9. DERIVATIVE INSTRUMENTS

The following tables summarize the gross fair values of individual derivative instruments and the impact of legal rights of offset as reported in the Consolidated Balance Sheets as of June 30, 2017 and December 31, 2016:



	Gross Amounts of Recognized Assets / Liabilities		Gross Amounts Offset in the Consolidated Balance Sheet		Net Amounts of Assets/ Liabilities Presented in the Consolidated Balance Sheet		Gross Amount of Collateral Received / Pledged Not Offset in the Consolidated Balance Sheet		Net Amount
June 30, 2017:
Derivative Assets:
Interest rate swaps	$	76,667	$	731	$	75,936	$	—	$	75,936
Futures contracts	3,111		—		3,111		—		3,111
Total non-VIE derivative assets	$	79,778	$	731	$	79,047	$	—	$	79,047
Derivative Liabilities:
Credit derivatives	$	9,006	$	—	$	9,006	$	—	$	9,006
Interest rate swaps	83,274		731		82,543		81,129		1,414
Futures contracts	—		—		—		—		—
Total non-VIE derivative liabilities	$	92,280	$	731	$	91,549	$	81,129	$	10,420
Variable Interest Entities Derivative Assets:
Currency swaps	$	65,507	$	—	$	65,507	$	—	$	65,507
Total VIE derivative assets	$	65,507	$	—	$	65,507	$	—	$	65,507
Variable Interest Entities Derivative Liabilities:
Interest rate swaps	$	2,064,071	$	—	$	2,064,071	$	—	$	2,064,071
Total VIE derivative liabilities	$	2,064,071	$	—	$	2,064,071	$	—	$	2,064,071

December 31, 2016:
Derivative Assets:
Interest rate swaps	$	139,045	$	61,839	$	77,206	$	—	$	77,206
Futures contracts	536		—		536		—		536
Total non-VIE derivative assets	$	139,581	$	61,839	$	77,742	$	—	$	77,742
Derivative Liabilities:
Credit derivatives	$	15,349	$	—	$	15,349	$	—	$	15,349
Interest rate swaps	365,776		61,839		303,937		156,925		147,012
Total non-VIE derivative liabilities	$	381,125	$	61,839	$	319,286	$	156,925	$	162,361
Variable Interest Entities Derivative Assets:
Currency swaps	$	80,407	$	—	$	80,407	$	—	$	80,407
Total VIE derivative assets	$	80,407	$	—	$	80,407	$	—	$	80,407
Variable Interest Entities Derivative Liabilities:
Interest rate swaps	$	2,078,601	$	—	$	2,078,601	$	—	$	2,078,601
Total VIE derivative liabilities	$	2,078,601	$	—	$	2,078,601	$	—	$	2,078,601

Effective January 3, 2017, the central clearing party ("CCP") for certain of Ambac's derivative contracts changed its rules governing the character of variation payments. Under the new CCP rules, variation payments are considered settlements of the associated derivative balance. Prior to the rule change such variation payments were considered to be margin and were not offset against the fair value of the derivatives, but were recognized as collateral receivable or payable. The amount of variation margin included within "Other assets" on the Consolidated Balance Sheet as of December 31, 2016, and was applied as a reduction to derivative liabilities effective January 3, 2017 under the new CCP rules is $71,023. Amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral are not offset against fair value amounts recognized for derivative instruments on the Consolidated Balance Sheets. The amounts representing the right to reclaim cash collateral and posted margin, recorded in “Other assets” were $52,977 and $137,701 as of June 30, 2017 and December 31, 2016, respectively. There were no amounts held representing an obligation to return cash collateral as of June 30, 2017 and December 31, 2016.

