What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-11-09 compared with 2020-08-06 · 562 added, 438 removed, 759 unchanged (57% of the section changed)

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CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

Management has included in Parts I and II of this Quarterly Report on Form 10-Q, including this MD&A, statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform

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Words such as “estimate,” “project,” “plan,” “believe,” “anticipate,” “intend,” “planned,” “potential” and similar expressions, or future or conditional verbs such as “will,” “should,” “would,” “could,” and “may,” or the negative of those expressions or verbs, identify forward-looking statements.

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These statements may relate to plans and objectives with respect to the future, among other things which may change.

We are alerting you to the possibility that our actual results may differ, possibly materially, from the expected objectives or anticipated results that may be suggested, expressed or implied by these forward-looking statements.

looking statements.

Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of the 2019 Annual Report on Form 10-K and in Part II, Item 1A of this quarterly Report on Form 10-Q.

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(13) credit risks related to large single risks, risk concentrations and correlated risks;

(14) the risk that the Ambac’s risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for

(14) the risk that the Ambac’s risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss;

(15) risks associated with adverse selection as Ambac’s insured portfolio runs off;

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(19) Ambac’s substantial indebtedness could adversely affect its financial condition and operating flexibility;

(20) Ambac may not be able to obtain financing or raise capital on acceptable terms or at all due to its substantial indebtedness and financial condition;

(20) Ambac may not be able to obtain financing or raise capital on acceptable terms or at all

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due to its substantial indebtedness and financial condition;

(21) Ambac may not be able to generate the significant amount of cash needed to service its debt and financial obligations, and may not be able to refinance its indebtedness;

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Background and Business Description to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q and Note 1.

Background and Business Description

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in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 , for a description of the Company and our key strategic priorities to achieve our primary goal to maximize stockholder value.

Background and Business Description in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, for a description of the Company and our key strategic priorities to achieve our primary goal to maximize stockholder value.

Ambac Assurance and Subsidiaries:

A key strategy for Ambac is to increase the value of its investment in Ambac Assurance by actively managing its assets and liabilities.

Asset management primarily entails maximizing the risk adjusted return on non-VIE invested assets and managing liquidity to help ensure resources are available to meet operational and strategic cash needs.

Asset management primarily entails maximizing

the risk adjusted return on non-VIE invested assets and managing liquidity to help ensure resources are available to meet operational and strategic cash needs.

These strategic cash needs include activities associated with Ambac's liability management and loss mitigation programs.

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Investments to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q for further details of fixed income investments by asset category and pooled investment funds by investment type.

At June 30, 2020 , Ambac and its subsidiaries owned $574 million of distressed Ambac-insured bonds, including significant concentrations of insured Puerto Rico and RMBS bonds, and excluding Ambac's holdings of secured notes issued by Ambac LSNI.

At September 30, 2020, Ambac and its subsidiaries owned $603 million of distressed Ambac-insured bonds, including significant concentrations of insured Puerto Rico and RMBS bonds, and excluding Ambac's holdings of secured notes issued by Ambac LSNI.

Subject to applicable internal and regulatory guidelines, market conditions and other constraints, Ambac may continue to opportunistically purchase or sell Ambac-insured securities.

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• Purchasing quota share reinsurance in June 2020 on a transportation revenue credit with net par outstanding of $33 million at December 31, 2019;

The following table provides a comparison of total, adversely classified ("ACC") and watch list credit net par outstanding in the insured portfolio at June 30, 2020 and December 31, 2019 .

• A refinancing in August 2020 of an international stadium transaction with net par outstanding of $217 million at December 31, 2019;

• Partial commutations of $32 million of adversely classified credits over the course of 2020.

The following table provides a comparison of total, adversely classified ("ACC") and watch list credit net par outstanding in the insured portfolio at September 30, 2020 and December 31, 2019.

Net par exposure within the U.S.

public finance market includes capital

appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds .

($ in millions)

public finance market includes capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds.

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($ in millions) September 30,

2020 December 31,

2019 Variance

Total $ 34,751 $ 38,018 $ (3,267) (9) %

ACC 8,576 7,535 1,041 14 %

Watch list 4,961 6,752 (1,791) (27) %

The decrease in total net par outstanding resulted from active de-risking initiatives, including the transactions noted above, as well as scheduled maturities, amortizations, refundings and calls.

Additionally, total net par outstanding reduced as a result of the weakening of British Pounds as compared to US Dollars.

The increase in ACC exposures is primarily due to the addition of credits impacted by COVID-19 (including $1,002 million of net par outstanding from the Watch List category), such as hotel tax, stadium, convention center and public house insured transactions, partially offset by active de-risking and paydowns or calls by issuers.

The decrease in Watch List net par outstanding resulted from active de-risking initiatives, including the transactions noted above, $970 million of net par outstanding downgraded to ACC due to COVID-19, as well as scheduled maturities, amortizations, refundings and calls.

The increase in ACC exposures is primarily due to the addition of credits impacted by COVID-19 (including $975 million of net par outstanding from the Watch List category), such as hotel tax, stadium, convention center and public house insured transactions, partially offset by active de-risking and issuer paydowns and calls.

The decrease in Watch List net par outstanding resulted from active de-risking initiatives (including the transactions noted above), downgrades to ACC due to COVID-19, and scheduled maturities, amortizations, refundings and calls.

In addition, as a result of the economic impacts from the COVID-19 pandemic, $2,651 million of net par outstanding in sectors such as mass transit, toll roads, and private higher education, among others, have been added to the Survey List.

The Survey List is a categorization for enhanced monitoring of currently performing credits.

We continue to experience stress in our exposure to Puerto Rico that consists of several different issuing entities (all below investment grade).

We also continue to experience stress in our exposure to Puerto Rico that consists of several different issuing entities (all below investment grade).

Each issuing entity has its own credit risk profile attributable to discreet revenue sources, direct general obligation pledges and general obligation guarantees.

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The COVID-19 outbreak had and continues to have a notable impact on general economic conditions, including but not limited to higher unemployment;

a broad based and significant decrease in asset valuations;

closure or severe curtailment of the operations and hence, revenues, of many businesses and public and private enterprises to which we are directly or indirectly exposed, such as hotels, restaurants, sports and entertainment facilities, airports and other transportation facilities, and retail establishments, mostly due to shelter-in-place orders, social distancing guidelines, travel bans and restrictions, and business shutdowns.

While many states eased restrictions during the later portion of the second quarter of 2020,

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States reversed course in late June to impose or reimpose social distancing guidelines and close down businesses that had begun opening as a result of a rise in new confirmed cases of COVID-19, raising the prospect of a delayed recovery.

In addition, in March 2020 a disagreement between Russia and Saudi Arabia over oil production quotas coupled with lower global demand as a result of the COVID-19 crisis led to volatility and overall lower oil prices which continued through the second quarter of 2020.

In the U.S., monetary policy and fiscal stimulus, particularly the Coronavirus Aid, Relief and Economic Security ("CARES") Act, have temporarily helped moderate the economic impact of COVID-19, along with stimulus and other actions taken by governments outside the U.S.

volatility in the capital markets;

closure or severe curtailment of the operations and hence, revenues, of many businesses and public and private enterprises to which we are directly or indirectly exposed, such as hotels, restaurants, sports and entertainment facilities, airports and other transportation facilities, and retail establishments, mostly due to social distancing guidelines, travel bans and restrictions, and business restrictions and shutdowns.

While many U.S.

states and territories have eased restrictions more recently and provided clear social distancing guidelines to support businesses, challenges remain, including the recent rise of new COVID-19 cases.

In the U.S., monetary policy and fiscal stimulus, particularly the Coronavirus Aid, Relief and Economic Security ("CARES")

Act, have temporarily helped moderate the economic impact of COVID-19, along with stimulus and other actions taken by governments outside the U.S.

Nonetheless, the U.S.

and most large global economies materially contracted through the second quarter of the year.

While a recovery is currently underway led by a sharp increase in retail sales in North America and the Eurozone in May and June, the trajectory and sustainability of the economic recovery is uncertain due to, among other things, the magnitude of job losses, the uncertainty or scaling back of government support measures and the rise of new COVID-19 cases in the U.S.

For the Ambac insured portfolio, credit risk continues to remain elevated due to the uncertain economic recovery from the COVID-19 crisis.

and most large global economies materially contracted through the third quarter of the year.

While a recovery is currently underway led by an increase in retail sales in North America and the Eurozone since May, the trajectory and sustainability of the economic recovery is uncertain due to, among other things, the magnitude of job losses, cooler weather that will curb outdoor activity, uncertainty regarding continued government support measures, the recent rise of new COVID-19 cases and uncertainty related to the timing and efficacy of a vaccine.

For the Ambac insured portfolio, credit risk remains elevated due to the historical and future economic and financial impact related to the COVID-19 crisis.

COVID-19 has also impacted Ambac's operating environment.

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Our employees have transitioned to working remotely while maintaining full operational capabilities.

In July 2020, Ambac opened certain of its offices to allow a portion of the workforce to safely return on a voluntary basis.

Since July 2020, Ambac opened certain of its offices to allow a portion of the workforce to safely return on a voluntary basis.

We have not experienced and do not anticipate incurring material net incremental operating expenditures to maintain the current operating environment.

In addition to our own staff, Ambac's critical third-party service providers are operating remotely and therefore we have conducted a review of these service providers and have not presently identified or experienced any limitations or operational constraints with respect to services provided in the current circumstances.

Although many of Ambac's critical third-party service providers are operating with employees working remotely, we have not presently identified or experienced any limitations or operational constraints with respect to services provided.

Ambac does not believe that our current operating environment has resulted in a significant change to our disclosure controls or internal controls over financial reporting.

COVID-19 has adversely impacted Ambac's financial position and results of operations as credit risk in the insured and investment portfolios has increased.

The municipal, project finance, mortgage-backed and student loan sectors, as well as other asset securitizations, in particular, could be materially adversely impacted, and as a result, with the exception of the mortgage-backed sector, we have increased loss reserves across each of these and other sectors during the six months ended June 30, 2020.

In the mortgage-backed sector, much lower interest rates have increased excess spread recoveries on previously paid claims and largely offset the impact of higher projected mortgage delinquencies and losses resulting from the COVID-19 pandemic.

We are continuously evaluating and updating our view of the macro economic environment as well as our specific credit view of each of our insured exposures considering the significant uncertainties brought upon us by the COVID-19 pandemic.

The overall financial impact from COVID-19 has been and will be a function of (i) the

ability of issuers of insured obligations and other counterparties to pay their obligations when due, whether due to operational or financial reasons;

The overall financial impact from COVID-19 has been and will be a function of (i) the willingness and ability of issuers of insured obligations and other counterparties to pay their obligations when due, whether due to operational or financial reasons;

(ii) the impact of changes to interest rates on policy and derivative payments;

and (iii) the performance of the investment portfolio.

Ambac’s insurance policies will be drawn in the event that the issuers of insured obligations do not make payments on their obligations when due.

• Ambac’s insurance policies will be drawn in the event that the issuers of insured obligations do not make payments on

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their obligations when due.

As a result of the COVID-19 related economic impact on issuers and markets where Ambac provides financial guarantees;

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While these positions were sold at a net gain, future investment losses and impairments may be possible.

Asset prices partially recovered during the second quarter of 2020.

Ambac recognized a total return for the investment portfolio of approximately 4.7% during the three months ended June 30, 2020.

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Given the economic uncertainties associated with the duration and effects of the COVID-19 pandemic, it is impossible to fully predict all of its consequences and, as a result, it is possible that our future operating results and financial condition may be materially adversely affected.

Asset prices partially recovered during the second and third quarters of 2020.

Ambac recognized a total return for the investment portfolio of approximately 2.4% and 2.3% for the three and nine months ended September 30, 2020, respectively.

materially adversely affected.

Refer to "Financial Guarantees In Force," "Results of Operations" and "Balance Sheet Commentary" for further financial details on the current impact from COVID-19.

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While we continue to pursue new business opportunities, we believe that the COVID-19 pandemic has caused a general slow down in activity as potential targets evaluate the financial and strategic impact of the pandemic on their businesses and due to the practical constraints of shelter-in-place orders, social distancing guidelines, travel bans and restrictions, and business shutdowns.

