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 September 30, 2014 and December 31, 2013 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, 2014
Fixed income securities:
Municipal obligations	$	930,171	$	18,611	$	9,340	$	939,442	$	—
Corporate obligations	1,802,775		12,457		9,549		1,805,683		—
Foreign obligations	126,304		1,359		2,550		125,113		—
U.S. government obligations	78,522		478		952		78,048		—
U.S. agency obligations	29,900		12		44		29,868		—
Residential mortgage-backed securities	1,664,096		169,004		8,608		1,824,492		2,476
Collateralized debt obligations	45,876		239		75		46,040		—
Other asset-backed securities	1,263,544		44,073		75		1,307,542		—
	5,941,188		246,233		31,193		6,156,228		2,476
Short-term	550,898		2		—		550,900		—
	6,492,086		246,235		31,193		6,707,128		2,476
Fixed income securities pledged as collateral:
U.S. government obligations	64,323		—		292		64,031		—
Total collateralized investments	64,323		—		292		64,031		—
Total available-for-sale investments	$	6,556,409	$	246,235	$	31,485	$	6,771,159	$	2,476

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 September 30, 2014 and December 31, 2013.

The amortized cost and estimated fair value of available-for-sale investments, excluding VIE investments, at September 30, 2014, by contractual maturity, were as follows:



	Amortized Cost		Estimated Fair Value
Due in one year or less	$	775,041	$	775,139
Due after one year through five years	1,183,781		1,183,703
Due after five years through ten years	1,247,527		1,251,073
Due after ten years	376,544		383,170
	3,582,893		3,593,085
Residential mortgage-backed securities	1,664,096		1,824,492
Collateralized debt obligations	45,876		46,040
Other asset-backed securities	1,263,544		1,307,542
Total	$	6,556,409	$	6,771,159

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, 2014 and December 31, 2013:



	Less Than 12 Months				12 Months or More				Total
	Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss
Successor Ambac - September 30, 2014
Fixed income securities:
Municipal obligations	$	67,274	$	1,369	$	155,408	$	7,971	$	222,682	$	9,340
Corporate obligations	474,889		3,419		209,911		6,130		684,800		9,549
Foreign government obligations	32,642		1,109		38,043		1,441		70,685		2,550
U.S. government obligations	9,302		351		14,667		601		23,969		952
U.S. agency obligations	—		—		4,413		44		4,413		44
Residential mortgage-backed securities	200,916		8,508		3,363		100		204,279		8,608
Collateralized debt obligations	5,442		75		—		—		5,442		75
Other asset-backed securities	169,755		75		—		—		169,755		75
	960,220		14,906		425,805		16,287		1,386,025		31,193
Short-term	1,368		—		—		—		1,368		—
	$	961,588	$	14,906	$	425,805	$	16,287	$	1,387,393	$	31,193
Fixed income securities, pledged as collateral:
U.S. government obligations	64,031		292		—		—		64,031		292
Total collateralized investments	64,031		292		—		—		64,031		292
Total temporarily impaired securities	$	1,025,619	$	15,198	$	425,805	$	16,287	$	1,451,424	$	31,485



	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, as of December 31, 2013 Successor Ambac did not have any gross unrealized losses that were 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 September 30, 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 September 30, 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 September 30, 2014, $240,497 of the total fair value and $11,202 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 Assurance claim payments, including interest on Deferred Amounts. Ambac estimates the timing of such claim payment receipts but the actual timing of such amounts are at the sole discretion of the Rehabilitator. Refer to Note 1 to the Unaudited Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for information relating to the amended Segregated Account Rehabilitation Plan and payments to be made on Deferred Amounts, together with interest thereon, as well as early redemptions of a portion of outstanding surplus notes (including accrued and unpaid interest thereon). Our evaluation of other-than-temporary impairments as of September 30, 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 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, further modifications to the Segregated Account Rehabilitation Plan or to the rules and guidelines promulgated thereunder, 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 September 30, 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 $8,608 of unrealized losses on residential mortgage-backed securities, $6,805 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 September 30, 2014 on these transactions.

