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 has two reportable business segments: Financial Guarantee and Financial Services.

Ambac’s financial guarantee business segment is conducted through its primary operating subsidiary, Ambac Assurance Corporation (“Ambac Assurance”) 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 Assurance also has another wholly-owned financial guarantee 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's subsidiaries from being able to write new business. An 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’s financial services business segment is conducted through subsidiaries of Ambac Assurance, which provide financial products, including investment agreements, funding conduits and interest rate swaps, principally to the clients of its financial guarantee business. Ambac Assurance insured all of the obligations of its financial services subsidiaries. These businesses are in active runoff, which is being effectuated by transaction terminations, settlements and scheduled amortization of contracts. The last remaining investment agreement matured in March 2017. The Financial Services business also maintains interest rate derivatives to mitigate interest rate risk in the insured and investment portfolios of the Financial Guarantee segment.

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.

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 March 31, 2017 for policies allocated to the Segregated Account was $11,274,275. 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 March 31, 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.

Ambac Assurance is evaluating the possibility of entering into, and may seek to enter into, one or more transactions to improve the financial condition of Ambac Assurance which may, subject to OCI approval, lead to the conclusion of the Segregated Account Rehabilitation Proceedings. In pursuing this objective, Ambac Assurance may seek to monetize certain assets, restructure, purchase, modify or exchange certain outstanding obligations, extinguish or modify certain contractual restrictions, and/or commute or reduce insured exposures, and is also discussing with OCI potential options for addressing outstanding Segregated Account and other obligations. Separately from or in connection with any such transaction we may seek to further optimize our capital and corporate structure to unlock shareholder value.

While the terms, conditions, and timing of a potential conclusion of the Segregated Account Rehabilitation Proceedings are in the sole discretion of the OCI, and subject to the approval of the Rehabilitation Court, Ambac Assurance has discussed, and is currently actively engaged in discussions, with counterparty creditors and OCI concerning a potential transaction pursuant to which outstanding Deferred Amounts and surplus notes, in each case including accrued interest, would be exchanged for or satisfied with cash, securities, or other instruments, assets or means. No assurance can be given that an agreement with respect to any such potential transaction will be reached or consummated.

On April 10, 2017, the Rehabilitator issued a statement indicating that the Special Deputy Commissioner ("SDC") has engaged in discussions with Ambac Assurance, policy beneficiaries, and other stakeholders to advance the goal of achieving a durable exit from Rehabilitation by the Segregated Account and, as a result, the SDC has recommended to the Rehabilitator that Ambac Assurance be allowed to further engage with stakeholders in an effort to reach a comprehensive consensual agreement for a durable plan of exit from Rehabilitation by the Segregated Account. According to the statement, the Rehabilitator agreed with such recommendation, recognizing that any such plan is subject to further review and that it will need to be approved by the Rehabilitator as well as the Rehabilitation Court. In his April 10th statement, the Rehabilitator also indicated that if a consensual plan acceptable to the Rehabilitator is not developed within sixty days from that time, the Rehabilitator may pursue a plan that he believes will provide for a durable exit and that is protective of policyholders. OCI has not specified a course of action to address Segregated Account or other obligations or to conclude the Segregated Account Rehabilitation Proceedings.

The Rehabilitator further indicated in the April 10, 2017 statement that he and the SDC are supportive of Ambac Assurance’s efforts to continue, over sixty days from that time, to work diligently to reach an agreement for a durable plan which will enable the Segregated Account to exit from Rehabilitation. The SDC is continuing to monitor this process closely and the Rehabilitator reserves the right to take all actions allowed or required under applicable law with respect to the Segregated Account, including the pursuit of the Rehabilitator's own aforementioned exit plan.

As of the date of this filing, Ambac Assurance has not reached any agreement on the terms of a potential transaction, and we cannot provide assurance that any such transaction will be entered into by Ambac Assurance within the timeframe allowed by OCI, or if it is, as to the ultimate timing, terms or conditions of any such transaction, or as to whether it could lead to the conclusion of the Segregated Account Rehabilitation Proceedings. Any such transaction would remain subject to the prior approval of the board of Ambac Assurance, OCI and the Rehabilitation Court and may require third party consents, which may not be obtained. 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.

The execution of Ambac’s strategy to increase the value of its investment in Ambac Assurance is 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.

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.

As a result of uncertainties associated with the aforementioned oversight by the Rehabilitator of the Segregated Account, 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 months ended March 31, 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.

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 losses and loss expenses of approximately $91,600 in the first quarter of 2017. The full benefit was partially offset by approximately $18,300 of losses related to other changes in assumptions, resulting in a net benefit of approximately $73,300. 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 Puerto 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 Highway and Transportation Authority ("HTA"), 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 receive 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 HTA, 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 any 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 summarily rejected 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, however, states that because COFINA does not generate surpluses, the dispositions of Chapter 4 are not applicable to COFINA. Moreover, the Explicative Declaration 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. Given that the statements in the Explicative Declaration seem to contradict the statutory language of Articles 4.01, 4.02 and 4.03, it is not clear how some of the provisions of 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 interfere with COFINA’s ability 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 COFINA structure and the rights of COFINA’s bondholders; 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 certain holders of senior COFINA bonds, sent a letter to BNY demanding immediate acceleration of all senior bonds issued by COFINA.

In response to letter requests from Governor Rossello, 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. It is currently unclear which additional Commonwealth entities and instrumentalities, if any, will pursue a plan of adjustment of their debts under Title III or continue to pursue consensual debt restructuring pursuant to Title VI of PROMESA. 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. 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, given that the Title III filings are the first two under PROMESA, 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.

Ambac Assurance is party to seven litigations related to its Puerto Rico exposures, including two litigations challenging the constitutionality and legality of the FEGP and the Fiscal Plan Compliance Act, discussed below under Note 11. Commitments and Contingencies.” Ambac Assurance filed several of those cases to protect and assert its rights under transaction documents and applicable law. Ambac Assurance has also intervened in the Lex Claims litigation to defend the COFINA structure against a challenge by certain GO bondholders. Some or all of the claims asserted in the cases against the Commonwealth or its officials or instrumentalities may be stayed under Title III of PROMESA. Accordingly, Ambac is unable to predict when and how the issues raised in those cases will be resolved. If we are 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. Primarily as a result of the continued uncertainty and volatility of the situation in Puerto Rico, Ambac incurred through losses and loss expenses a $169,400 expense associated with its Public Finance insured portfolio in the three months ended March 31, 2017. The majority of this incurred expense is attributable to increasing reserves for potential future losses, including estimated payments to commute certain exposures and expenses associated with mitigating and remediating such potential losses. 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 March 31, 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.