As of June 30, 2020 the net assets of AFG were $481 million .

As of September 30, 2020 the net assets of AFG, excluding its equity investments in subsidiaries, were $465 million.

($ in millions)

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Other net assets (3)

(1) During the three months ended September 30, 2020, AFG purchased Everspan Insurance Company, from Ambac Assurance and repositioned it as a subsidiary of a new intermediary holding company that is directly owned by AFG.

This acquisition required a cash payment from AFG to Ambac Assurance of approximately $14 million.

(2) Includes surplus notes (fair value of $59 million) issued by Ambac Assurance that are eliminated in consolidation.

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Financial Statement Impact of Foreign Currency:

The impact of foreign currency as reported in Ambac's Unaudited Consolidated Statement of Total Comprehensive Income for the six months ended June 30, 2020 , included the following:

The impact of foreign currency as reported in Ambac's Unaudited Consolidated Statement of Total Comprehensive Income for the nine months ended September 30, 2020, included the following:

($ in millions)

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Refer to Note 2.

Basis of Presentation and Significant Accounting Policies to the Unaudited

Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for further details on transaction gains and losses.

Basis of Presentation and Significant Accounting Policies to the Unaudited Consolidated Financial Statements

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included in Part I, Item 1 in this Form 10-Q for further details on transaction gains and losses.

Future changes to currency rates may adversely affect our financial results.

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structured finance and international finance.

The following table provides a breakdown of guaranteed net par outstanding by market at June 30, 2020 and December 31, 2019 .

The following table provides a breakdown of guaranteed net par outstanding by market at September 30, 2020 and December 31, 2019.

Net par exposures within the U.S.

public finance market include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds.

public finance market include capital appreciation bonds which are reported at the par amount at the time of issuance of the

insurance policy as opposed to the current accreted value of the bonds.

Guaranteed net par outstanding includes the exposures of policies insuring variable interest entities (“VIEs”) consolidated in accordance with the Consolidation Topic of the ASC.

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Background and Business Description in the Notes to the Consolidated Financial Statements included in Part II, Item 8 in the Company's Annual Report on Form 10-K for the year ended December 31, 2019:

($ in millions)

($ in millions) September 30,

2020 December 31,

Public Finance (1) (2)

$ 16,041 $ 17,653

Structured Finance 6,614 7,508

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Total net par outstanding $ 34,751 $ 38,018

Includes $5,615 and $5,654 of Military Housing net par outstanding at June 30, 2020 and December 31, 2019 , respectively.

Includes $1,105 and $1,123 of Puerto Rico net par outstanding at June 30, 2020 and December 31, 2019 , respectively.

(1) Includes $5,596 and $5,654 of Military Housing net par outstanding at September 30, 2020 and December 31, 2019, respectively.

(2) Includes $1,070 and $1,123 of Puerto Rico net par outstanding at September 30, 2020 and December 31, 2019, respectively.

Components of Puerto Rico net par outstanding include capital appreciation bonds which are reported at the par amount at the time of issuance of the related insurance policy as opposed to the current accreted value of the bonds.

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The table below shows Ambac’s ten largest insured exposures, by repayment source, as a percentage of total financial guarantee net par outstanding at June 30, 2020 :

The table below shows Ambac’s ten largest insured exposures, by repayment source, as a percentage of total financial guarantee net par outstanding at September 30, 2020:

($ in millions)

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Outstanding (2)

Mitchells & Butlers Finance plc-UK Pub Securitisation

UK-Asset Securitizations

Capital Hospitals plc (3)

UK-Infrastructure

Aspire Defence Finance plc

UK-Infrastructure

New Jersey Transportation Trust Fund Authority - Transportation System

US-Lease and Tax-backed Revenue

Anglian Water

National Grid Gas

Posillipo Finance II S.r.l

Italy-Sub-Sovereign

Ostregion Investmentgesellschaft NR 1 SA (3)

Austria-Infrastructure

Mets Queens Baseball Stadium Project, NY, Lease Revenue

US-Stadium Financing

RMPA Services plc

UK-Infrastructure

IF AUK Mitchells & Butlers Finance plc-UK Pub Securitisation UK-Asset Securitizations BBB $ 950 2.7 %

IF AUK Capital Hospitals plc (3)

UK-Infrastructure A- 851 2.4 %

IF AUK Aspire Defence Finance plc UK-Infrastructure A- 821 2.4 %

IF AUK Anglian Water UK-Utility A- 805 2.3 %

PF AAC New Jersey Transportation Trust Fund Authority - Transportation System US-Lease and Tax-backed Revenue BBB- 772 2.2 %

IF AUK National Grid Gas UK-Utility A- 743 2.1 %

IF AUK Posillipo Finance II S.r.l Italy-Sub-Sovereign BIG 728 2.1 %

IF AUK Ostregion Investmentgesellschaft NR 1 SA (3)

Austria-Infrastructure BIG 691 2.0 %

IF AUK RMPA Services plc UK-Infrastructure BBB+ 542 1.6 %

PF AAC Mets Queens Baseball Stadium Project, NY, Lease Revenue US-Stadium Financing BIG 540 1.6 %

$ 7,443 21.4 %

PF = Public Finance, SF = Structured Finance, IF = International Finance

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Ambac Assurance has issued policies for these transactions that will only pay in the event that Ambac UK does not pay under its insurance policies ("second to pay policies").

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Net par related to the top ten exposures reduced $197 from December 31, 2019.

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The decrease from 2019 was primarily related to foreign exchange and scheduled paydowns.

The concentration of net par amongst the top ten (as a percentage of net par outstanding) increased slightly to 21% at June 30, 2020 , from 20% at December 31, 2019 .

The concentration of net par amongst the top ten (as a percentage of net par outstanding) increased slightly to 21% at September 30, 2020, from 20% at December 31, 2019.

However, certain credits within the top ten have had Ambac rating downgrades since December 31, 2019, primarily related to the impact of COVID-19, including Mitchells & Butlers Finance plc, New Jersey Transportation Trust Fund Authority and Mets Queens Baseball Stadium Project.

Aspire Defence Finance plc's rating at June 30, 2020 , improved since December 31, 2019 .

Aspire Defence Finance plc's rating at September 30, 2020, improved since December 31, 2019.

The remaining insured portfolio of financial guarantees has an average net par outstanding of $32 million per single risk, with insured exposures ranging up to $504 million and a median net par outstanding of $5 million.

Given that Ambac has not written any new insurance policies since 2008, the risk exists that the insured portfolio becomes increasingly concentrated to large and/or below investment grade exposures.

COVID-19 and the public health responses by the US federal and state governments have shut down significant portions of the US economy, including areas that Ambac's insured obligors rely upon to generate the revenues and cash flows necessary to service debts we insure.

Governments outside the US, in markets in which Ambac operates, have implemented similar measures to the US.

Ambac has undertaken a detailed analysis of the potential impact of the closure of certain portions of the US economy and certain other economies, including the UK, Italy, and Australia, to assess the impact of the current global economic contraction on its insured financial guarantee portfolio.

The duration and depth of the economic contraction;

COVID-19 and the public health responses by the US federal and state governments at the onset of the pandemic resulted in a shut down for several months of significant portions of the US economy, including areas that Ambac's insured obligors rely upon to generate the revenues and cash flows necessary to service debts we insure.

Governments outside the US, in markets in which Ambac operates, also implemented similar measures to the US.

Ambac undertook a detailed analysis of the potential impact of the closure of certain portions of the US economy and certain other economies, including the UK, Italy, and Australia, to assess the impact of the resulting global economic contraction on its insured financial guarantee portfolio.

The economic contraction and the subsequent but still uncertain recovery;

actions such as monetary policy and fiscal stimulus, including the CARES Act in the US that was signed into law on March 27, 2020, and future fiscal stimulus programs;

and our insured obligors' financial flexibility and ability to mitigate the

operational and economic impact of the recession will determine the ultimate impact to Ambac's insured portfolio.

and our insured obligors' financial flexibility and ability to mitigate the operational and economic impact of the recession will determine the ultimate impact to Ambac's insured portfolio.

CARES Act and Other Relief Measures:

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• A program for direct lending, loans, loan guarantees and investments to eligible businesses, states and municipalities, including to passenger airlines and cargo airlines;

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• A program for small business loans (Paycheck Protection Program, as amended by the Paycheck Protection Program and Health Care Enhancement Act (“PPP & HCE Act”));

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The Federal Housing Administration ("FHA") of the US Department of Housing and Urban Development and the Federal Housing Finance Agency ("FHFA") are providing temporary relief measures that require mortgage loan servicers to offer relief to borrowers who suffer hardship as a result of COVID-19.

The relief measures announced include moratoriums on foreclosures and evictions as well as the expansion of forbearance and subsequent repayment options.

The relief measures include moratoriums on foreclosures and evictions as well as the expansion of forbearance and subsequent repayment options.

Such servicers are generally applying these guidelines to non-FHFA loans, including those loans owned by special purpose entities that have their securitized obligations guaranteed by Ambac Assurance.

Moreover, several State agencies have issued similar guidance to mortgage loan servicers concerning loan forbearances and other relief for borrowers.

Depending on the severity and length of the economic downturn, there may be increasing pressure to extend the duration of forbearances and subsequently to offer generous repayment plans.

While the impact of these and other forbearance measures on Ambac Assurance's insured RMBS obligations are unclear, we have assumed that such measures, as well as the economic impact of the global recession, will have an adverse impact on delinquencies and home price appreciation for the mortgages that underlie our insured RMBS transactions.

Depending on the trajectory and strength of the economic recovery, there may still be pressure to extend the duration of forbearances and subsequently to offer generous repayment plans.

Forbearances increased sharply across the Ambac Assurance's insured first lien RMBS obligations during the second quarter of 2020 and early in the third quarter of 2020, but then dropped later in the third quarter of 2020, albeit to still elevated levels.

The ultimate impact of forbearances and other relief measures, such as foreclosure and eviction moratoriums,

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on Ambac Assurance's insured RMBS obligations are still unclear.

However, we have assumed that such measures, as well as the residual impact of the global recession, will have an adverse impact on our insured RMBS transactions.

Consequently, we have anticipated that we will experience an increase in claim payments for certain of our insured RMBS obligations.

However, we also anticipate that the significant decline in interest rates experienced

during 2020 will likely generate additional excess spread recoveries on insured RMBS obligations that will likely more than compensate for such adverse effects.

However, we also anticipate that the significant decline in interest rates experienced during 2020 will likely generate additional excess spread recoveries on insured RMBS obligations that will mostly compensate for such adverse effects.

In addition to, as well as in connection with, the CARES Act, the Federal Reserve has implemented a number of programs to improve liquidity and the functioning of the financial markets in an effort to help mitigate the impact of the COVID-19 pandemic on financial markets and the macro economy as well as certain displaced sectors of the economy, including those in which Ambac operates, including, but not limited to:

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The UK Government introduced a number of measures to mitigate the impact of these enforced closures including rebating employers 80% of staff salaries (up to a £2,500 per month per employee cap), tax deferrals, business loan schemes and property tax relief.

These measures are slowly being withdrawn between August 1, 2020 and the end of the year.

On November 5, 2020 the UK Government reimposed the closure the closure of non-essential leisure food and retail operations with the expectation that this closure will continue for the four weeks to December 2, 2020.

The mitigating measures noted above will continue through this period before then being slowly withdrawn by March 31, 2021.

While Ambac expects the foregoing measures to help mitigate economic damage and aid the functioning of the capital markets, Ambac's exposure to credit risk as a result of the economic fallout from the COVID-19 pandemic remains elevated, and we could experience material losses that would adversely impact our future results of operations and financial condition.

Insured Portfolio:

Ambac established a set of base case assumptions that includes a deep recession during the first half of 2020 with a modest recovery in the second half of 2020 that still leaves the U.S.

Ambac established a set of base case assumptions that included a deep recession during the first half of 2020 with a modest recovery in the second half of 2020 that still leaves the U.S.

with an overall contraction in GDP for the full year.

