Fair Value Measurements

3 Months Ended

Mar. 31, 2020

Fair Value Disclosures [Abstract]

Fair Value Measurements

7. FAIR VALUE MEASUREMENTS

The Fair Value Measurement Topic of the ASC establishes a framework for measuring fair value and disclosures about fair value measurements.

Fair Value Hierarchy:

The Fair Value Measurement Topic of the ASC specifies a fair value hierarchy based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company-based assumptions. The fair value hierarchy prioritizes model inputs into three broad levels as follows:

l	Level 1	Quoted prices for identical instruments in active markets. Assets and liabilities classified as Level 1 include US Treasury and other foreign government obligations traded in highly liquid and transparent markets, certain highly liquid pooled fund investments, exchange traded futures contracts, variable rate demand obligations and money market funds.
l	Level 2	Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Assets and liabilities classified as Level 2 generally include investments in fixed income securities representing municipal, asset-backed and corporate obligations, certain interest rate swap contracts and most long-term debt of variable interest entities consolidated under the Consolidation Topic of the ASC.
l	Level 3	Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. This hierarchy requires the use of observable market data when available. Assets and liabilities classified as Level 3 include credit derivative contracts, certain uncollateralized interest rate swap contracts, equity interests in Ambac sponsored special purpose entities and certain investments in fixed income securities. Additionally, Level 3 assets and liabilities generally include loan receivables, and certain long-term debt of variable interest entities consolidated under the Consolidation Topic of the ASC.

The Fair Value Measurement Topic of the ASC permits, as a practical expedient, the estimation of fair value of certain investments in funds using the net asset value per share of the investment or its equivalent (“NAV”). Investments in funds valued using NAV are not categorized as Level 1, 2 or 3 under the fair value hierarchy. The following table sets forth the carrying amount and fair value of Ambac’s financial assets and liabilities as of March 31, 2020 and December 31, 2019, including the level within the fair value hierarchy at which fair value measurements are categorized. As required by the Fair Value Measurement Topic of the ASC, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

	Carrying Amount			Total Fair Value			Fair Value Measurements Categorized as:
March 31, 2020:							Level 1		Level 2			Level 3
Financial assets:
Fixed income securities:
Municipal obligations	$	218		$	218		$	—	$	218		$	—
Corporate obligations	1,261			1,261			—		1,261			—
Foreign obligations	42			42			42		—			—
U.S. government obligations	177			177			177		—			—
Residential mortgage-backed securities	203			203			—		203			—
Commercial mortgage-backed securities	51			51			—		51			—
Collateralized debt obligations	132			132			—		132			—
Other asset-backed securities	283			283			—		217			66
Fixed income securities, pledged as collateral:
Short-term	85			85			85		—			—
Short term investments	586			586			528		57			—
Other investments (1)	363			345			84		—			30
Cash, cash equivalents and restricted cash	89			89			86		3			—
Derivative assets:
Credit derivatives	—			—			—
Interest rate swaps—asset position	89			89			—		10			79
Interest rate swaps—liability position	(1		)	(1		)	—		(1		)	—
Other assets - equity in sponsored VIE	3			3			—		—			3
Other assets-Loans	10			11			—		—			11
Variable interest entity assets:
Fixed income securities: Corporate obligations	2,806			2,806			—		—			2,806
Fixed income securities: Municipal obligations	122			122			—		122			—
Restricted cash	2			2			2		—			—
Loans	2,932			2,932			—		—			2,932
Derivative assets: Currency swaps-asset position	62			62			—		62			—
Total financial assets	$	9,513		$	9,498		$	1,004	$	2,335		$	5,927
Financial liabilities:
Long term debt, including accrued interest	$	3,217		$	2,924		$	—	$	2,584		$	341
Derivative liabilities:
Credit derivatives	2			2			—		—			2
Interest rate swaps—asset position	(1		)	(1		)	—		(1		)	—
Interest rate swaps—liability position	136			136			—		136			—
Liabilities for net financial guarantees written (2)	(763		)	1,057			—		—			1,057
Variable interest entity liabilities:
Long-term debt (includes $4,092 at fair value)	4,263			4,274			—		4,115			158
Derivative liabilities: Interest rate swaps—liability position	1,610			1,610			—		1,610			—
Total financial liabilities	$	8,464		$	10,001		$	—	$	8,444		$	1,558

