10. 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, 2013 and December 31, 2012.


	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
Successor Ambac—June 30, 2013:
Derivative Assets:
Interest rate swaps	$	144,707	$	56,381	$	88,326	$	—	$	88,326
Futures contracts		2,852		—		2,852		1,673		1,179

Total non-VIE derivative assets	$	147,559	$	56,381	$	91,178	$	1,673	$	89,505

Derivative Liabilities:
Credit derivatives	$	232,267	$	—	$	232,267	$	—	$	232,267
Interest rate swaps		275,712		56,381		219,331		89,711		129,620
Futures contracts		—		—		—		—		—
Other contracts		192		—		192		—		192

Total non-VIE derivative liabilities	$	508,171	$	56,381	$	451,790	$	89,711	$	362,079

Variable Interest Entities
Interest rate swaps	$	1,897,311	$	—	$	1,897,311	$	—	$	1,897,311
Currency swaps		92,472		—		92,472		—		92,472

Total VIE derivative liabilities	$	1,989,783	$	—	$	1,989,783	$	—	$	1,989,783


	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
Predecessor Ambac—December 31, 2012:
Derivative Assets:
Interest rate swaps	$	198,117	$	73,264	$	124,853	$	—	$	124,853
Futures contracts		1,253		—		1,253		—		1,253

Total non-VIE derivative assets	$	199,370	$	73,264	$	126,106	$	—	$	126,106

Derivative Liabilities:
Credit derivatives	$	213,585	$	—	$	213,585	$	—	$	213,585
Interest rate swaps		390,774		73,264		317,510		180,113		137,397
Futures contracts		—		—		—		—		—
Other contracts		220		—		220		—		220

Total non-VIE derivative liabilities	$	604,579	$	73,264	$	531,315	$	180,113	$	351,202

Variable Interest Entities
Interest rate swaps	$	2,131,315	$	—	$	2,131,315	$	—	$	2,131,315
Currency swaps		90,466		—		90,466		—		90,466

Total VIE derivative liabilities	$	2,221,781	$	—	$	2,221,781	$	—	$	2,221,781

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 $0 and $5,472 as of June 30, 2013 and December 31, 2012, respectively. The amounts representing the obligation to return cash collateral recorded in “Other liabilities” were $1,673 and $0 as of June 30, 2013 and December 31, 2012.


		Successor Ambac			Predecessor Ambac
	Location of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income	Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Period from May 1 through June 30, 2013			Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Period from April 1 through April 30, 2013			Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Three months ended June 30, 2012
Financial Guarantee:
Credit derivatives	Net change in fair value of credit derivatives	$	51,220		$	(73,171	)	$	(7,415	)

Financial Services derivatives products:
Interest rate swaps	Derivative products		74,169			(29,600	)		(108,175	)
Currency swaps	Derivative products		—			—			81
Futures contracts	Derivative products		9,831			(3,588	)		(16,070	)
Other derivatives	Derivative products		(287	)		22			73

Total Financial Services derivative products			83,713			(33,166	)		(124,091	)

Call options on long-term debt	Other income		—			—			39,030

Variable Interest Entities:
Currency swaps	Income on variable interest entities		(1,890	)		(4,820	)		(10,787	)
Interest rate swaps	Income on variable interest entities		437,624			(103,072	)		(48,478	)

Total Variable Interest Entities			435,734			(107,892	)		(59,265	)

Total derivative contracts		$	570,667		$	(214,229	)	$	(151,741	)


		Successor Ambac			Predecessor Ambac
	Location of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income	Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Period from May 1 through June 30, 2013			Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Period from January 1 through April 30, 2013			Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Six months ended June 30, 2012
Financial Guarantee:
Credit derivatives	Net change in fair value of credit derivatives	$	51,220		$	(60,384	)	$	(14,637	)

Financial Services derivatives products:
Interest rate swaps	Derivative products		74,169			(30,622	)		(65,990	)
Currency swaps	Derivative products		—			—			237
Futures contracts	Derivative products		9,831			(3,133	)		(11,762	)
Other derivatives	Derivative products		(287	)		20			381