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states and local governments which are currently facing significant budget deficits as tax revenues have faltered as a result of COVID-19 related shutdowns, job losses and travel restrictions.

State and local governments have shed an estimated 1.5 million jobs and are facing tough choices to close budget gaps, including tax increases, furloughs, public safety cuts, planned capital expenditure cuts, pension funding holidays, and other measures.

In addition states may need cut aid to local municipalities that are also under pressure from lost revenues.

State and local governments have

shed an estimated 1.5 million jobs and are facing tough choices to close budget gaps, including tax increases, furloughs, public safety cuts, planned capital expenditure cuts, pension funding holidays, and other measures.

In addition states may need to cut aid to local municipalities that are also under pressure from lost revenues.

Monetary policy and federal stimulus through the CARES Act (and potential subsequent CARES Act programs) and other programs has benefited and is expected to continue to benefit in the overall economic recovery and more specifically provide some relief to state and local governments, including to issuers of municipal debt insured by Ambac, although the sufficiency of such benefits remains uncertain.

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As part of the detailed analysis of the insured portfolio, we have identified certain Public Finance sectors that are most susceptible to potential claims or impairments as a result of a prolonged or uneven recovery from the COVID-19 crisis.

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($ in millions)

Market / Sector

Total Debt Service Due Next Twelve Months

Market / Sector Total NPO Total Debt Service Due Next Twelve Months

Hotels / Convention Centers

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Total Public Finance

The RMBS and student loan insured portfolios are expected to be adversely impacted by the previously mentioned forbearances and the general economic downturn.

$ 2,415 $ 274.2

The RMBS and student loan insured portfolios are expected to be adversely impacted by the previously mentioned forbearances and the general economic downturn in the first half of the year and the developing but uncertain recovery in the second half of the year where unemployment is still elevated and job participation rates are depressed.

Expected to offset such impact for RMBS exposures is the benefit to excess spread within the securitization structures as a result of the significant reduction in interest rates, which will result in higher recoveries.

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Ambac and its advisors are working closely with impacted issuers to review their plans and liquidity facilities in light of these events.

Ambac's NPO with respect to these international demand dependent policies are as follows:

In connection with these efforts Ambac de-risked an international stadium transaction in the three months ended September 30, 2020 with $217 million of NPO at December 31, 2019.

Ambac's remaining NPO with respect to these international demand dependent policies are as follows:

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($ in millions)

Market / Sector

Total Debt Service Due for Twelve Months

Market / Sector Total NPO Total Debt Service Due for Twelve Months

Higher Education

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Toll Roads / Bridges

$ 2,067 $ 156.6

At this time, there are significant uncertainties surrounding the ultimate number of claims and scope of damage resulting from this pandemic.

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Potential losses from the economic consequences of the COVID-19 pandemic could be material and therefore may have a material adverse effect on our results of operations and financial condition.

Ambac has exposure to the Commonwealth of Puerto Rico (the "Commonwealth") and its instrumentalities across several different issuing entities with total net par exposure of $1,105 as of June 30, 2020 .

Each has its own credit risk profile attributable to, as applicable, discrete revenue sources, direct general obligation pledges and/or general obligation guarantees.

At this time, it remains very difficult to predict what the shape and timing of the post COVID-19 recovery will be for the Commonwealth of Puerto Rico, not least because the depth and length of COVID-19's impact is still uncertain.

In the short-term, it is known that tax revenue to the Commonwealth’s general fund collections lagged projections by nearly $1.8 billion, or 16.8%, in fiscal year 2020 and were roughly $2.5 billion below fiscal year 2019 collections, according to the Puerto Rico Fiscal Agency and Financial Advisory Authority’s Treasury Single Account report, which is as of June 26, 2020.

General fund collections slowed due to the COVID-19 outbreak and imposed lockdown.

Separately, Puerto Rico Highways and Transportation Authority's ("PRHTA") total consolidated fiscal year 2020 revenues were $404.3 million, 36.3% lower than the $634.8 million budget projection.

The underperformance was due to a variety of factors including a reduction in the traffic and toll collections due to COVID-19.

Over the longer-term, Puerto Rico's recovery profile will be impacted by a wide range of factors including, but not limited to:

t he fiscal and monetary policies of the federal government which will shape the trajectory of the U.S.

However, general fund net revenues totaled $1.259 billion in July and August 2020, outpacing projections for the first two months of fiscal year 2021 by $255 million, or 25.5%.

It is unclear if this trend will hold, what this implies for the Commonwealth’s ability to pay debt service, and what if any lasting effects COVID-19 will have on the economic and financial profile of Puerto Rico.

Over the longer-term, Puerto Rico's recovery profile will be impacted by a wide range of factors as well as financial considerations including, but not limited to:

• the fiscal and monetary policies of the federal government which will shape the trajectory of the U.S.

• the speed and efficacy of targeted federal aid packages to (1) help Puerto Rico address the negative economic effects of the pandemic and (2) rebuild better and more resilient infrastructure post-Hurricanes Irma and Maria in 2017 and earthquakes in 2020;

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• the willingness and ability of the Commonwealth government to implement much needed fiscal and structural reforms.

Commonwealth Fiscal Plan

On May 27, 2020, the Oversight Board certified its own version of a new Commonwealth Fiscal Plan.

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The Commonwealth Fiscal Plan will significantly inform the Commonwealth Plan of Adjustment, and the diminished economic performance described in the new Fiscal Plan implies worse outcomes than had been previously disclosed for creditors under the Commonwealth's Plan of Adjustment.

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The Oversight Board asked the Title III court in September 2020 to allow it to provide a status update in late October 2020, which was granted.

The period until late October is needed to assess the assumptions of the Commonwealth Fiscal Plan, according to the Oversight Board's status report filed in September 2020.

Both the Oversight Board and mediation team “will realize in short order” if a modified Plan can be negotiated, and the additional time will also enable the Oversight Board and AAFAF to know “whether any remaining hurdles of such plan can be overcome or if the electoral process will need to be completed before that might occur”.

In the October 2020 status update the Oversight Board indicated that it was premature to schedule consideration of the Disclosure Statement and Commonwealth Plan of Adjustment, as the Fiscal Plan assumptions continue to be tested and conversations are ongoing with the Puerto Rico Fiscal Agency and Financial Advisory Authority concerning amending the current Commonwealth Plan of Adjustment.

The next status update is due December 4, 2020.

On October 28, 2020, the Court ordered the Oversight Board to file, by February 10, 2021, either (i) an informative motion with a term sheet disclosing the economic and structural terms and features of a proposed amended Commonwealth Plan of Adjustment, or (ii) the proposed amended Commonwealth Plan of Adjustment itself, together with a proposed timeline for disclosure statement and confirmation hearings.

PRHTA Fiscal Plan

On June 26, 2020, the Oversight Board certified its own version of the Fiscal Plan for PRHTA.

The PRHTA Fiscal Plan states that based on cash flow projections, the existing PRHTA debt service will require significant restructuring and PRHTA’s full commitment to reforms.

It's currently unclear what the Oversight Board's scope of debt restructuring will be.

As for reforms, the PRHTA Fiscal Plan requires PRHTA to establish an independent board with experienced and knowledgeable directors, and requires six measures to improve revenue, including increases in toll fine collections, tolls, introduction of congestion pricing, and four measures to cut expenses, including reducing pension and employee healthcare costs.

The PRHTA Fiscal Plan states agency reform measures are critical to PRHTA’s sustainability, and that in fiscal year 2020, implementation significantly fell behind the performance goals for fiscal measures established by the 2019 PRHTA Fiscal Plan.

The 2020 PRHTA Fiscal Plan shows the improvements in PRHTA’s operating and capital performance over various revenue and expense categories due to

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the $4.7 billion benefit that would be achieved if PRHTA fully and timely implements the outlined fiscal measures.

Implementing these measures would reduce PRHTA’s projected pre-Commonwealth transfer deficit to approximately $1.7 billion from approximately $6.4 billion projected in the baseline scenario.

An annual transfer of approximately $2.2 billion from the Commonwealth to PRHTA would fund the capital deficit not covered by the operating surplus, resulting in a net 30-year budget surplus of $461 million – which would presumably be the starting point for recoveries to PRHTA creditors.

The cumulative and annual budget surplus post-measures in the 2020 PRHTA Fiscal Plan is drastically lower than the budget surplus post-measures in the 2019 PRHTA Fiscal Plan:

fiscal year 2022 surplus of $33 million vs.

$120 million and fiscal year 2023 surplus of $1 million vs.

$154 million.

Since the document form and projection structure/line items are different in the 2020 PRHTA Fiscal Plan vs.

2019 PRHTA Fiscal Plan, comparability and reconciliation between the two versions is difficult and as such understanding the full extent of the decrease in the budget surplus in the latest plan remains challenging.

COVID-19 is likely a driver, but it also appears that the 2020 PRHTA Fiscal Plan may not include Act 30 license fees ($130 million annually) or all of the $400 to $500 million in annual revenues that come from various excise taxes that also support the PRHTA debt insured by Ambac Assurance (e.g.

gas tax, diesel tax, petroleum products tax, cigarette tax, motor vehicle license fees).

Without these revenues, it unlikely PRHTA will be able to service its existing debt in any meaningful way.

PRHTA has defaulted on its debt service payments since 2016, and based on the 2020 PRHTA Fiscal Plan projections of cash flow, the existing PRHTA debt service may need to be reduced through a Title III plan of adjustment, unless the PRHTA Fiscal Plan projections change again.

The amount of net revenues available for other needs in the 2020 PRHTA Fiscal Plan besides implementation of the capital improvement program, such as the payment of debt service, are highly dependent on PRHTA achieving additional positive cash flow to enable PRHTA eventually to operate at a surplus without the need for projected Commonwealth financial support to meet HTA budget gaps.

However, the 2020 PRHTA Fiscal Plan projects a declining subsidy from the Commonwealth over the next 30 years.

If the Act 30 licenses fees and/or the various excise taxes were re-incorporated into the 2020 Fiscal Plan, recoveries for Ambac Assurance insured debt may be materially higher than inferred from the current version of the 2020 PRHTA Fiscal Plan.

It is unknown if and when a PRHTA Plan of Adjustment will be filed by the Oversight Board or confirmed by the court overseeing the Title III proceedings of PRHTA.

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Commonwealth Plan of Adjustment

On February 9, 2020, the Oversight Board announced it reached an agreement in principle ("Plan Support Agreement") with certain creditors supporting the restructuring of the Commonwealth's General Obligation and PBA debt, and intended to file an amended Plan of Adjustment ("Amended POA") reflecting the terms of this agreement.

On February 28, 2020, the Oversight Board filed an Amended POA and an amended Disclosure Statement to restructure $35 billion of debt and other claims against the Commonwealth of Puerto Rico, PBA, and ERS, as well as more than $50 billion in pension liabilities.

The Amended POA would reduce Commonwealth debt and other claims from $35 billion to less than $11 billion, a 70% cut and would also reduce the Commonwealth’s annual debt service by 56%.

Treatment for pension claims would include a reduction in pension payments by as much as 8.5% for retirees who currently receive at least $1,200 a month, such that 60% of retirees would not face any cuts, and the establishment of a pension reserve fund to help support retirement payments in future years.

The Amended POA, as is, disproportionately disadvantages claims against the Commonwealth related to certain revenue bonds issued by Puerto Rico instrumentalities, including those insured by Ambac Assurance.

The Amended POA provides for estimated recovery of 3.9% on claims against the Commonwealth related to PRHTA bonds, Puerto Rico Infrastructure Financing Authority (PRIFA) Special Tax Revenue (Rum Tax) bonds, and Puerto Rico Convention Center District Authority (PRCCDA) bonds.

It is unknown if and how the Amended POA may be modified or what the final adjustments will be to the revenues available to the Puerto Rico instrumentalities addressed in the Amended POA or the recoveries on claims against the Commonwealth by creditors of those instrumentalities, including Ambac and Ambac-insured bondholders.

However, if the Amended POA were confirmed in

its current form, Ambac's financial condition would suffer a material negative impact.