	Carrying Amount			Total Fair Value		Fair Value Measurements Categorized as:
December 31, 2019:						Level 1		Level 2		Level 3
Financial assets:
Fixed income securities:
Municipal obligations	$	215		$	215	$	—	$	215	$	—
Corporate obligations	1,430			1,430		—		1,430		—
Foreign obligations	44			44		44		—		—
U.S. government obligations	156			156		156		—		—
Residential mortgage-backed securities	248			248		—		248		—
Commercial mortgage-backed securities	50			50		—		50		—
Collateralized debt obligations	146			146		—		146		—
Other asset-backed securities	287			287		—		215		72
Fixed income securities, pledged as collateral:
Short-term	85			85		85		—		—
Short term investments	653			653		598		55		—
Other investments (1)	478			493		136		—		61
Cash and cash equivalents and restricted cash	79			79		70		9		—
Derivative assets:
Interest rate swaps—asset position	75			75		—		8		67
Other assets - equity in sponsored VIE	3			3		—		—		3
Other assets-loans	10			13		—		—		13
Variable interest entity assets:
Fixed income securities: Corporate obligations	2,957			2,957		—		—		2,957
Fixed income securities: Municipal obligations	164			164		—		164		—
Restricted cash	2			2		2		—		—
Loans	3,108			3,108		—		—		3,108
Derivative assets: Currency swaps—asset position	52			52		—		52		—
Total financial assets	$	10,242		$	10,260	$	1,091	$	2,593	$	6,281
Financial liabilities:
Long term debt, including accrued interest	$	3,262		$	3,274	$	—	$	2,829	$	445
Derivative liabilities:
Interest rate swaps—liability position	89			89		—		89		—
Liabilities for net financial guarantees written (2)	(863		)	284		—		—		284
Variable interest entity liabilities:
Long-term debt	4,554			4,567		—		4,408		159
Derivative liabilities: Interest rate swaps—liability position	1,657			1,657		—		1,657		—
Total financial liabilities	$	8,699		$	9,872	$	—	$	8,983	$	889

(1) Excluded from the fair value measurement categories in the table above are investment funds of $232 and $296 as of March 31, 2020 and December 31, 2019, respectively, which are measured using NAV as a practical expedient.

(2) The carrying value of net financial guarantees written includes the following balance sheet items: Premium receivables; Reinsurance recoverable on paid and unpaid losses; Deferred ceded premium; Subrogation recoverable; Insurance intangible asset; Unearned premiums; Loss and loss expense reserves; Ceded premiums payable, premiums taxes payable and other deferred fees recorded in Other liabilities.

Determination of Fair Value:

When available, Ambac uses quoted active market prices specific to the financial instrument to determine fair value, and classifies such items within Level 1. The determination of fair value for financial instruments categorized in Level 2 or 3 involves judgment due to the complexity of factors contributing to the valuation. Third-party sources from which we obtain independent market quotes also use assumptions, judgments and estimates in determining financial instrument values and different third parties may use different methodologies or provide different values for financial instruments. In addition, the use of internal valuation models may require assumptions about hypothetical or inactive markets. As a result of these factors, the actual trade value of a financial instrument in the market, or exit value of a financial instrument position by Ambac, may be significantly different from its recorded fair value.

Ambac’s financial instruments carried at fair value are mainly comprised of investments in fixed income securities, equity interests in pooled investment funds, derivative instruments, certain variable interest entity assets and liabilities and interests in Ambac sponsored special purpose entities. Valuation of financial instruments is performed by Ambac’s finance group using methods approved by senior financial management with consultation from risk management and portfolio managers as appropriate. Preliminary valuation results are discussed with portfolio managers quarterly to assess consistency with market transactions and trends as applicable. Market transactions such as trades or negotiated settlements of similar positions, if any, are reviewed to validate fair value model results. However, many of the financial instruments valued using significant unobservable inputs have very little or no observable market activity. Methods and significant inputs and assumptions used to determine fair values across portfolios are reviewed quarterly by senior financial management. Other valuation control procedures specific to particular portfolios are described further below.

Fixed Income Securities:

The fair values of fixed income investment securities are based primarily on market prices received from quotes or alternative pricing sources. Because many fixed income securities do not trade on a daily basis, pricing sources apply available market information through processes such as matrix pricing to calculate fair value. Such prices generally consider a variety of factors, including recent trades of the same and similar securities. In those cases, the items are classified within Level 2. For those fixed income investments where quotes were not available or cannot be reasonably corroborated, fair values are based on internal valuation models. Key inputs to the internal valuation models generally include maturity date, coupon and yield curves for asset-type and credit rating characteristics that closely match those characteristics of the specific investment securities being valued. Items valued using valuation models are classified according to the lowest level input or value driver that is significant to the valuation. Thus, an item may be classified in Level 3 even though there may be significant inputs that are readily observable. Longer (shorter) expected maturities or higher (lower) yields used in the valuation model will, in isolation, result in decreases (increases) in fair value. Generally, lower credit ratings or longer expected maturities will be accompanied by higher yields used to value a security. At March 31, 2020, approximately 4%, 94% and 2% of the fixed income investment portfolio

(excluding variable interest entity investments) was valued using broker quotes, alternative pricing sources and internal valuation models, respectively. At December 31, 2019, approximately 4%, 94% and 2% of the fixed income investment portfolio (excluding variable interest entity investments) was valued using broker quotes, alternative pricing sources and internal valuation models, respectively.