The following tables summarize the location and amount of gains and losses of derivative contracts in the Consolidated Statements of Total Comprehensive Income (Loss) for the three and six months ended June 30, 2017 and 2016:



	Location of Gain or (Loss) Recognized in Consolidated Statements of Total Comprehensive Income (Loss)	Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income (Loss)
		Three Months Ended June 30,						Six Months Ended June 30,
		2017			2016			2017			2016
Non-VIEs:
Credit derivatives	Net change in fair value of credit derivatives	$	6,624		$	3,955		$	7,676		$	16,821
Non-VIE derivatives:
Interest rate swaps	Net gains (losses) on interest rate derivatives	37,141			(33,326		)	37,249			(110,433		)
Futures contracts	Net gains (losses) on interest rate derivatives	(3,073		)	(3,005		)	(4,695		)	(9,322		)
Total Non-VIE derivatives		34,068			(36,331		)	32,554			(119,755		)
Variable Interest Entities:
Currency swaps	Income (loss) on variable interest entities	(9,951		)	14,366			(14,899		)	26,305
Interest rate swaps	Income (loss) on variable interest entities	34			(437		)	14,530			(158,780		)
Total Variable Interest Entities		(9,917		)	13,929			(369		)	(132,475		)
Total derivative contracts		$	30,775		$	(18,447	)	$	39,861		$	(235,409	)

Credit Derivatives:

Credit derivatives, which are privately negotiated contracts, provide the counterparty with credit protection against the occurrence of a specific event such as a payment default or bankruptcy relating to an underlying obligation. Upon a credit event, Ambac is required to make payments equal to the difference between the scheduled debt service payment and the actual payment made by the issuer. Credit derivatives issued are insured by Ambac Assurance. None of the outstanding credit derivative transactions at June 30, 2017 include ratings based collateral-posting triggers or otherwise require Ambac to post collateral regardless of Ambac’s ratings or the size of the mark to market exposure to Ambac.

The portfolio of our credit derivatives were written on a “pay-as-you-go” basis. Similar to an insurance policy execution, pay-as-you-go provides that Ambac pays interest shortfalls on the referenced transaction as they are incurred on each scheduled payment date, but only pays principal shortfalls upon the earlier of (i) the date on which the assets designated to fund the referenced obligation have been disposed of and (ii) the legal final maturity date of the referenced obligation.

Ambac maintains internal credit ratings on its guaranteed obligations, including credit derivative contracts, solely to indicate management’s view of the underlying credit quality of the guaranteed obligations. Independent rating agencies may have assigned different ratings on the credits in Ambac’s portfolio than Ambac’s internal ratings. The following table summarizes the gross principal notional outstanding for CDS contracts, by Ambac rating as of June 30, 2017 and December 31, 2016:



Ambac Rating	June 30, 2017		December 31, 2016
AAA	$	—	$	—
AA	240,850		315,201
A	—		227,146
BBB ⁽¹⁾	142,750		127,250
Below investment grade ⁽²⁾	72,192		67,783
Total	$	455,792	$	737,380


(1)	BBB internal ratings reflect bonds which are of medium grade credit quality with adequate capacity to pay interest and repay principal. Certain protective elements and margins may weaken under adverse economic conditions and changing circumstances. These bonds are more likely than higher rated bonds to exhibit unreliable protection levels over all cycles.


(2)	Below investment grade internal ratings reflect bonds which are of speculative grade credit quality with the adequacy of future margin levels for payment of interest and repayment of principal potentially adversely affected by major ongoing uncertainties or exposure to adverse conditions.

The table below summarizes other information related to credit derivatives outstanding as of June 30, 2017 and December 31, 2016:



	June 30, 2017		December 31, 2016
Number of CDS transactions	5		8
Remaining expected weighted-average life of obligations (in years)	5.7		5.2
Gross principal notional outstanding	$	455,792	$	737,380
Net derivative liabilities at fair value	$	9,006	$	15,349

The maximum potential amount of future payments under Ambac’s credit derivative contracts is generally the gross principal notional outstanding amount included in the above table plus future interest payments payable by the derivative reference obligations. Since Ambac’s credit derivatives typically reference obligations of or assets held by special purpose entities that meet the definition of a VIE, the amount of maximum potential future payments for credit derivatives is included in the table in Note 3. Special Purpose Entities, Including Variable Interest Entities.

