Derivative Instruments

6 Months Ended

Jun. 30, 2012

Derivative Instruments [Abstract]

Derivative Instruments

9. Derivative Instruments

The following tables summarize the location and fair values of individual derivative instruments reported in the Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011. Amounts are presented gross of the effect of offsetting balances even where a legal right of offset exists.

Fair Values of Derivative Instruments

	Derivative Asset			Derivative Liability
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair value
June 30, 2012
Derivatives held for trading
Credit derivatives	Derivative assets	$	—	Derivative liabilities	$	211,617
Interest rate swaps	Derivative assets		392,766	Derivative liabilities		180,713
	Derivative liabilities		582	Derivative assets		259,852
Currency swaps	Derivative assets		—	Derivative liabilities		570
Futures contracts	Derivative assets		—	Derivative liabilities		1,541
Other contracts	Derivative assets		—	Derivative liabilities		180
Total derivatives held for trading			393,348			654,473
Call options on long-term debt	Derivative assets		—	Derivative liabilities		—
Total non-VIE derivatives		$	393,348		$	654,473
Variable Interest Entities
Currency swaps	VIE—Derivative liabilities		—	VIE—Derivative liabilities		85,072
Interest rate swaps	VIE—Derivative liabilities		—	VIE—Derivative liabilities		1,978,737
Total VIE derivatives		$	—		$	2,063,809
December 31, 2011:
Derivatives held for trading
Credit derivatives	Derivative assets	$	—	Derivative liabilities	$	190,653
Interest rate swaps	Derivative assets		411,652	Derivative liabilities		251,303
	Derivative liabilities		30,859	Derivative assets		242,500
Currency swaps	Derivative assets		—	Derivative liabilities		2,423
Futures contracts	Derivative assets		—	Derivative liabilities		627
Other contracts	Derivative assets		—	Derivative liabilities		361
Total derivatives held for trading			442,511			687,867
Call options on long-term debt	Derivative assets		6,055	Derivative liabilities		—
Total non-VIE derivatives		$	448,566		$	687,867
Variable Interest Entities
Currency swaps	VIE—Derivative liabilities		27,779	VIE—Derivative liabilities		90,857
Interest rate swaps	VIE—Derivative liabilities		—	VIE—Derivative liabilities		2,023,974
Total VIE derivatives		$	27,779		$	2,114,831

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 $28,455 and $47,421 as of June 30, 2012 and December 31, 2011, respectively. The amounts representing the obligation to return cash collateral, recorded in “Other liabilities” were $0 and $0 as of June 30, 2012 and December 31, 2011.

The following tables summarize the location and amount of gains and losses of derivative contracts in the Consolidated Statements of Total Comprehensive Income for the three and six month periods ended June 30, 2012 and 2011, respectively:

	Location of Gain or (Loss) Recognized in Consolidated Statements of Total Comprehensive Income	Amount of Gain or (Loss) Recognized in Consolidated Statements of Total Comprehensive Income
		Three months ended June 30, 2012			Three months ended June 30, 2011
Financial Guarantee:
Credit derivatives	Net change in fair value of credit derivatives	$	(7,415	)	$	24,287
Financial Services derivatives products:
Interest rate swaps	Derivative products		(108,175	)		(57,952	)
Currency swaps	Derivative products		81			(354	)
Futures contracts	Derivative products		(16,070	)		(7,307	)
Other derivatives	Derivative products		73			19
Total Financial Services derivative products			(124,091	)		(65,594	)
Call options on long-term debt	Other income		39,030			4,045
Variable Interest Entities:
Credit derivatives	Income (loss) on variable interest entities		—			—
Currency swaps	Income (loss) on variable interest entities		(10,787	)		(9,970	)
Interest rate swaps	Income (loss) on variable interest entities		(48,478	)		(147,350	)
Total Variable Interest Entities			(59,265	)		(157,320	)
Total derivative contracts		$	(151,741	)	$	(194,582	)
	Location of Gain or (Loss) Recognized in Consolidated Statements of Total Comprehensive Income	Amount of Gain or (Loss) Recognized in Consolidated Statements of Total Comprehensive Income
		Six months ended June 30, 2012			Six months ended June 30, 2011
Financial Guarantee:
Credit derivatives	Net change in fair value of credit derivatives	$	(14,637	)	$	15,384
Financial Services derivatives products:
Interest rate swaps	Derivative products		(65,990	)		(34,260	)
Currency swaps	Derivative products		237			(556	)
Futures contracts	Derivative products		(11,762	)		(9,875	)
Other derivatives	Derivative products		381			100
Total Financial Services derivative products			(77,134	)		(44,591	)
Call options on long-term debt	Other income		100,710			20,770
Variable Interest Entities:
Credit derivatives	Income (loss) on variable interest entities		—			(4,511	)
Currency swaps	Income (loss) on variable interest entities		(21,994	)		(22,669	)
Interest rate swaps	Income (loss) on variable interest entities		45,237			(88,521	)
Total Variable Interest Entities			23,243			(115,701	)
Total derivative contracts		$	32,182		$	(124,138	)