Ambac performs various review and validation procedures to quoted and modeled prices for fixed income securities, including price variance analyses, missing and static price reviews, overall valuation analysis by portfolio managers and finance managers and reviews associated with our ongoing impairment analysis. Unusual prices identified through these procedures will be evaluated further against alternative third party quotes (if available) and/or internally modeled prices, and the pricing source values will be challenged as necessary. Price challenges generally result in the use of the pricing source’s quote as originally provided or as revised by the source following their internal diligence process. A price challenge may result in a determination by either the pricing source or Ambac management that the pricing source cannot provide a reasonable value for a security or cannot adequately support a quote, in which case Ambac would resort to using either other quotes or internal models. Results of price challenges are reviewed by portfolio managers and finance managers.

Information about the valuation inputs for fixed income securities classified as Level 3 is included below:

Other asset-backed securities: This security is a subordinated tranche of a resecuritization collateralized by Ambac-insured military housing bonds. The fair value classified as Level 3 was $66 and $72 at March 31, 2020 and December 31, 2019, respectively. Fair value was calculated using a discounted cash flow approach with expected future cash flows discounted using a yield consistent with the security type and rating. Significant inputs for the valuation at March 31, 2020 and December 31, 2019 include the following:

March 31, 2020:
a. Coupon rate:	5.98%
b. Average Life:	15.36 years
c. Yield:	13.00%
December 31, 2019:
a. Coupon rate:	5.97%
b. Average Life:	15.58 years
c. Yield:	11.75%

Other Investments:

Other investments primarily relate to investments in pooled investment funds. The fair value of pooled investment funds is determined using dealer quotes or alternative pricing sources when such investments have readily determinable fair values. When fair value is not readily determinable, pooled investment funds are valued using NAV as a practical expedient as permitted under the Fair Value Measurement Topic of the ASC. Refer to Note 8.

Investments for additional information about such investments in pooled funds that are reported at fair value using NAV as a practical expedient.

Other investments also includes Ambac's equity interest in a non-consolidated VIE created in connection with Ambac's monetization of Ambac Assurance junior surplus notes. This equity interest is carried under the equity method. Fair value for the non-consolidated VIE equity interest is internally calculated using a market approach and is classified as Level 3.

Derivative Instruments:

Ambac’s derivative instruments primarily comprise interest rate swaps, credit default swaps and exchange traded futures contracts. Fair value is determined based upon market quotes from independent sources, when available. When independent quotes are not available, fair value is determined using valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. The valuation of certain derivative contracts also require the use of data inputs and assumptions that are determined by management and are not readily observable in the market. Under the Fair Value Measurement Topic of the ASC, Ambac is required to consider its own credit risk when measuring the fair value of derivatives and other liabilities. Factors considered in estimating the amount of any Ambac credit valuation adjustment ("CVA") on such contracts include collateral posting provisions, right of set-off with the counterparty, the period of time remaining on the derivative and the pricing of recent terminations. The fair value of credit derivative liabilities was reduced by $0 and $0 at March 31, 2020 and December 31, 2019, respectively, as a result of incorporating an Ambac CVA into the valuation model for these contracts. Interest rate swap liabilities are collateralized and are not adjusted with an Ambac CVA at March 31, 2020 and December 31, 2019.

Interest rate swaps that are not centrally cleared are valued using vendor-developed models that incorporate interest rates and yield curves that are observable and regularly quoted. These models provide the net present value of the derivatives based on contractual terms and observable market data. Generally, the need for counterparty (or Ambac) CVAs on interest rate derivatives is mitigated by the existence of collateral posting agreements under which adequate collateral has been posted. Certain of these derivative contracts entered into with financial guarantee customers are not subject to collateral posting agreements. Counterparty credit risk related to such customer derivative assets is included in our determination of their fair value.