Changes in fair value of Ambac’s credit derivative contracts are accounted for at fair value since they do not qualify for the financial guarantee scope exception under the Derivatives and Hedging Topic of the ASC. Changes in fair value are recorded in “Net change in fair value of credit derivatives” on the Consolidated Statements of Total Comprehensive Income (Loss). Although CDS contracts are accounted for at fair value, they are surveilled similar to non-derivative financial guarantee contracts. As with financial guarantee insurance policies, Ambac’s Portfolio Risk Management group tracks credit migration of CDS contracts’ reference obligations from period to period.

Adversely classified credits are assigned risk classifications by the Portfolio Risk Management group. As of June 30, 2017, there are two CDS contracts on Ambac’s adversely classified credit listing, with a net derivative liability fair value of $6,031 and gross notional principal outstanding of $72,192. As of December 31, 2016, there were two CDS contracts on Ambac’s adversely classified credit listing, with a net derivative liability fair value of $6,123 and total notional principal outstanding of $67,783.

Interest Rate Derivatives:

Ambac, through its subsidiary Ambac Financial Services (“AFS”), provided interest rate swaps to states, municipalities and their authorities, asset-backed issuers and other entities in connection with their financings. Additionally, AFS uses interest rate derivatives as an economic hedge against the effects of rising interest rates elsewhere in the Company, including on Ambac’s financial guarantee exposures. As of June 30, 2017 and December 31, 2016 the notional amounts of AFS’s derivatives are as follows:



	Notional
Type of derivative	June 30, 2017		December 31, 2016
Interest rate swaps—receive-fixed/pay-variable	$	579,648	$	973,130
Interest rate swaps—pay-fixed/receive-variable	281,920		1,874,678
US Treasury futures contracts—short	1,105,000		195,000

Derivatives of Consolidated Variable Interest Entities

Certain VIEs consolidated under the Consolidation Topic of the ASC entered into derivative contracts to meet specified purposes within the securitization structure. The notional for VIE derivatives outstanding as of June 30, 2017 and December 31, 2016 are as follows:



	Notional
Type of VIE derivative	June 30, 2017		December 31, 2016
Interest rate swaps—receive-fixed/pay-variable	$	1,428,396	$	1,352,010
Interest rate swaps—pay-fixed/receive-variable	2,409,852		2,300,584
Currency swaps	393,350		312,357
Credit derivatives	12,132		12,059

Contingent Features in Derivatives Related to Ambac Credit Risk

Ambac’s over-the-counter interest rate swaps are centrally cleared when eligible. Certain interest rate swaps remain with professional swap-dealer counterparties and certain front-end counterparties. These non-cleared swaps are generally executed under standardized derivative documents including collateral support and master netting agreements. Under these agreements, Ambac is required to post collateral in the event net unrealized losses exceed predetermined threshold levels. Additionally, given that Ambac Assurance is no longer rated by an independent rating agency, counterparties have the right to terminate the swap positions.

As of June 30, 2017 and December 31, 2016, the net liability fair value of derivative instruments with contingent features linked to Ambac’s own credit risk was $81,814 and $82,944, respectively, related to which Ambac had posted cash and securities as collateral with a fair value of $102,090 and $128,754, respectively. All such ratings-based contingent features have been triggered as requiring maximum collateral levels to be posted by Ambac while preserving counterparties’ rights to terminate the contracts. Assuming all such contracts terminated on June 30, 2017, settlement of collateral balances and net derivative liabilities would result in a net receipt of cash and/or securities by Ambac. If counterparties elect to exercise their right to terminate, the actual termination payment amounts will be determined in accordance with derivative contract terms, which may result in amounts that differ from market values as reported in Ambac’s financial statements.