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:



	Period from July 1			Period from July 1
	through			through
	September 30, 2014			September 30, 2013
Gross realized gains on securities	$	7,658		$	3,906
Gross realized losses on securities	(3,908		)	(7,239		)
Foreign exchange gains (losses)	6,295			(6,977		)
Net realized gains (losses)	$	10,045		$	(10,310	)
Net other-than-temporary impairments ⁽¹⁾	$	(5,011	)	$	(38,037	)



	Successor Ambac –						Predecessor Ambac –
	Period from January 1			Period from May 1			Period from January 1
	through			through			through
	September 30, 2014			September 30, 2013			April 30, 2013
Gross realized gains on securities	$	37,355		$	20,518		$	47,448
Gross realized losses on securities	(7,779		)	(8,831		)	(320		)
Foreign exchange (losses) gains	(175		)	(3,525		)	6,177
Net realized gains	$	29,401		$	8,162		$	53,305
Net other-than-temporary impairments ⁽¹⁾	$	(24,157	)	$	(40,039	)	$	(467	)


(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 period from January 1, 2013 through 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 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 September 30, 2014. Future changes in our estimated liquidity needs could result in a determination that Ambac no longer has the ability to hold additional 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, 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	11,337
Securities previously impaired	—
Reductions for credit impairments previously recognized on:
Securities that matured or were sold during the period	—
Balance as of September 30, 2014	$	12,519

Predecessor Ambac:
Balance as of January 1, 2013	$	183,300
Additions for credit impairments recognized on:
Securities not previously impaired	467
Securities previously impaired	—
Reductions for credit impairments previously recognized on:
Securities that matured or were sold during the period	(183,767		)
Balance as of April 30, 2013	$	—

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		)
Balance as of September 30, 2013	$	1,029

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 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, these 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, 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 - September 30, 2014
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio	$	330,681	$	158,040	$	172,641
Cash and securities pledged from derivative counterparties	—		—		—

Successor Ambac - December 31, 2013
Sources of Collateral:
Cash and securities pledged directly from the investment portfolio	$	500,986	$	371,723	$	129,263
Cash and securities pledged from derivative counterparties	690		—		—

Securities carried at $6,766 and $6,799 at September 30, 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 $0 and $240,150 at September 30, 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 third party debt was fully repaid in 2013 and trust was liquidated in 2014. Prior to liquidation of the trust, the securities could not be sold or repledged by the trust. These assets were held and the secured debt issued by entities that qualified as VIEs and were 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 September 30, 2014 and December 31, 2013, respectively:



	Municipal obligations		Corporate obligations		Mortgage and asset- backed securities		Short-term		Total		Weighted Average Underlying Rating ⁽¹⁾
Successor Ambac - September 30, 2014:
Ambac Assurance Corporation ⁽²⁾	$	66,213	$	—	$	2,206,828	$	—	$	2,273,041	CCC
Assured Guaranty Municipal Corporation	290,395		78,423		—		—		368,818		A+
National Public Finance Guarantee Corporation	234,577		34,707		—		—		269,284		A+
Assured Guaranty Corporation	—		—		2,639		—		2,639		D
MBIA Insurance Corporation	—		—		—		—		—
Financial Guarantee Insurance Corporation	—		—		—		—		—
Total	$	591,185	$	113,130	$	2,209,467	$	—	$	2,913,782	B

Successor Ambac - December 31, 2013:
Ambac Assurance Corporation ⁽²⁾	$	64,596	$	—	$	1,747,283	$	—	$	1,811,879	CCC
Assured Guaranty Municipal Corporation	372,392		77,163		—		—		449,555		A+
National Public Finance Guarantee Corporation	532,752		37,642		—		—		570,394		AA-
Assured Guaranty Corporation	—		—		2,917		—		2,917		D
MBIA Insurance Corporation	—		17,444		—		—		17,444		BBB-
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 September 30, 2014 and December 31, 2013, respectively, insured by Ambac UK.

Investment Income:

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



	Period from July 1			Period from July 1
	through			through
	September 30, 2014			September 30, 2013
Fixed income securities	$	84,339		$	53,301
Short-term investments	832			626
Loans	123			109
Investment expense	(2,413		)	(2,260		)
Securities available-for-sale and short-term	82,881			51,776
Other investments	700			350
Total net investment income	$	83,581		$	52,126



	Successor Ambac –						Predecessor Ambac –
	Period from January 1			Period from May 1			Period from January 1
	through			through			through
	September 30, 2014			September 30, 2013			April 30, 2013
Fixed income securities	$	233,878		$	83,732		$	118,097
Short-term investments	2,000			788			677
Loans	415			193			146
Investment expense	(7,723		)	(3,726		)	(2,549		)
Securities available-for-sale and short-term	228,570			80,987			116,371
Other investments	5,905			(2,665		)	369
Total net investment income	$	234,475		$	78,322		$	116,740

Net investment income from Other investments includes income on investments in unconsolidated subsidiaries and changes in fair value on securities classified as trading or under the fair value option. With respect to securities classified as trading or under the fair value option, Successor Ambac gains for the three and nine months ended September 30, 2014 on securities still held at September 30, 2014 was $329 and $5,965, respectively. Successor Ambac gains and (losses) for the three and five months ended September 30, 2013 on such securities still held at the reporting date was $1,577 and ($784), respectively. Predecessor Ambac losses for the four months ended April 30, 2013 were ($78) for such securities still held at September 30, 2013