Ambac's remaining credit derivatives ("CDS") are valued using an internal model that uses traditional financial guarantee CDS pricing to calculate the fair value of the derivative contract based on the reference obligation's current pricing, remaining life and credit rating and Ambac's own credit risk. The model calculates the difference between the present value of the projected fees receivable under the CDS and our estimate of the fees a financial guarantor of comparable credit quality would charge to provide the same protection at the balance sheet date. Unobservable inputs used include Ambac's internal reference obligation credit ratings and expected life, estimates of fees that would be charged to assume the credit derivative obligation and Ambac's CVA. Ambac is party to

only one remaining credit derivative with internal credit rating of AA at March 31, 2020. Ambac has not made any significant changes to its modeling techniques or related model inputs for the periods presented.

Financial Guarantees:

Fair value of net financial guarantees written represents our estimate of the cost to Ambac to completely transfer its insurance obligation to another market participant of comparable credit worthiness. In theory, this amount should be the same amount that another market participant of comparable credit worthiness would hypothetically charge in the market place, on a present value basis, to provide the same protection as of the balance sheet date. This fair value estimate of financial guarantees is presented on a net basis and includes direct and assumed contracts written, net of ceded reinsurance contracts.

Long-term Debt:

Long-term debt includes Ambac Assurance surplus notes and junior surplus notes, the Ambac Note and Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions and the Ambac UK debt issued in connection with the Ballantyne commutation. The fair values of surplus notes, the Ambac Note and Tier 2 Notes are classified as Level 2. The fair value of junior surplus notes and Ambac UK debt are classified as Level 3.

Other Financial Assets and Liabilities:

Included in Other assets are Loans and Ambac’s equity interest in an Ambac sponsored VIE established to provide certain financial guarantee clients with funding for their debt obligations. The fair values of these financial assets are estimated based upon internal valuation models and are classified as Level 3.

Variable Interest Entity Assets and Liabilities:

The financial assets and liabilities of VIEs consolidated under the Consolidation Topic of the ASC consist primarily of fixed income securities, loans, derivative and debt instruments and are generally carried at fair value. These consolidated VIEs are securitization entities which have liabilities and/or assets guaranteed by Ambac Assurance or Ambac UK. The fair values of VIE debt instruments are determined using the same methodologies used to value Ambac’s fixed income securities in its investment portfolio as described above. VIE debt fair value is based on market prices received from independent market sources. Such quotes are considered Level 2 and generally consider a variety of factors, including recent trades of the same and similar securities. VIE debt fair value balances at March 31, 2020 and December 31, 2019 were based on market prices received from independent market sources and do not use significant unobservable inputs. Comparable to the sensitivities of investments in fixed income securities described above, longer (shorter) expected maturities or higher (lower) yields used in the valuation model will, in isolation, result in decreases (increases) in fair value liability measurement for VIE debt.

VIE derivative asset and liability fair values are determined using valuation models. When specific derivative contractual terms are available and may be valued primarily by reference to interest rates, foreign exchange rates and yield curves that are observable and regularly quoted, the derivatives are valued using vendor-developed models. Other derivatives within the VIEs that include significant unobservable valuation inputs are valued using internally developed

models. VIE derivative liability fair value balances at March 31, 2020 and December 31, 2019 were developed using vendor-developed models and do not use significant unobservable inputs.

The fair value of VIE assets are obtained from market quotes when available. Typically VIE asset fair values are not readily available from market quotes and are estimated internally. The consolidated VIEs are entities in which net cash flows from assets and derivatives (after adjusting for financial guarantor cash flows and other expenses) will be paid out to note holders or equity interests. Internal valuations of VIE assets (fixed income securities or loans), therefore, are generally derived from the fair value of notes and derivatives, as described above, adjusted for the fair value of cash flows from Ambac’s financial guarantee. The fair value of financial guarantee cash flows include: (i) estimated future premiums discounted at a rate consistent with that implicit in the fair value of the VIE’s liabilities and (ii) internal estimates of future loss payments by Ambac discounted at a rate that includes Ambac’s own credit risk. Estimated future premium payments to be paid by the VIEs were discounted at a par-weighted average rate of 2.5% and 2.7% at March 31, 2020 and December 31, 2019, respectively. At March 31, 2020, the range of these discount rates was between 2.3% and 11.0%. The value of future loss payments to be paid by Ambac to the VIEs was adjusted to include an Ambac CVA appropriate for the term of expected Ambac claim payments.

Additional Fair Value Information for Financial Assets and Liabilities Accounted for at Fair Value:

The following tables present the changes in the Level 3 fair value category for the periods presented in 2020 and 2019. Ambac classifies financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Thus, the gains and losses presented below include changes in the fair value related to both observable and unobservable inputs.