On February 9, 2020, the Oversight Board announced it reached an agreement in principle ("Plan Support Agreement") with certain creditors supporting the restructuring of the Commonwealth's General Obligation and PBA debt, and intended to file an amended Commonwealth Plan of Adjustment ("Amended POA") reflecting the terms of this agreement.

On February 28, 2020, the Oversight Board filed an Amended POA and an amended Disclosure Statement to restructure approximately $35 billion of debt and other claims against the Commonwealth of Puerto Rico, PBA, ERS, and other issuers as well as more than $50 billion in pension liabilities.

The Amended POA would reduce Commonwealth debt and other claims from $35 billion to less than $11 billion, a 70% haircut and would also reduce the Commonwealth’s annual debt service by 56%.

Treatment for pension claims would include a reduction in pension payments by as much as 8.5% for retirees who currently receive at least $1,200 a month, such that approximately 75% of current and future retirees would not face any cuts, and the establishment of a pension reserve fund to help support retirement payments in future years.

The Amended POA disproportionately disadvantaged claims against the Commonwealth related to certain revenue bonds issued by Puerto Rico instrumentalities, including those insured by Ambac Assurance, providing for an estimated recovery of 3.9% on claims against the Commonwealth related to PRHTA bonds, Puerto Rico Infrastructure Financing Authority (PRIFA) Special Tax Revenue (Rum Tax) bonds, and Puerto Rico Convention Center District Authority (PRCCDA) bonds.

On September 20, 2020, the Oversight Board announced that it and principal creditor parties to the Plan Support Agreement agreed to release documents related to the ongoing debt restructuring negotiations under Title III of PROMESA.

The materials include an August 18, 2020, fiscal plan macroeconomic overview and revised Plan of Adjustment proposal from the Oversight Board and an August 24, 2020, Plan Support Agreement counterproposal from creditors.

According to a press release from the Oversight Board, notwithstanding the information release, the Oversight Board and related creditors continue to negotiate and the Plan Support Agreement has not been terminated.

The revised Commonwealth Plan of Adjustment proposed by the Oversight Board and a counterproposal by the principal creditor parties to the Commonwealth Plan Support Agreement both call for a $2 billion increase in cash consideration for general obligation/Public Buildings Authority bondholders and lower caps on maximum annual debt service compared with the current Plan Support Agreement.

The blended general obligation/Public Buildings Authority bond recovery under the Oversight Board’s proposal (which appears to have been offered to related creditors on July 30, 2020) would range from 52.7% to 58.4%, while the PSA creditors’ counterproposal contemplates a blended recovery based on such claims at 73.6%.

Implied recoveries related to certain revenue bonds insured by Ambac Assurance would be below 3%.

It is unclear if and how the Commonwealth Plan of Adjustment will be ultimately modified or how the final adjustments will impact revenues available to the Puerto Rico instrumentalities addressed in the Amended POA or the recoveries on claims

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against the Commonwealth by creditors of those instrumentalities, including Ambac and Ambac-insured bondholders.

However, if the Amended POA were confirmed in its current form, Ambac's financial condition would suffer a material negative impact.

Refer to Note 6.

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There can be no assurance that losses may not exceed such estimates.

Currently, the schedule for confirmation proceedings regarding the Amended POA, and the hearings regarding the Disclosure Statement that must precede confirmation hearings, is not yet set.

However, on July 15, 2020, the Oversight Board filed a status report in Court that included a request to provide the Court with an updated status report regarding the timeline for the debtors’ Plan of Adjustment and Disclosure Statement process by September 11, 2020.

Judge Swain subsequently granted the request and directed the Oversight Board to file an updated status report, including a proposal for the debtors’ Plan and Disclosure Statement process, by September 9, 2020.

Political Developments

On July 1, 2020, Oversight Board Chairman Jose Carrion and Board member Carlos Garcia announced that they informed the White House they will not be available for re-nomination to serve another three-year term on the Oversight Board.

Carrion said he is stepping down by October 5, and Garcia said he is resigning his post effective August 31.

In a press conference, Carrion said he knows of “at least” one additional board member who does not intend to serve an additional term but said it is not up to him to make the announcement.

It is unclear how the resignations will impact the debt restructuring process, negotiations, timing and ultimate outcome for Ambac.

Governor Vazquez has recently come under fire for her termination (on July 3, 2020) of the Secretary of the Department of Justice, which was conducting various investigations into Vazquez and her advisors.

The Governor’s replacement halted all such investigations and subsequently resigned on July 8, 2020 succumbing to political pressure.

On July 20, 2020 it was announced that Governor Vazquez and five officials will be subject to investigation by a special independent prosecutor regarding emergency supplies management during the series of earthquakes that occurred in early 2020.

Governor Vazquez may also face an investigation into recent government contracts and related procurement of COVID-19 tests.

It is unclear how these investigations may affect the outcome of the August 2020 primary, where Vazquez is competing for the party gubernatorial ticket against former Resident Commissioner Pedro Pierluisi.

On August 31, 2020, the terms of Oversight Board members Carlos M.

García and José Ramón González expired, and on October 5, 2020, the term of Oversight Board Chairman José Carrión expired.

On October 6, 2020, the four remaining members of the Oversight Board at that time (David A.

Skeel, Arthur J.

González, Ana J.

Matosantos and Andrew Biggs) voted unanimously to designate Skeel as the new Oversight Board Chairman.

On October 7, 2020, President Donald J.

Trump appointed Justin Peterson to replace Arthur J.

González as member of the Oversight Board.

The four current members of the Oversight Board continue to carry out all functions and duties while awaiting the potential appointment of additional or replacement members.

However, under section 206(b) of PROMESA, an affirmative vote of no fewer than five members of the board is required to issue a restructuring certification.

On August 16, 2020, Governor Wanda Vázquez acknowledged losing the primary of her pro-statehood party to Pedro Pierluisi, who briefly served as the governor last year amid political turmoil.

Pierluisi faced Mayor Carlos Delgado among other candidates during the gubernatorial election held on November 3, 2020.

No winner has been declared.

It is unclear how the Oversight Board member turnover and local elections will impact the debt restructuring process, negotiations, timing and ultimate outcome for Ambac.

Ambac Title III Litigation Update

Ambac Assurance is party to a number of litigations related to its Puerto Rico exposures, and actively participates in the Commonwealth’s Title III proceedings before the United States District Court for the District of Puerto Rico.

On January 16, 2020, Ambac Assurance filed motions which sought to lift the stay and allow Ambac and others to enforce their rights related to HTA, CCDA and PRIFA in an alternative forum.

On July 2, 2020, Judge Swain issued orders denying, in large part, these motions.

Supplemental briefing on the motions to lift the stay has concluded and a final decision is expected this fall.

Ambac is unable to predict when and how the issues raised in these cases

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will be resolved.

If Ambac Assurance is unsuccessful in any of these proceedings, Ambac’s financial condition, including liquidity, loss reserves and capital resources may suffer a material negative impact.

On January 16, 2020, Ambac Assurance, together with other monoline insurers, filed motions which sought to lift the automatic stay and allow Ambac and others to enforce their rights related to HTA, CCDA and PRIFA in an alternative forum.

Through orders issued on July 2 and September 9, 2020, Judge Swain largely denied the motions, while holding in abeyance further proceedings in the CCDA motion relating to a particular account over which it is undisputed the monolines have a lien.

Ambac Assurance and the other movants have appealed the HTA and PRIFA decisions.

Briefing is expected to be completed by December 21, 2020, with argument heard in February 2021.

Ambac is unable to predict when and how the issues raised in these cases will be resolved.

Assurance is unsuccessful in any of these proceedings, Ambac’s financial condition, including liquidity, loss reserves and capital resources may suffer a material negative impact.

On January 16, 2020 the Oversight Board filed four adversary proceeding complaints against Ambac Assurance, and other monoline insurers, seeking to disallow their proofs of claim against the Commonwealth as they relate to HTA, CCDA, and PRIFA bonds.

On April 28, 2020, the Oversight Board filed partial motions for summary judgment.

Briefing has concluded on those motions for summary judgment and oral argument was held on September 23, 2020.

A decision is pending.

Ambac Assurance, along with other monoline insurers, filed a motion seeking appointment as trustees under Section 926 of the Bankruptcy Code to pursue certain avoidance actions on behalf of HTA against the Commonwealth of Puerto Rico.

The motion attached a proposed complaint detailing the avoidance claims that movants would pursue.

On August 11, 2020 the Court denied the motion and Ambac Assurance and the other movants have appealed that denial.

Ambac Assurance and the other movants filed a motion to hold that appeal in abeyance pending the First Circuit’s resolution of the appeal from the Court’s denial of the HTA Lift-Stay Motion.

Briefing has concluded on the motion to hold the appeal in abeyance and a decision is pending.

Refer to "Financial Guarantees in Force" in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Ambac’s Annual Report on Form 10-K for the year ended December 31, 2019 and Note 11.

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However, Judge Swain issued a scheduling order on June 30, 2020, setting monthly omnibus hearings through the end of 2021.

The timeline for resolution of Puerto Rico’s debt restructuring process is uncertain but may extend into 2021.

It appears the Oversight Board will attempt to move forward with the Amended POA and Plan Support Agreement in some modified form over the intermediate term.

The debt restructuring process status report the Oversight Board filed with the Court on July 15, 2020 stated, “Having completed the process of certifying the Commonwealth Fiscal Plan and corresponding Budget, the Oversight Board has resumed discussions with AAFAF concerning the terms of a Plan of Adjustment and what, if any, modifications or amendments need to be proposed to the Plan of Adjustment and Disclosure Statement filed with the Court on February 28, 2020.

The Oversight Board anticipates that, in the coming weeks, the Oversight Board and AAFAF shall entertain discussions with creditors (those party to the Plan Support Agreement, as amended on March 13, 2020 and April 1, 2020, as well as other parties in interest), with the guidance of the mediation team led by the Judge Barbara J.

Houser, to address the new reality created by the COVID-19 pandemic.

The discussions with creditors will take into account, among other things, this Court’s July 2, 2020 decisions in connection with certain motions for relief from the automatic stay filed by holders and insurers of HTA bonds, CCDA bonds, and PRIFA Rum Tax Bonds.

Furthermore, the outcome of the ongoing litigation regarding the ERS bonds will guide the parties with respect to claims, if any, that may impact the revision of the Commonwealth’s proposed Plan of Adjustment.

While the Oversight Board has resumed Plan discussions, because of the fluid situation on the Island, the Oversight Board is unprepared at this time to propose a schedule for the Debtors’ Plan of Adjustment and Disclosure Statement processes."

No assurances can be given that debt restructuring negotiations will be successfully concluded, that Commonwealth, Oversight Board and creditor parties will reach definitive agreements on debt restructurings, that any additional negotiated transaction, debt restructuring, definitive agreement or Plan of Adjustment will be approved by the court and completed, or that any transaction or Plan of Adjustment will not have a materially adverse impact on Ambac's financial condition or results of operations.

The Commonwealth of Puerto Rico is projected to benefit from over $49 billion of federal disaster aid for infrastructure

improvement initiatives or recovery efforts, as a result of the damage cause by hurricanes Irma and Maria as well as the earthquakes that began in late December 2019.

To date, only about $16.5 billion of the total has been disbursed.

More than $20 billion of Community Development Block Grants (CDBG) was appropriated by Congress for Puerto Rico for reconstruction following Hurricane Maria, but very little has yet been drawn down.

The Department of Housing and Urban Development (HUD), which administers the CDBG program, has approved release of a second tranche of CDBG funds totaling $8.2 billion, which brings the total amount available for drawdown to nearly $10 billion (an additional roughly $10 billion has not yet been approved by HUD for release).

In order to ensure federal taxpayer dollars are spent effectively and efficiently, HUD has conditioned release of the $8.2 billion on various requirements that Puerto Rico must meet.

Governor Wanda Vasquez has agreed to these requirements, which include a prohibition on any of the funds from being used to rebuild the electric grid until (and unless) HUD publishes additional requirements on such spending;

overturns an executive order establishing a $15 minimum wage for government construction projects using CDBG;

requires greater Puerto Rico to provide greater transparency and implement enhanced financial controls;

and requires CDFBG spending plans to be submitted to the Oversight Board for determination that they are in accordance with its certified budgets and fiscal plans.