Total Financial Services derivative products			83,713			(33,735	)		(77,134	)

Call options on long-term debt	Other income		—			—			100,710

Variable Interest Entities:
Currency swaps	Income on variable interest entities		(1,890	)		(116	)		(21,994	)
Interest rate swaps	Income on variable interest entities		437,624			(203,620	)		45,237

Total Variable Interest Entities			435,734			(203,736	)		23,243

Total derivative contracts		$	570,667		$	(297,855	)	$	32,182

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. 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, 2013 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 majority 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. One transaction, which is not “pay-as-you-go,” has a notional of approximately $13,346 and a net liability fair value of $8 as of June 30, 2013. This transaction terminated in July 2013.

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, 2013 and December 31, 2012:

Successor Ambac—June 30, 2013


Ambac Rating	CLO		Other		Total
AAA	$	13,346	$	452,512	$	465,858
AA		1,568,030		737,424		2,305,454
A		168,841		1,758,588		1,927,429
BBB ⁽¹⁾		—		882,332		882,332
Below investment grade ⁽²⁾		—		279,987		279,987

	$	1,750,217	$	4,110,843	$	5,861,060

Predecessor Ambac—December 31, 2012


Ambac Rating	CLO		Other		Total
AAA	$	166,200	$	512,283	$	678,483
AA		4,676,362		1,278,756		5,955,118
A		1,313,205		2,370,988		3,684,193
BBB⁽¹⁾		—		672,293		672,293
Below investment grade ⁽²⁾		—		291,690		291,690

	$	6,155,767	$	5,126,010	$	11,281,777

(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, 2013 and December 31, 2012:

Successor Ambac—June 30, 2013


	CLO			Other			Total
Number of CDS transactions		9			20			29
Remaining expected weighted-average life of obligations (in years)		2.5			5.1			4.3
Gross principal notional outstanding	$	1,750,217		$	4,110,843		$	5,861,060
Net derivative liabilities at fair value	$	(11,996	)	$	(220,271	)	$	(232,267	)

Predecessor Ambac—December 31, 2012


	CLO			Other			Total
Number of CDS transactions		30			21			51
Remaining expected weighted-average life of obligations (in years)		2.2			5.2			3.6
Gross principal notional outstanding	$	6,155,767		$	5,126,010		$	11,281,777
Net derivative liabilities at fair value	$	(34,645	)	$	(178,940	)	$	(213,585	)

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. 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 4, 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. 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, 2013, there are four CDS contracts on Ambac’s adversely classified credit listing, with a net derivative liability fair value of $81,478 and total notional principal outstanding of $279,987. As of December 31, 2012, there were four CDS contracts on Ambac’s adversely classified credit listing, with a net derivative liability fair value of $67,219 and total notional principal outstanding of $291,690.

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 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. As of June 30, 2013 and December 31, 2012 the notional amounts of AFS’s trading derivative products are as follows:


	Notional
Type of derivative	Successor Ambac – June 30, 2013		Predecessor Ambac – December 31, 2012
Interest rate swaps—receive-fixed/pay-variable	$	703,384	$	727,926
Interest rate swaps—pay-fixed/receive-variable		1,571,088		1,657,382
Interest rate swaps—basis swaps		161,690		161,690
Futures contracts		100,000		161,500
Other contracts		75,650		75,651

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, 2013 and December 31, 2012 are as follows:


Type of VIE derivative	Notional
Type of VIE derivative	Successor Ambac – June 30, 2013		Predecessor Ambac – December 31, 2012
Interest rate swaps—receive-fixed/pay-variable	$	1,669,298	$	1,782,999
Interest rate swaps—pay-fixed/receive-variable		4,356,549		4,707,454
Currency swaps		707,264		755,438
Credit derivatives		18,958		20,885

Call Option 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. 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 for the three months ended June 30, 2012; and $100,710 for the six months ended June 30, 2012.

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, 2013 and December 31, 2012, the net liability fair value of all derivative instruments with contingent features linked to Ambac’s own credit risk was $89,711 and $180,113, respectively, related to which Ambac had posted assets as collateral with a fair value of $164,340 and $271,251, 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, 2013, 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.