Level 3 - Financial Assets and Liabilities Accounted for at Fair Value
									VIE Assets and Liabilities
	Investments			Other Assets(1)		Derivatives			Investments			Loans			Long-term Debt			Total
Three Months Ended March 31, 2020:
Balance, beginning of period	$	72		$	3	$	66		$	2,957		$	3,108		$	—		$	6,207
Total gains/(losses) realized and unrealized:
Included in earnings	—			—		12			30			88			—			130
Included in other comprehensive income	(6		)	—		—			(181		)	(190		)	—			(377		)
Purchases	—			—		—			—			—			—			—
Issuances	—			—		—			—			—			—			—
Sales	—			—		—			—			—			—			—
Settlements	—			—		(1		)	—			(74		)	—			(76		)
Balance, end of period	$	66		$	3	$	77		$	2,806		$	2,932		$	—		$	5,884
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—		$	—	$	12		$	30		$	88		$	—		$	129
The amount of total gains/(losses) included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	(6	)	$	—	$	—		$	(181	)	$	(190	)	$	—		$	(377	)
Three Months Ended March 31, 2019:
Balance, beginning of period	$	72		$	5	$	46		$	2,737		$	4,288		$	(217	)	$	6,930
Total gains/(losses) realized and unrealized:
Included in earnings	—			—		8			67			88			(3		)	160
Included in other comprehensive income	—			—		—			54			85			(4		)	135
Purchases	—			—		—			—			—			—			—
Issuances	—			—		—			—			—			—			—
Sales	—			—		—			—			—			—			—
Settlements	—			—		(1		)	—			(85		)	—			(87		)
Balance, end of period	$	72		$	4	$	53		$	2,858		$	4,376		$	(224	)	$	7,139
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—		$	—	$	8		$	67		$	88		$	3		$	166

(1) Other assets carried at fair value and classified as Level 3 relate to an equity interest in an Ambac sponsored VIE.

The tables below provide roll-forward information by class of investments and derivatives measured using significant unobservable inputs.

Level 3 - Investments by Class:
	Three Months Ended March 31,
Other Asset Backed Securities	2020			2019
Balance, beginning of period	$	72		$	72
Total gains/(losses) realized and unrealized:
Included in earnings	—			—
Included in other comprehensive income	(6		)	—
Purchases	—			—
Issuances	—			—
Sales	—			—
Settlements	—			—
Balance, end of period	$	66		$	72
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	—		$	—
The amount of total gains/(losses) included in other comprehensive income attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	(6		)

Level 3 - Derivatives by Class:
	Three Months Ended March 31, 2020									Three Months Ended March 31, 2019
	Interest Rate Swaps			Credit Derivatives			Total Derivatives			Interest Rate Swaps			Credit Derivatives			Total Derivatives
Balance, beginning of period	$	67		$	—		$	66		$	47		$	(1	)	$	46
Total gains/(losses) realized and unrealized:
Included in earnings	13			(1		)	12			8			—			8
Included in other comprehensive income	—			—			—			—			—			—
Purchases	—			—			—			—			—			—
Issuances	—			—			—			—			—			—
Sales	—			—			—			—			—			—
Settlements	(1		)	—			(1		)	(1		)	—			(1		)
Balance, end of period	$	79		$	(2	)	$	77		$	54		$	(1	)	$	53
The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to assets and liabilities still held at the reporting date	$	13		$	(2	)	$	12		$	8		$	—		$	8

Invested assets and VIE long-term debt are transferred into Level 3 when internal valuation models that include significant unobservable inputs are used to estimate fair value. All such securities that have internally modeled fair values have been classified as Level 3.

Derivative instruments are transferred into Level 3 when the use of unobservable inputs becomes significant to the overall valuation.

There were no transfers of financial instruments into or out of Level 3 in the periods disclosed.

Gains and losses (realized and unrealized) relating to Level 3 assets and liabilities included in earnings for the affected periods are reported as follows:

	Net Investment Income		Net Gains (Losses) on Derivative Contracts		Income (Loss) on Variable Interest Entities		Other Income or (Loss)
Three Months Ended March 31, 2020:
Total gains or losses included in earnings for the period	$	—	$	12	$	118	$	—
Changes in unrealized gains or losses included in earnings relating to the assets and liabilities still held at the reporting date	—		12		118		—
Three Months Ended March 31, 2019:
Total gains or losses included in earnings for the period	$	—	$	8	$	152	$	—
Changes in unrealized gains or losses included in earnings relating to the assets and liabilities still held at the reporting date	—		8		152		—