HUD has also appointed a federal monitor to oversee use of CDBG funds.

The Oversight Board states, on their COVID-19 webpage, that Puerto Rico residents, businesses, and government appear to be eligible for approximately $14 billion in federal aid under the CARES Act.

The full extent of federal government support to Puerto Rico is still uncertain as existing federal stimulus has not been fully implemented and additional measures are likely to be enacted.

On October 28, 2020, Judge Swain ordered the Oversight Board to engage with all relevant parties in responsible and meaningful negotiations in an effort to arrive at a substantially consensual Plan of Adjustment.

The timeline for resolution of Puerto Rico’s debt restructuring process is uncertain and will extend into 2021.

The Oversight Board disclosed, in a status report filed with the Title III court in September 2020, that it has resumed formal discussions with creditors with the guidance of the mediation team led by Judge Houser.

Prior to the talks with creditors, the Oversight Board held discussions with AAFAF concerning the terms of a Commonwealth Plan of Adjustment and what, if any, modifications or amendments needed to be proposed.

The status report also said that the Oversight Board considered it premature to propose a schedule for consideration of the Commonwealth Plan of Adjustment and Disclosure Statement due to several factors, including the upcoming November election.

More specifically, the report states the Oversight Board “and its advisors have engaged in active dialogue with individual creditors and their respective advisors, both those party to the

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Plan Support Agreement as well as other notable parties in interest.

While parties have re-engaged, both formally and informally, in light of (a) the nascent stage of such discussions, (b) the current state of material litigations before the court, the determinations of which shall influence the tenor of such discussions, and (c) the political and electoral process on-Island, the Oversight Board submits it is premature to propose a schedule for consideration of the Commonwealth Plan of Adjustment and Disclosure Statement.” The Oversight Board filed an updated status report in October 2020 which also indicated that it was premature to propose a schedule for consideration of the Commonwealth Plan of Adjustment and Disclosure Statement due to several factors, including the upcoming November election.

No assurances can be given that debt restructuring negotiations will be successfully concluded, that the Commonwealth, Oversight Board and creditor parties will reach definitive agreements on debt restructurings, that any additional negotiated transaction, debt restructuring, definitive agreement or Plan of Adjustment will be approved by the court and completed, or that any transaction or Plan of Adjustment will not have a materially adverse impact on Ambac's financial condition or results of operations.

The Commonwealth of Puerto Rico is projected to benefit from over $60 billion of federal disaster aid for infrastructure improvement initiatives or recovery efforts, as a result of the damage cause by hurricanes Irma and Maria as well as the earthquakes that began in late December 2019.

On September 18, 2020, the White House announced plans for FEMA to award almost $13 billion in new disaster aid, primarily for rebuilding Puerto Rico's electrical grid that was damaged by hurricanes Maria and Irma three years ago.

The majority of the grants ($9.6 billion) will flow to the Puerto Rico Electric Power Authority to repair and replace transmission and distribution lines, substations, generation systems and general grid improvements as part of its strategic transformation.

About $2.3 billion in grants will flow to the Puerto Rico’s Department of Education for school construction projects.

This aid allocation will raise the amount the federal government has obligated to Puerto Rico to approximately $38 billion for Puerto Rico’s recovery.

However, distribution of disaster aid to date post-hurricanes has been slower than expected.

Only one-third, or $16.9 billion, of previously allocated funds have been disbursed to the Commonwealth, according to COR (the Puerto Rico government's Central Recovery and Reconstruction Office).

The slow pace of distribution, primarily for HUD grants, reflects a complicated project approval process but also increased oversight of funds following allegations of Puerto Rico’s mismanagement of aid last year.

To date, HUD has only distributed a fraction of disaster relief funds to Puerto Rico,

about 0.5% of funds previously approved by Congress.

Of the funds received by the Commonwealth, the bulk flowing from FEMA include monies for public assistance projects, including rebuilding roads, bridges, police stations and hospitals damaged during the hurricanes.

Individuals have also received close to $3 billion in FEMA assistance to date, including funding housing assistance for residents that have lost their homes as a result of the disaster, but also for certain home repair, medical, child care and clean-up expenses.

The full extent of federal government support to Puerto Rico is still uncertain as existing federal stimulus has not been fully disbursed and additional measures are likely to be enacted.

President, Puerto Rico governor, or Oversight Board makeup could accelerate the aid distribution process if there was a higher comfort level from the federal government regarding the local management and efficacy of federal disaster resources.

While the previously allocated federal disaster relief funds, Medicaid money, and the more recent COVID-19 crisis related funds are all expected to support economic recovery and growth and in Puerto Rico, there can be no assurances as to the certainty, timing, usage, efficacy or magnitude of benefits to creditor outcomes related to disaster aid and ensuing economic growth, if any.

Ambac has considered these developments and other factors in evaluating its Puerto Rico loss reserves.

During the six months ended June 30, 2020 , Ambac had incurred losses associated with its Domestic Public Finance insured portfolio of $220 million , which was impacted by lower discount rates, the continued uncertainty and volatility of the situation in Puerto Rico, including the potential impact of the COVID-19 crisis on the Commonwealth and the developing potential impact of the COVID-19 crisis on other sectors in the Domestic Public Finance insured portfolio;

During the nine months ended September 30, 2020, Ambac had incurred losses associated with its Domestic Public Finance insured portfolio of $263 million, which was impacted by lower discount rates, the continued uncertainty and volatility of the situation in Puerto Rico, including the potential impact of the COVID-19 crisis on the Commonwealth and the developing potential impact of the COVID-19 crisis on other sectors in the Domestic Public Finance insured portfolio;

and loss adjustment expenses related to the cost of defending our rights and pursuing recoveries.

While management believes its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance that Ambac may not incur additional losses in the future, particularly given the developing economic, political, and legal circumstances in Puerto Rico and the overall uncertain impact of the COVID-19 crisis on the

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Commonwealth and the Domestic Public Finance Insured Portfolio in general.

Such additional losses may have a material adverse effect on Ambac’s results of operations and financial condition.

Exposure Currency

The table below shows the distribution by currency of Ambac Assurance’s insured exposure as of June 30, 2020 :

(Amounts in millions)

Net Par Amount

The table below shows the distribution by currency of Ambac Assurance’s insured exposure as of September 30, 2020:

(Amounts in millions) Net Par Amount

Outstanding in

Base Currency

Net Par Amount

Base Currency Net Par Amount

Outstanding in

Dollars $ 23,033 $ 23,033

British Pounds £ 7,403 9,550

Australian Dollars

Euros € 1,518 1,778

Australian Dollars A$ 545 390

Total $ 34,751

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Ratings Distribution

The following charts provide a rating distribution of net par outstanding based upon internal Ambac credit ratings (1) and a distribution by bond type of Ambac's below investment grade ("BIG") net par exposures at June 30, 2020 and December 31, 2019 .

BIG is defined as those exposures with an Ambac internal credit rating below BBB-:

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Ambac credit ratings are subject to revision at any time and do not constitute investment advice.

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Net Par Outstanding

Summary of Below Investment

Grade Exposure ($ in millions)

Grade Exposure ($ in millions) September 30,

2020 December 31,

Public Finance:

Lease and tax-backed (1)

$ 1,199 $ 1,109

General obligation (1)

Stadium 540 —

Transportation 30 27

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Structured Finance:

RMBS 2,941 3,362

Student loans 540 620

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International Finance:

Other 1,537 1,455

Total International Finance 1,537 1,455

Lease and tax-backed revenue includes $996 and $1,014 of Puerto Rico net par at June 30, 2020 and December 31, 2019 , respectively.

General obligation includes $109 and $109 of Puerto Rico net par at June 30, 2020 and December 31, 2019 , respectively.

Total $ 7,471 $ 7,484

(1) Lease and tax-backed revenue includes $969 and $1,014 of Puerto Rico net par at September 30, 2020 and December 31, 2019, respectively.

General obligation includes $101 and $109 of Puerto Rico net par at September 30, 2020 and December 31, 2019, respectively.

Components of Puerto Rico net par outstanding includes capital appreciation bonds which are reported at the par amount at the time of issuance of the related insurance policy as opposed to the current accreted value of the bonds.

(2) Relates to military housing net par.

The increase in below investment grade exposures is primarily due the addition of certain exposures driven by the COVID-19 pandemic (lease and tax-backed, stadiums and an international structured finance exposure) partially offset by the commutation of certain general obligation exposures and the impact of foreign exchange rates resulting from the strengthening of the US Dollar.

Below investment grade exposures could continue to increase as a relative proportion of the guarantee portfolio given that stressed borrowers generally have less ability to prepay or refinance their debt.

The net decline in below investment grade exposures is primarily due to commutation of certain general obligation exposures, the partial commutation of a structured finance transaction mostly offset by the addition of certain exposures driven by the COVID-19 pandemic (lease and tax-backed, stadiums and an international structured finance exposure).

Below investment grade exposures could increase as a relative proportion of the guarantee portfolio given that stressed borrowers generally have less ability to prepay or refinance their debt.

Accordingly, due to these and other factors, it is not unreasonable to expect the proportion of below investment grade exposure in the guarantee portfolio to continue to increase in the future.

RESULTS OF OPERATIONS

Net loss attributable to common stockholders for the three months ended June 30, 2020 , was $35 million compared to a net loss attributable to common stockholders of $128 million for the three months ended June 30, 2019 .

The decreased loss was primarily driven by (i) lower insurance intangible amortization, (ii) net gain on derivative contracts in the current quarter, (iii) lower provision for income taxes, and (iv) lower operating and interest expenses, partially offset by:

(a) increased losses and loss expenses, primarily due to the loss benefit in the three months ended June 30, 2019, driven by the Ballantyne commutation , (b) lower net investment income, and (c) lower net realized investment gains.

Net loss attributable to common stockholders for the six months ended June 30, 2020 , was $315 million compared to a net loss attributable to common stockholders of $172 million for the six months ended June 30, 2019 .

Net loss attributable to common stockholders for the three months ended September 30, 2020, was $108 million compared to net income attributable to common stockholders of $66 million for the three months ended September 30, 2019.

The decrease in net income was primarily driven by (i) receipt of $142 million arising from the settlement between the SEC and Citigroup which was recognized as a gain in Other income for the three months ended September 30, 2019, (ii) higher losses and loss expenses, (iii) lower net realized investment gains, (iv) lower income on variable interest entities, and (v) lower net investment income, partially offset by:

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interest and operating expenses and (b) higher net gains on derivative contracts.

Net loss attributable to common stockholders for the nine months ended September 30, 2020, was $423 million compared to a net loss attributable to common stockholders of $106 million for the nine months ended September 30, 2019.

The increase in loss was primarily driven by:

(i) lower net investment income, (ii) lower net realized investment gains, (iii) larger net losses on derivative contracts, (iii) lower net premiums earned, (iv) lower income on variable interest entities and (v) higher loss and loss expenses, partially offset by (a) lower insurance intangible amortization, (b) lower interest and operating expenses.

(i) higher loss and loss expenses, (ii) receipt of $142 million arising from the settlement between the SEC and Citigroup which was recognized as a gain in Other income for the nine months ended September 30, 2019, (iii) lower net investment income, (iv) lower net realized investment gains, and (v) lower income on variable interest entities, partially offset by (a) lower insurance intangible amortization and (b) lower interest and operating expenses.

A summary of our financial results is shown below:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

($ in millions) 2020 2019 2020 2019

3 unchanged sentences

Net gains (losses) on derivative contracts 7 (10) (61) (61)

Other income (expense) 2 141 2 133

Income (loss) on variable interest entities — 11 3 30

6 unchanged sentences

Ambac's results of operations and financial position have been adversely impacted by the COVID-19 pandemic's effect on the global economy and financial markets.

Significant interest rate declines during the first quarter of 2020 drove a net increase to loss reserves and losses on interest rate derivative contracts.

Significant interest rate declines during the first quarter of 2020 contributed materially to a net increase in loss reserves and losses on interest rate derivative contracts.

Credit driven losses were also recognized in the three months ended March 31, 2020, within losses incurred (primarily from public finance insurance policies) and losses in counterparty credit adjustments on derivative asset valuations.