Financial Guarantee 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 generally required to make payments equal to the difference between the scheduled debt service payment and the actual payment made by the issuer. The majority of our credit derivatives are 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.

In a small number of transactions, Ambac is required to (i) make a payment equal to the difference between the par value and market value of the underlying obligation or (ii) purchase the underlying obligation at its par value and a loss is realized for the difference between the par and market value of the underlying obligation. There are six transactions, which are not “pay-as-you-go”, with a combined notional of approximately $148,273 and a net liability fair value of $252 as of June 30, 2012. These transactions are primarily in the form of CLOs written between 2002 and 2005. Substantially all of Ambac’s credit derivative contracts relate to structured finance transactions. Credit derivatives issued are insured by Ambac Assurance. None of our outstanding credit derivative transactions at June 30, 2012, 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.

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 tables summarize the net par outstanding for CDS contracts, by Ambac rating, for each major category as of June 30, 2012 and December 31, 2011:

June 30, 2012 Ambac Rating	CLO		Other		Total
AAA	$	127,730	$	920,142	$	1,047,872
AA		5,756,517		846,291		6,602,808
A		1,702,167		2,755,418		4,457,585
BBB(1)		—		485,965		485,965
Below investment grade (2)		—		290,186		290,186
	$	7,586,414	$	5,298,002	$	12,884,416
December 31, 2011 Ambac Rating	CLO		Other		Total
AAA	$	297,741	$	913,857	$	1,211,598
AA		6,193,522		1,248,584		7,442,106
A		1,737,314		2,967,445		4,704,759
BBB(1)		—		518,142		518,142
Below investment grade (2)		—		290,007		290,007
	$	8,228,577	$	5,938,035	$	14,166,612

(1) BBB internal rating reflects 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 (“BIG”) 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 tables below summarize information by major category as of June 30, 2012 and December 31, 2011:

	CLO			Other			Total
June 30, 2012
Number of CDS transactions		38			22			60
Remaining expected weighted-average life of obligations (in years)		2.3			5.8			3.7
Gross principal notional outstanding	$	7,586,414		$	5,298,002		$	12,884,416
Net derivative liabilities at fair value	$	(51,166	)	$	(160,451	)	$	(211,617	)
	CLO			Other			Total
December 31, 2011
Number of CDS transactions		44			24			68
Remaining expected weighted-average life of obligations (in years)		2.7			6.0			4.1
Gross principal notional outstanding	$	8,228,577		$	5,938,035		$	14,166,612
Net derivative liabilities at fair value	$	(54,320	)	$	(136,333	)	$	(190,653	)

