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 September 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—September 30, 2013:
Derivative Assets:
Interest rate swaps	$	141,139	$	58,177	$	82,962	$	—	$	82,962
Futures contracts		—		—		—		—		—

Total non-VIE derivative assets	$	141,139	$	58,177	$	82,962	$	—	$	82,962

Derivative Liabilities:
Credit derivatives	$	202,653	$	—	$	202,653	$	—	$	202,653
Interest rate swaps		253,728		58,177		195,551		69,513		126,038
Futures contracts		2,023		—		2,023		2,023		—
Other contracts		155		—		155		—		155

Total non-VIE derivative liabilities	$	458,559	$	58,177	$	400,382	$	71,536	$	328,846

Variable Interest Entities
Interest rate swaps	$	1,960,732	$	—	$	1,960,732	$	—	$	1,960,732
Currency swaps		86,472		—		86,472		—		86,472

Total VIE derivative liabilities	$	2,047,204	$	—	$	2,047,204	$	—	$	2,047,204


	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 $5,599 and $5,472 as of September 30, 2013 and December 31, 2012, respectively. The amounts representing the obligation to return cash collateral recorded in “Other liabilities” were $0 and $0 as of September 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 – Three Months Ended September 30, 2013			Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Three months ended September 30, 2012
Financial Guarantee:
Credit derivatives	Net change in fair value of credit derivatives	$	31,194		$	27,440

Financial Services derivatives products:
Interest rate swaps	Derivative products		13,299			(33,036	)
Currency swaps	Derivative products		—			570
Futures contracts	Derivative products		(961	)		(3,485	)
Other derivatives	Derivative products		34			(56	)

Total Financial Services derivative products			12,372			(36,007	)

Call options on long-term debt	Other income		—			—

Variable Interest Entities:
Currency swaps	Income on variable interest entities		6,000			5,581
Interest rate swaps	Income on variable interest entities		(63,421	)		(2,723	)

Total Variable Interest Entities			(57,421	)		2,858

Total derivative contracts		$	(13,855	)	$	(5,709	)


		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 – Five Months Ended September 30, 2013			Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Four Months Ended April 30, 2013			Amount of Gain or (Loss) Recognized in Consolidated Statement of Total Comprehensive Income – Nine months ended September 30, 2012
Financial Guarantee:
Credit derivatives	Net change in fair value of credit derivatives	$	82,414		$	(60,384	)	$	12,803

Financial Services derivatives products:
Interest rate swaps	Derivative products		87,468			(30,622	)		(99,026	)
Currency swaps	Derivative products		—			—			807
Futures contracts	Derivative products		8,870			(3,133	)		(15,247	)
Other derivatives	Derivative products		(253	)		20			325

Total Financial Services derivative products			96,085			(33,735	)		(113,141	)

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

Variable Interest Entities:
Currency swaps	Income on variable interest entities		4,110			(116	)		(16,413	)
Interest rate swaps	Income on variable interest entities		374,203			(203,620	)		42,514

Total Variable Interest Entities			378,313			(203,736	)		26,101

Total derivative contracts		$	556,812		$	(297,855	)	$	26,473

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 September 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. The last transaction that was not “pay-as-you-go” 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 gross principal notional outstanding for CDS contracts, by Ambac rating, for each major category as of September 30, 2013 and December 31, 2012:

Successor Ambac—September 30, 2013


Ambac Rating	CLO		Other		Total
AAA	$	193,286	$	479,173	$	672,459
AA		1,289,541		206,064		1,495,605
A		126,551		1,775,161		1,901,712
BBB ⁽¹⁾		—		856,041		856,041
Below investment grade ⁽²⁾		—		281,547		281,547

	$	1,609,378	$	3,597,986	$	5,207,364

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 September 30, 2013 and December 31, 2012:

Successor Ambac—September 30, 2013


	CLO			Other			Total
Number of CDS transactions		8			18			26
Remaining expected weighted-average life of obligations (in years)		2.3			5.3			4.4
Gross principal notional outstanding	$	1,609,378		$	3,597,986		$	5,207,364
Net derivative liabilities at fair value	$	(10,201	)	$	(192,452	)	$	(202,653	)

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 September 30, 2013, there are four CDS contracts on Ambac’s adversely classified credit listing, with a net derivative liability fair value of $67,164 and gross notional principal outstanding of $281,547. 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 September 30, 2013 and December 31, 2012 the notional amounts of AFS’s trading derivative products are as follows:


	Notional
Type of derivative	Successor Ambac – September 30, 2013		Predecessor Ambac – December 31, 2012
Interest rate swaps—receive-fixed/pay-variable	$	701,218	$	727,926
Interest rate swaps—pay-fixed/receive-variable		1,544,880		1,657,382
Interest rate swaps—basis swaps		146,705		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 September 30, 2013 and December 31, 2012 are as follows:


Type of VIE derivative	Notional
Type of VIE derivative	Successor Ambac – September 30, 2013		Predecessor Ambac – December 31, 2012
Interest rate swaps—receive-fixed/pay-variable	$	1,776,084	$	1,782,999
Interest rate swaps—pay-fixed/receive-variable		4,635,242		4,707,454
Currency swaps		752,510		755,438
Credit derivatives		19,665		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 $100,710 for the nine months ended September 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 September 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 $69,513 and $180,113, respectively, related to which Ambac had posted assets as collateral with a fair value of $140,273 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 September 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.