Financial market disruptions were reflected through lower valuations of certain fixed income securities (recorded through other comprehensive income) and the majority of other investments (recorded through net investment income).

During the second quarter of 2020, credit spreads partially recovered (impacting counterparty credit adjustments on derivative assets and valuations of investment securities).

During the second and third quarters of 2020, credit spreads partially

recovered (favorably impacting counterparty credit adjustments on derivative assets and valuations of investment securities).

The scope, duration and magnitude of the direct and indirect effects of COVID-19 are evolving in ways that are difficult or impossible to anticipate.

As a result, it is possible that Ambac's results of operations and financial condition may be further adversely affected by the evolving affects of the COVID-19 pandemic.

For additional information on the risks posed by

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57 2020 Second Quarter FORM 10-Q |

COVID-19, refer to “Part II, Item 1A-Risk Factors” in this Quarterly Report on Form 10-Q.

For additional information on the risks posed by COVID-19, refer to “Part II, Item 1A-Risk Factors” in this Quarterly Report on Form 10-Q.

During 2019, Ambac executed on a number of restructuring/commutation transactions that had significant impacts to the consolidated results of operations.

As described further below, the completion of the these transactions, including the related changes to invested assets, intangible assets, loss reserves and debt of the Company, had a significant impact on the comparability of the results of operation for the three and six months ended June 30, 2020 and 2019 .

The most significant transactions, which are more fully discussed in "Financial Guarantees in Force" in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Ambac’s Annual Report on Form 10-K for the year ended December 31, 2019 were:

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With the successful implementation of the Restructuring, Ambac UK has ceased to have any exposure with respect to the obligations of Ballantyne.

The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for the three and six months ended June 30, 2020 and 2019 , respectively.

The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for the three and nine months ended September 30, 2020 and 2019, respectively.

Net Premiums Earned .

3 unchanged sentences

For installment premium paying transactions, we offset the recognition of any remaining UPR by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement), which may cause negative accelerated premium revenue.

Net premiums earned increased $3 million and decreased $14 million for the three and six months ended June 30, 2020 , respectively, compared to the same periods in the prior year.

Net premiums earned increased $5 million and decreased $10 million for the three and nine months ended September 30,

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59 2020 Third Quarter FORM 10-Q |

2020, respectively, compared to the same periods in the prior year.

Normal net premiums earned and accelerated premiums are reconciled to total net premiums earned in the table below.

The following table provides a breakdown of normal premiums earned by market:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

($ in millions) 2020 2019 2020 2019

6 unchanged sentences

Total net premiums earned $ 15 $ 10 $ 36 $ 46

The decrease in normal premiums earned in the three and six months ended June 30, 2020 , is primarily attributable to (i) the continued runoff of the insured portfolio in all markets and (ii) changes to allowance for credit losses on premiums receivables.

Ambac adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments ("CECL"), on January 1, 2020, and will assess the allowance for credit losses on premium receivables on a quarterly basis.

The increase in normal premiums earned for the three months ended September 30, 2020, is primarily due to changes in allowances for credit losses on premium receivables, partially offset by the continued runoff of the insured portfolio in all markets.

The decrease in normal premiums earned for the nine months ended September 30, 2020, is primarily attributable to (i) the continued runoff of the insured portfolio in all markets and (ii) changes to allowance for credit losses on premiums receivables.

Ambac adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments ("CECL"), on January 1, 2020, and assesses the allowance for credit losses on premium receivables on a quarterly basis.

Prior to adoption of ASU 2016-13, Ambac assessed collectability of premium receivables in accordance with ASC 944 and recorded an allowance for uncollectible premiums.

The three and six months ended June 30, 2020 , includes an increase in the allowance for credit losses since adoption of CECL of $2 million and $4 million, respectively, as compared to an increase of $1 million for the three and six months ended June 30, 2019 .

The three and nine months ended September 30, 2020, includes an increase in the allowance for credit losses since adoption of CECL of $2 million and $5 million, respectively, as compared to an increase of $6 million and $7 million for the three and nine months ended September 30, 2019, respectively.

Terminations and accelerations, including those which occurred in prior periods, result in lower normal premiums earned in current and future periods.

Public Finance normal earned premiums for the three and six months ended June 30, 2020 , were also impacted by reinsurance cessions in the second half of 2019.

The increase in accelerated earnings in the three months ended June 30, 2020 , as compared to the three months ended June 30, 2019 , is primarily driven by negative accelerations related to the Ballantyne commutation that occurred in June 2019.

The decrease in accelerated earnings in the six months ended June 30, 2020 , as compared to the six months ended June 30, 2019 , is primarily related to the COFINA restructuring that occurred in February 2019, partially offset by negative accelerations related to the Ballantyne commutation that occurred in June 2019.

Public Finance normal earned premiums for the three and nine months ended September 30, 2020, were also impacted by reinsurance cessions in the second half of 2019.

The increase in accelerated earnings in the three months ended September 30, 2020, as compared to the three months ended September 30, 2019, is primarily driven by the termination of an international credit.

The decrease in accelerated earnings in the nine months ended September 30, 2020, as compared to the nine months ended September 30, 2019, is primarily related to the COFINA restructuring, partially offset by negative accelerations related to the Ballantyne commutation and two international commercial asset-backed exposures, all of which occurred in 2019.

Net Investment Income.

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As described further below, investment income from holdings of Ambac-insured securities (including Secured Notes issued by Ambac LSNI, LLC) for the periods presented have primarily been affected by restructuring transactions involving Puerto Rico and Ballantyne bonds.

Investments in pooled investment funds and certain other investments are either classified

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58 2020 Second Quarter FORM 10-Q |

as trading securities with changes in fair value recognized in earnings or are reported under the equity method.

These funds and other investments are reported in Other investments on the Unaudited Consolidated Balance Sheets and consist primarily of pooled fund investments in diversified asset classes.

Investments in pooled investment funds and certain other investments are either classified as trading securities with changes in fair value recognized in earnings or are reported under the equity method.

These funds and other investments are reported in Other investments on the Unaudited Consolidated Balance Sheets, which consists primarily of pooled fund investments in diversified asset classes.

For further information about investment funds held, refer to Note 8.

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and Other investments is summarized in the table below:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

($ in millions) 2020 2019 2020 2019

1 unchanged sentence

Ambac-insured (including Secured Notes)

$ 15 $ 18 $ 47 $ 104

Securities available-for-sale and short-term other than Ambac-insured

1 unchanged sentence

Net investment income

Net investment income decreased $34 million and $110 million for the three and six months ended June 30, 2020 , respectively, compared to the same periods in the prior year.

As described further below, the variances were primarily driven by pricing volatility within fund investments resulting from the impact of the COVID-19 pandemic on financial markets, a smaller allocation to higher yielding Ambac-insured securities and a lower overall invested asset base.

Other investments income (loss) increased $19 million and decreased $41 million for the three and six months ended June 30, 2020 , respectively, compared to the same periods in the prior year.

Other investment income (loss) for the three months ended June 30, 2020, reflects the partial recovery of fair value losses reported in the first quarter of 2020, which were primarily in hedge and other fund investments focusing on asset-backed securities, equities, high-yield, leveraged loans and private credit.

The first quarter 2020 losses were driven by adverse changes in fair values stemming from an increase in risk premiums (including credit spreads) as a consequence of the economic and financial market impact of the COVID-19 pandemic.

The extent of market recovery on Ambac's investments in these funds varied during the second quarter of 2020, but in aggregate returned over half of first quarter losses.

Ambac currently views year-to-date unrealized losses on its fund investments as temporary, subject to any subsequent decisions to monetize certain investments in connection with changes in liquidity needs, investment strategy, market conditions, and/or other circumstances.

Other investment income for the three and six months ended June 30, 2019, was driven primarily by gains

on equity and high-yield and loan funds, partially offset by losses on insurance-linked securities.

Investment income from Ambac-insured securities was lower in both the three and six month periods ended June 30, 2020, compared to the prior year periods due primarily to the effects of 2019 de-risking activities and ongoing redemptions of Secured Notes issued by Ambac LSNI, LLC.

Ambac's holdings of insured COFINA and Ballantyne bonds were settled in connection with the February 2019 COFINA commutation and June 2019 Ballantyne commutation, respectively.

In addition to the reduced amount of holdings subsequent to these settlements, the Ballantyne transaction resulted in accelerated accretion on the bonds in the three months ended June 30, 2019, accounting for the majority of the decrease in income from Ambac-insured securities for both comparative periods.

Additionally, income from Secured Notes is down as a result of early redemptions as well as lower LIBOR indexed coupon rates effective for the three and six months ended June 30, 2020 , as compared to the three and six months ended June 30, 2019 .

Net investment income from available-for-sales securities other than Ambac-insured securities decreased as a result of the favorable impact on income for the three and six months ended June 30, 2019 , of high yielding uninsured COFINA bonds received under the POA, as well as the impact of a smaller asset base and lower average yields in 2020.

$ 37 $ 45 $ 69 $ 186

Net investment income decreased $7 million and $117 million for the three and nine months ended September 30, 2020, respectively, compared to the same periods in the prior year.

As described further below, the variances were primarily driven by pricing volatility within fund investments resulting from the impact of the COVID-19 pandemic on financial markets and the impact of de-risking transactions in 2019, including lower subsequent allocations to higher yielding Ambac-insured securities and a lower overall invested asset base.

• Other investments income (loss) increased $6 million and decreased $37 million for the three and nine months ended September 30, 2020, respectively, compared to the

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60 2020 Third Quarter FORM 10-Q |

same periods in the prior year.

The increase in other investment income (loss) for the three months ended September 30, 2020, compared to the prior year period, resulted from stronger average performance and a larger allocation to this sector.

Third quarter 2020 gains reflect the continued price recovery on asset classes most significantly impacted by fair value losses in the first quarter of 2020, including hedge funds and funds investing in high-yield bonds, leveraged loans and equities.

Other investment income for the three months ended September 30, 2020, also reflected gains on additional hedge fund investments made during the period.

The loss for the nine months ended September 30, 2020, was driven by adverse changes in fair values experienced in the first quarter of the year stemming from an increase in risk premiums (including credit spreads) as a consequence of the economic and financial market impact of the COVID-19 pandemic, partially offset by fair value recoveries and gains on new investments in subsequent quarters.

Other investment income for the three and nine months ended September 30, 2019, was driven primarily by gains on equity and high-yield and loan funds, partially offset by losses on insurance-linked securities.

• Investment income from Ambac-insured securities was lower in both the three and nine month periods ended September 30, 2020, compared to the prior year periods due primarily to the effects of 2019 de-risking activities, ongoing early redemptions of Secured Notes issued by Ambac LSNI, LLC and the effects of declining interest rates.

The decline of income from Ambac-insured securities for the three months ended September 30, 2020, was driven by redemptions and lower LIBOR indexed coupon rates on the Secured Notes compared to the three months ended September 30, 2019.

Lower income from Ambac-insured securities for the nine months ended September 30, 2020 compared to the same period of 2019, primarily resulted from accelerated discount accretion on Ballantyne bonds, recognized in connection with the Restructuring in the second quarter of 2019.

Other contributing factors to the decrease from the first nine months of 2019 are redemptions and lower rates on the Secured Notes and lower holdings of Ambac insured-RMBS.

• Net investment income from available-for-sales securities other than Ambac-insured securities decreased as a result of the favorable impact on income for the three and nine months ended September 30, 2019, of high yielding uninsured COFINA bonds received under the POA, as well as the impact of a smaller asset base and lower average yields in 2020.

All of the uninsured COFINA bonds were sold from Ambac's non-VIE investment portfolio by December 31, 2019.

Portfolio repositioning away from BBB rated corporates, commercial mortgage backed securities and certain CLOs in the second quarter of 2020 also contributed to lower net investment income from available-for-sale securities for the three months ended June 30, 2020.

Use of funds for early debt redemptions and operating cash needs, combined with portfolio allocation toward other investments and Ambac-insured bonds from lower rated investment grade corporates, commercial mortgage backed securities and certain CLOs in 2020 resulted in a lower asset base in this portion of the portfolio.