The maximum potential amount of future payments under Ambac’s credit derivative contracts written on a “pay-as-you-go” basis is generally the gross principal notional outstanding amount included in the above table plus future interest payments payable by the derivative reference obligations. For contracts that are not written with pay-as-you-go terms, the maximum potential future payment is represented by the principal notional only. Since Ambac’s credit derivatives typically reference obligations of or assets held by SPEs that meet the definition of a VIE, the amount of maximum potential future payments for credit derivatives is included in the table in Note 5, 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 ASC Topic 815. Changes in fair value are recorded in “Net change in fair value of credit derivatives” on the Consolidated Statements of Total Comprehensive Income. 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 surveillance group tracks credit migration of CDS contracts’ reference obligations from period to period. Adversely classified credits are assigned risk classifications by the surveillance group. As of June 30, 2012, there are four CDS contracts on Ambac’s adversely classified credit listing, with a net derivative liability fair value of $59,423 and total notional principal outstanding of $290,186. As of December 31, 2011 there were four CDS contracts on Ambac’s adversely classified credit listing, with a net derivative liability fair value of $46,056 and a total notional principal outstanding of $290,007.

Financial Services Derivative Products:

Ambac, through its subsidiary Ambac Financial Services (“AFS”), provided interest rate and currency swaps to states, municipalities and their authorities, asset-backed issuers and other entities in connection with their financings. AFS manages its interest rate swaps business with the goal of being market neutral to changes in benchmark interest rates while retaining some basis risk and excess interest rate sensitivity as an economic hedge against the effects of rising interest rates elsewhere in the Company, including on Ambac’s financial guarantee exposures. Basis risk in the portfolio arises primarily from (i) variability in the ratio of benchmark tax-exempt to taxable interest rates, (ii) potential changes in the counterparty bond issuers’ bond-specific variable rates relative to taxable interest rates, and (iii) variability between Treasury and swap rates. The derivative portfolio also includes an unhedged Sterling-denominated exposure to Consumer Price Inflation in the United Kingdom. As of June 30, 2012 and December 31, 2011 the notional amounts of AFS’s trading derivative products are as follows:

Type of derivative	Notional June 30, 2012		Notional December 31, 2011
Interest rate swaps—receive-fixed/pay-variable	$	978,781	$	1,370,995
Interest rate swaps—pay-fixed/receive-variable		2,094,301		3,798,305
Interest rate swaps—basis swaps		175,835		175,835
Currency swaps		3,549		13,559
Futures contracts		295,000		53,500
Other contracts		118,450		118,930

Derivatives of Consolidated Variable Interest Entities

Certain VIEs consolidated under ASC Topic 810 entered into derivative contracts to meet specified purposes within the securitization structure. The notional for VIE derivatives outstanding as of June 30, 2012 and December 31, 2011 are as follows:

	Notional		Notional
Type of VIE derivative	June 30, 2012		December 31, 2011
Interest rate swaps—receive-fixed/pay-variable	$	1,721,100	$	1,702,113
Interest rate swaps—pay-fixed/receive-variable		4,586,220		4,535,626
Currency swaps		729,213		721,168
Credit derivatives		20,605		20,934

Call Options on Long-Term Debt

Ambac Assurance had certain contractual options to repurchase $500,000 of its surplus notes at a discount to their par value which were considered stand-alone derivatives. Surplus notes are classified under Long-term debt on the Consolidated Balance Sheets. These call options were exercised in June 2012. The fair value of the options was $6,055 as of December 31,2011 Gains from the change in fair value of the call options were recognized within Other income in the Consolidated Statements of Total Comprehensive Income in the amount of $39,030 and $4,045 for the three months ended June 30, 2012 and 2011, respectively; and $100,710 and $20,770 for the six months ended June 30, 2012 and 2011, respectively.

Contingent Features in Derivatives Related to Ambac Credit Risk

Ambac’s interest rate swaps with professional swap-dealer counterparties and certain front-end counterparties 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, 2012 and December 31, 2011, the aggregate fair value of all derivative instruments with contingent features linked to Ambac’s own credit risk that are in a net liability position after considering legal rights of offset was $238,203 and $266,626, respectively, related to which Ambac had posted assets as collateral with a fair value of $286,660 and $263,530, 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 contracts terminated on June 30, 2012, 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.