at $6,811 and $6,799 at March 31, 2014 and December 31, 2013, 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 $236,674 and $240,150 at March 31, 2014 and December 31, 2013, 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 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. 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, 2014 and December 31, 2013, respectively:



	Municipal obligations		Corporate obligations		Mortgage and asset- backed securities						Weighted Average Underlying Rating ⁽¹⁾
	Municipal obligations		Corporate obligations		Mortgage and asset- backed securities		Short-term		Total		Weighted Average Underlying Rating ⁽¹⁾
Successor Ambac - March 31, 2014:
Ambac Assurance Corporation ⁽²⁾	$	66,002	$	—	$	2,051,280	$	—	$	2,117,282	CCC
National Public Finance Guarantee Corporation	400,268		37,872		—		—		438,140		AA-
Assured Guaranty Municipal Corporation	312,622		78,835		—		—		391,457		A+
MBIA Insurance Corporation	—		17,436		—		—		17,436		BBB-
Assured Guaranty Corporation	—		—		2,816		—		2,816		D
Financial Guarantee Insurance Corporation	—		—		2,755		—		2,755		D
Total	$	778,892	$	134,143	$	2,056,851	$	—	$	2,969,886	B+
Successor Ambac - December 31, 2013:
Ambac Assurance Corporation ⁽²⁾	$	64,596	$	—	$	1,747,283	$	—	$	1,811,879	CCC+
National Public Finance Guarantee Corporation	532,752		37,642		—		—		570,394		A+
Assured Guaranty Municipal Corporation	372,392		77,163		—		—		449,555		A+
MBIA Insurance Corporation	—		17,444		—		—		17,444		BBB-
Assured Guaranty Corporation	—		—		2,917		—		2,917		D
Financial Guarantee Insurance Corporation	—		—		2,869		—		2,869		D
Total	$	969,740	$	132,249	$	1,753,069	$	—	$	2,855,058	BB-


(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 $51,395 and $50,953 at March 31, 2014 and December 31, 2013, respectively, insured by Ambac UK.

Investment Income:

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



	Successor Ambac –			Predecessor Ambac –
	Three Months Ended March 31, 2014			Three Months Ended March 31, 2013
Fixed income securities	$	70,985		$	86,331
Short-term investments	303			595
Loans	117			108
Investment expense	(2,598		)	(1,977		)
Securities available-for-sale and short-term	68,807			85,057
Other investments	1,994			(543		)
Total net investment income	$	70,801		$	84,514

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 for the three months ended March 31, 2014 on securities still held at the March 31, 2014 was $2,449. Predecessor Ambac losses for the three months ended March 31, 2013 on securities still held at March 31, 2014 were $614.