This reallocation along with steadily declining reinvestment

rates on short-term holdings resulted in lower averages yields on available-for-sale securities other than Ambac-insured compared to the prior year periods.

Net Realized Investment Gains (Losses).

The following table provides a breakdown of net realized gains (losses) for the periods presented:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

($ in millions) 2020 2019 2020 2019

Net gains (losses) on securities sold or called

$ 4 $ 12 $ 20 $ 42

Net foreign exchange gains (losses)

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Total net realized gains (losses)

Net realized gains on securities sold or called for the three and six months ended June 30, 2020 , are primarily from sales in connection with routine portfolio management.

Net realized gains on securities sold or called for the three and six months ended June 30, 2019 , included $7 million and $26 million, respectively, of net gains related to the impact of the COFINA Plan of Adjustment, including sales of Ambac-insured Puerto Rico COFINA bonds and new uninsured COFINA bonds received in the commutation.

Also included in realized gains for the three and six months ended June

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59 2020 Second Quarter FORM 10-Q |

30, 2019, are $23 million of realized foreign exchange gains arising from the settlement of Ballantyne bonds held in the investment portfolio.

$ 2 $ 18 $ 20 $ 71

Net realized gains on securities sold or called for the three and nine months ended September 30, 2020, are primarily from sales in connection with routine portfolio management.

Net realized gains on securities sold or called for the three and nine months ended September 30, 2019, included $7 million and $33 million, respectively, of net gains related to the impact of the COFINA Plan of Adjustment, including sales of Ambac-insured Puerto Rico COFINA bonds and new uninsured COFINA bonds received in the commutation.

Also included in realized gains for the nine months ended September 30, 2019, are $23 million of realized foreign exchange gains arising from the settlement of Ballantyne bonds held in the investment portfolio.

Impairments are reported through earnings if management intends to sell securities or it is more likely than not that the Company will be required to sell before recovery of amortized cost.

7 unchanged sentences

Results from credit derivatives were not significant to the periods presented.

Net gains (losses) on interest rate derivatives for the three and six months ended June 30, 2020 , were $1 million and $(67) million , respectively, compared to ($36) million and $(52) million for the three and six months ended June 30, 2019 , respectively.

The net gain for the three months ended June 30, 2020, reflects a gain from reduced counterparty credit adjustments, partially offset by the impact of interest rate movements on the portfolio.

The net loss for six months ended June 30, 2020, reflects significant declines in forward interest rates, triggered by the COVID-19 pandemic, and losses from the application of counterparty credit adjustments, described further below.

The net losses for three and six months ended June 30, 2019 , were driven by the impact of declines in forward interest rates during the period.

Net carrying costs were not significant to the periods presented.

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61 2020 Third Quarter FORM 10-Q |

Net gains (losses) on interest rate derivatives for the three and nine months ended September 30, 2020, were $6 million and $(61) million, respectively, compared to ($10) million and $(63) million for the three and nine months ended September 30, 2019, respectively.

The net gain for the three months ended September 30, 2020, reflects a gain from reduced counterparty credit adjustments.

The net loss for nine months ended September 30, 2020, reflects significant declines in forward interest rates, triggered by the COVID-19 pandemic, and losses from the application of counterparty credit adjustments, described further below.

The net losses for three and nine months ended September 30, 2019, reflect the impact of declines in forward interest rates, partially offset by negative net carrying costs driven by an inverted yield curve.

• Counterparty credit adjustments are generally applicable for uncollateralized derivative assets that may not be offset by derivative liabilities under a master netting agreement.

Inclusion of counterparty credit adjustments in the valuation of interest rate derivatives resulted in gains (losses) within Net gains (losses) on derivative contracts of $8 million and $(21) million for the three and six months ended June 30, 2020 , respectively, and $(3) million for the three and six months ended June 30, 2019 .

The gain for the three months ended June 30, 2020, was driven by narrower credit spreads, in a partial reversal of first quarter 2020 results.

The loss for the six months ended June 30, 2020, was driven by wider credit spreads, including the effect of a credit rating downgrade of a derivative counterparty by Ambac during the first quarter, simultaneous with an increase in the underlying asset value as interest rates declined.

Inclusion of counterparty credit adjustments in the valuation of interest rate derivatives resulted in gains (losses) within Net gains (losses) on derivative contracts of $6 million and $(15) million for the three and nine months ended September 30, 2020, respectively, and $(5) million and $(8) million for the three and nine months ended September 30, 2019, respectively.

The gain for the three months ended September 30, 2020, was driven by narrower credit spreads and a decrease in the underlying net asset value of the derivative assets as long term interest rates began to rise.

The loss for the nine months ended September 30, 2020, was driven by wider credit spreads, including the effect of a credit rating downgrade of a derivative counterparty by Ambac during the first quarter, simultaneous with an increase in the underlying asset value as interest rates declined.

The losses on counterparty credit adjustments for the 2019 periods are primarily due to increases in the underlying asset values as interest rates declined.

Other income (expense) .

Other income (expense) includes various fees, primarily consent and waiver fees, as well as foreign exchange gains/(losses) unrelated to investments or loss reserves.

For the three and nine months ended September 30, 2020, other income (expense) included foreign exchange gains and amortization of fee income.

Other income also includes proceeds received by Ambac Assurance in September 2019 in connection with an SEC action against Citigroup Global Markets Inc.

in the amount of $142 million.

Income (Loss) on Variable Interest Entities .

Included within Income (loss) on variable interest entities are income statement amounts relating to VIEs, consolidated under the Consolidation

Topic of the ASC as a result of Ambac's variable interest arising from financial guarantees written by Ambac's subsidiaries, including gains or losses attributable to consolidating or deconsolidating VIEs during the periods reported.

Included within Income (loss) on variable interest entities are income statement amounts relating to VIEs, consolidated under the Consolidation Topic of the ASC as a result of Ambac's variable interest arising from financial guarantees written by Ambac's subsidiaries, including gains or losses attributable to consolidating or deconsolidating VIEs during the periods reported.

Generally, the Company’s consolidated VIEs are entities for which Ambac has provided financial guarantees on all of or a portion of its assets or liabilities.

In consolidation, assets and liabilities of the VIEs are initially reported at fair value and the related insurance assets and liabilities are eliminated.

However, the amount of VIE net assets (liabilities) that remain in consolidation generally result from the net positive (negative) projected cash flows from (to) the VIEs which are attributable to Ambac’s insurance subsidiaries in the form of financial guarantee insurance premiums, fees and losses.

subsidiaries in the form of financial guarantee insurance premiums, fees and losses.

In the case of VIEs with net negative projected cash flows, the net liability is generally to be funded by Ambac’s insurance subsidiaries through insurance claim payments.

Differences between the net carrying value of the insurance accounts under the Financial Services—Insurance Topic of the ASC and the carrying value of the consolidated VIE’s net assets or liabilities are recorded through income at the time of consolidation or deconsolidation.

Additionally, terminations or other changes to Ambac's financial guarantee insurance policies that impact projected cash flows between a consolidated VIE and Ambac could result in gains or losses, even if such policy changes do not result in deconsolidation of the VIE.

Income (loss) on variable interest entities was a loss of less than a million and income of $3 million for the three and six months ended June 30, 2020 , respectively, compared to income of $3 million and $19 million for the three and six months ended June 30, 2019 , respectively.

Results for the three months ended June 30, 2020 , reflect the further reduction in value of net assets of a VIE driven by the ongoing shut-down of parts of the economy resulting from COVID-19.

Results for the six months ended June 30, 2020 , were due primarily to realized gains of $8 million on sales of assets from the COFINA Trust partially offset by the lower valuation of net assets on a VIE driven by the economic uncertainty caused by COVID-19.

Results for the six months ended June 30, 2019, were driven by the $15 million gain on consolidation of the COFINA Trust.

Income (loss) on variable interest entities was a loss of less than a million and income of $3 million for the three and nine months ended September 30, 2020, respectively, compared to income of $11 million and $30 million for the three and nine months ended September 30, 2019, respectively.

Results for the three months ended September 30, 2020, reflect a modest reduction in value of net assets of a VIE related to the ongoing shut-down of parts of the UK economy resulting from COVID-19.

Results for the nine months ended September 30, 2020, were due primarily to realized gains of $8 million on sales of assets from one VIE (the COFINA Trust) partially offset by the lower valuation of net assets on a VIE impacted by COVID-19.

Results for the three and nine months ended September 30, 2019, were driven by the impact of the COFINA Trust created in connection with the restructuring of Puerto Rico COFINA debt.

Income from COFINA Trust for the three months ended September 30, 2019, was $11 million, primarily from realized gains on sales of assets from the trust used for early redemptions of debt.

Income from COFINA Trust for nine months ended September 30, 2019, was $26 million, including $15 million from consolidation and $13 million from realized investment gains, partially offset by net interest expense and fees.

The three and nine months ended September 30, 2019, also included a $2 million loss from deconsolidation of a VIE.

Refer to Note 3.

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Generally, the sponsor of an RMBS transaction provided representations and warranties with respect to the securitized loans, including representations with respect to the loan characteristics, the absence of borrower fraud in the underlying loan pools or other misconduct in the origination process and attesting to the compliance of loans with the prevailing underwriting policies.

Ambac has recorded representation and

Ambac has recorded representation and warranty subrogation recoveries, net of

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60 2020 Second Quarter FORM 10-Q |

warranty subrogation recoveries, net of reinsurance, of $1,731 million and $1,702 million at June 30, 2020 , and December 31, 2019 , respectively.

62 2020 Third Quarter FORM 10-Q |

reinsurance, of $1,731 million and $1,702 million at September 30, 2020, and December 31, 2019, respectively.

The increase in these recoveries was primarily driven by lower discount rates used to discount estimated cash flows.

2 unchanged sentences

The following provides details, by bond type, for losses and loss expenses (benefit) incurred for the periods presented:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

($ in millions) 2020 2019 2020 2019

RMBS $ 27 $ (25) $ (91) $ (133)

Domestic Public Finance 43 77 263 197

1 unchanged sentence

Ambac UK and Other Credits 8 — 20 (125)

Includes loss expenses incurred (benefit) of $34 and $37 for the three and six months ended June 30, 2020 , respectively, and ($1) and $28 for the three and six months ended June 30, 2019 , respectively.

Losses and loss expenses (benefit) for the three and six months ended June 30, 2020 , were driven by the following:

Higher projected losses in domestic public finance driven mostly by lower discount rates (primarily relating to Puerto Rico) and incurred losses related to transactions directly impacted by the economic impact from COVID-19;

$ 83 $ 37 $ 216 $ (84)

(1) Includes loss expenses incurred of $46 and $83 for the three and nine months ended September 30, 2020, respectively, and $23 and $52 for the three and nine months ended September 30, 2019, respectively.

Losses and loss expenses (benefit) for the three and nine months ended September 30, 2020, were driven by the following:

• Higher projected losses in domestic public finance driven by lower discount rates (primarily relating to Puerto Rico), loss expenses incurred and incurred losses related to transactions directly impacted by the economic impact from COVID-19;

• An increase in student loan losses as a result of lower discount rates and the impact from COVID-19;

partially offset by

Favorable RMBS development as a result of the positive impact of lower interest rates on excess spread, reduced by the negative impact of lower discount rates and expected losses from COVID-19 related delinquencies/defaults.

Losses and loss expenses (benefit) for the three and six months ended June 30, 2019 , were driven by the following:

Favorable development within Ambac UK and Other Credits primarily due to the Ballantyne commutation;

Favorable RMBS development as a result of credit improvement, a trustee settlement related to Lehman sponsored transactions of $19 million and the impact on excess spread from declines in interest rates;

partially offset by,

Higher projected losses in domestic public finance driven mostly by lower discount rates and additions to Puerto Rico loss reserves.

• Increased RMBS losses for the three months ended September 30, 2020, related to expected losses from COVID-19 related delinquencies and improved RMBS losses for the nine months ended September 30, 2020, as a result of the positive impact of lower interest rates on excess spread, reduced by lower discount rates and expected losses from COVID-19 related delinquencies.

Losses and loss expenses (benefit) for the three and nine months ended September 30, 2019, were driven by the following:

• For the nine months ended September 30, 2019, favorable development within Ambac UK and Other Credits primarily due to the Ballantyne commutation completed in June 2019;

• Favorable RMBS development as a result of credit improvement, the impact on excess spread from declines in interest rates, and additionally for the nine months ended September 30, 2019, a trustee settlement related to Lehman sponsored transactions partially offset by,

• Higher projected losses in domestic public finance driven mostly by a lower discount rates and additions to Puerto Rico loss reserves.

Insurance Intangible Amortization.

Insurance intangible amortization for the three and six months ended June 30, 2020 , was $14 million and $27 million, respectively, a decrease of $213 million and $236 million over the three and six months ended June 30, 2019 , respectively.

The decrease is primarily due to accelerated amortization as a result of the Ballantyne commutation that occurred in the second quarter of 2019.

Insurance intangible amortization for the three and nine months ended September 30, 2020, was $14 million and $41 million, respectively, a decrease of $4 million and $239 million over the three and nine months ended September 30, 2019, respectively.

The decrease from the nine months ended September 30, 2019, is primarily due to accelerated amortization as a result of the Ballantyne commutation that occurred in the second quarter of 2019.

Operating Expenses.

1 unchanged sentence

The following table provides a summary of operating expenses for the periods presented:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

($ in millions) 2020 2019 2020 2019

$ 13 $ 14 $ 38 $ 46

Non-compensation

2 unchanged sentences

Total operating expenses $ 23 $ 26 $ 67 $ 80

Gross operating expenses decreased $9 million and $10 million for the three and six months ended June 30, 2020 , respectively, compared to the same periods in the prior year.

Operating expenses incurred relating to COVID-19 have been minimal for the three and six months ended June 30, 2020 .

The decrease in operating expenses during the three months ended June 30, 2020 as compared to the three months ended June 30, 2019 was due to the following:

Lower compensation costs primarily related to lower salaries resulting from continued right sizing of staffing levels and incentive compensation costs related to changes in performance metrics primarily impacted by the Ballantyne restructuring and

Lower non-compensation costs primarily due to reduced legal and consulting services.

The decrease in operating expenses during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, was due to the following:

Lower compensation costs primarily due to lower salaries resulting from continued right sizing of staffing levels and incentive compensation costs related to changes in performance metrics primarily impacted by the Ballantyne restructuring and

Lower non-compensation costs primarily due to a UK Value Added Tax (VAT) refund recognized in the six months ended June 30, 2020 , and reduced consulting services.

Legal and consulting services provided for the benefit of OCI amounted to $1 million and $1 million during the six months ended June 30, 2020 and 2019 , respectively.

Gross operating expenses decreased $3 million and $13 million for the three and nine months ended September 30, 2020, respectively, compared to the same periods in the prior year.

Operating expenses incurred relating to COVID-19 have not been significant for the three and nine months ended September 30, 2020.

The decrease in operating expenses during the three months ended September 30, 2020, as compared to the three months ended September 30, 2019, was due to the following:

• Lower compensation costs primarily related to lower salaries resulting from continued right sizing of staffing levels and

• Lower non-compensation costs primarily due to reduced premises costs as a result of re-locating our corporate headquarters.

The decrease in operating expenses during the nine months ended September 30, 2020, as compared to the nine months ended September 30, 2019, was due to the following:

• Lower compensation costs primarily due to lower salaries and severance resulting from continued right sizing of staffing levels and lower incentive compensation costs primarily related to the Ballantyne restructuring in 2019 and

• Lower non-compensation costs primarily due to a UK Value Added Tax (VAT) refund recognized in the nine months ended September 30, 2020, reduced consulting services and lower premises costs as a result of re-locating our corporate headquarters, offset by increased legal fees.

Legal and consulting services provided for the benefit of OCI were flat at $2 million during the nine months ended September 30, 2020 and 2019.

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Interest Expense.

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Additionally, interest expense includes discount accretion when the debt instrument carrying value is at a discount to par.

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The following table provides details by type of obligation for the periods presented:

Three Months Ended June 30,

Six Months Ended June 30,

Three Months Ended September 30, Nine Months Ended September 30,

($ in millions) 2020 2019 2020 2019

Surplus notes (1)

$ 17 $ 25 $ 67 $ 73

Ambac note 25 35 83 110

Tier 2 notes 7 7 21 19

Other — — 1 —

Total interest expense $ 50 $ 67 $ 172 $ 202

(1) Includes junior surplus notes

The decrease in interest expense for the three and six months ended June 30, 2020 , compared to the three and six months ended June 30, 2019 , was primarily driven by optional redemptions and lower rate resets of the floating rate Ambac Note, and lower discount accretion on surplus notes, partially offset by interest compounding on the surplus notes and the Tier 2 Notes.

The decrease in interest expense for the three and nine months ended September 30, 2020, compared to the three and nine months ended September 30, 2019, was primarily driven by optional redemptions and lower rate resets of the floating rate Ambac Note and lower discount accretion on surplus notes, partially offset by interest compounding on the surplus notes and the Tier 2 Notes.

Surplus note principal and interest payments require the approval of OCI.

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The interest on the outstanding surplus notes and junior surplus notes were accrued for and Ambac Assurance is accruing interest on the interest amounts following each scheduled payment date.

Total accrued and unpaid interest for surplus notes and junior surplus notes outstanding to third parties were $323 million and $159 million , respectively, at June 30, 2020 .

Total accrued and unpaid interest for surplus notes and junior surplus notes outstanding to third parties were $334 million and $165 million, respectively, at September 30, 2020.

Provision for Income Taxes .

The provision for income taxes for the three and six months ended June 30, 2020 , was $2 million and a benefit of $4 million , a decrease of $26 million and $35 million compared to the provision for income taxes reported for three and six months ended June 30, 2019 .

The change for the three and six months ended June 30, 2020 , as compared to the three and six months ended June 30, 2019 , was primarily attributable to Ambac UK, which had higher taxable income in 2019 due to the Ballantyne restructuring and commutation, and a taxable loss, related to

investment losses on pooled funds, in the three months ended March 31, 2020.

The provision for income taxes for the three and nine months ended September 30, 2020, was $0 million and a benefit of $5 million, a decrease of $3 million and $38 million compared to the provision for income taxes reported for three and nine months ended September 30, 2019.

The change for the three and nine months ended September 30, 2020, as compared to the three and nine months ended September 30, 2019, was primarily attributable to Ambac UK, which had higher taxable income in 2019 due to the Ballantyne restructuring and commutation.

LIQUIDITY AND CAPITAL RESOURCES

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("AFG") Liquidity .

AFG's liquidity is primarily dependent on its cash, investments, and net receivables totaling $481 million as of June 30, 2020 , and secondarily on its expense sharing and other arrangements with Ambac Assurance.

AFG's liquidity is primarily dependent on its cash, investments (excluding equity investments in subsidiaries), and net receivables totaling $465 million as of September 30, 2020, and secondarily on its expense sharing and other arrangements with Ambac Assurance.

• During the three months ended September 30, 2020, AFG purchased Everspan Insurance Company, from Ambac Assurance and repositioned it as a subsidiary of a new intermediary holding company that is directly owned by AFG.

This acquisition required a cash payment from AFG to AAC of approximately $14 million.

• Pursuant to the amended and restated tax sharing agreement among AFG, Ambac Assurance and certain affiliates (the "Amended TSA"), Ambac Assurance is required to make payments ("tolling payments") to AFG with respect to the utilization of net operating loss carry-forwards (“NOLs”).

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• Under an inter-company cost allocation agreement, AFG is reimbursed by Ambac Assurance for a portion of certain operating costs and expenses and, if approved by OCI, entitled to an additional payment of up to $4 million per year to cover expenses not otherwise reimbursed.

OCI approved this $4 million reimbursement f or 2019 expenses, which was paid in March 2020.

OCI approved this $4 million reimbursement for 2019 expenses, which was paid in March 2020.

AFG's investments include securities directly and indirectly issued by and/or insured by Ambac Assurance, some of which are eliminated in consolidation.

Securities issued or insured by Ambac Assurance are generally less liquid than investment grade and other traded investments.

It is highly unlikely that Ambac Assurance will be able to make dividend payments to AFG for the foreseeable future and therefore cash and investments, payments under the intercompany cost allocation agreement and future tolling payments, if any, will be AFG’s principal source of liquidity in the near term.

It is highly unlikely that Ambac Assurance will be able to make dividend payments to AFG for the foreseeable future and therefore cash and investments, payments under the intercompany cost allocation agreement and tolling payments, if any, will be AFG’s principal sources of liquidity in the near term.

Refer to Part I, Item 1, “Insurance Regulatory Matters — Dividend Restrictions, Including Contractual Restrictions” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, and Note 8.

Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 , for more information on dividend payment restrictions.

Insurance Regulatory Restrictions to the Consolidated Financial Statements included

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in Part II, Item 8, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, for more information on dividend payment restrictions.

The principal uses of liquidity are the payment of operating expenses, including costs to explore opportunities to grow and diversify Ambac;

and the making of investments, including securities issued or insured by Ambac Assurance.

Future uses of liquidity may include the acquisition or capitalization of new businesses.

and the making of investments, which may include securities issued or insured by Ambac Assurance or Ambac UK and other less liquid investments.

Additional uses of liquidity may include the acquisition or capitalization of new businesses.

Contingencies could cause material liquidity strains.

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sales of investments;

proceeds from repayment of

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affiliate loans;

proceeds from repayment of affiliate loans;

and recoveries on claim payments, including from litigation and reinsurance recoveries.

Termination of installment premium policies on an accelerated basis may adversely impact Ambac Assurance’s liquidity.

The principal uses of Ambac Assurance’s liquidity are the payment of operating and loss adjustment expenses, claims, commutation and related expense payments on insurance policies, ceded reinsurance premiums, principal and interest payments on the Ambac Note, surplus note principal and interest payments, Tier 2 Note payments, additional loans to affiliates, tolling payments due to AFG under the Amended TSA, and purchases of securities and other investments that may not be immediately converted into cash.

The COVID-19 pandemic has had a negative impact on Ambac's available liquidity as a consequence of the adverse reaction of the capital markets, which led to a reduction in the value and marketability of our invested assets;

The principal uses of Ambac Assurance’s liquidity are the payment of operating and loss adjustment expenses;

commutation and related expense payments on insurance policies;

ceded reinsurance premiums;

principal and interest payments on the Ambac Note, surplus notes and Tier 2 Notes;

additional loans to affiliates;

tolling payments due to AFG under the Amended TSA;

and purchases of securities and other investments that may not be immediately converted into cash.

• The COVID-19 pandemic has had a negative impact on Ambac's liquidity resources as a consequence of the adverse reaction of the capital markets, which led to a reduction in the value and marketability of our invested assets;

derivative losses, which required either timely settlement or additional collateral posting;

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Any such payment on surplus notes would require either payment or collateralization of a portion of the Tier 2 Notes under the terms of the Tier 2 Note indenture.

Long-term Debt in the Notes to Consolidated Financial Statements, included in Part II, Item 8, in the Company's Annual Report on Form 10-K for the year ended December 31, 2019 for further discussion of the payment terms and conditions of the Tier 2 Notes.

Long-term Debt in the Notes to Consolidated Financial Statements, included in Part II, Item 8, in the Company's Annual Report on Form 10-K for

the year ended December 31, 2019, for further discussion of the payment terms and conditions of the Tier 2 Notes.

As discussed more fully in "Results of Operations" above in this Management's Discussion and Analysis, OCI declined Ambac Assurance's request to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on June 7, 2020.

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Ambac Assurance loans cash and securities to AFS as needed to fund payments under these derivative contracts, collateral posting requirements and operating expenses.

Intercompany loans are governed by an established lending

agreement with defined borrowing limits that has received non-disapproval from OCI.

Intercompany loans are governed by an established lending agreement with defined borrowing limits that has received non-disapproval from OCI.

Ambac Assurance manages its liquidity risk by maintaining comprehensive analyses of projected cash flows and maintaining specified levels of cash and short-term investments at all times.

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and uncertainty inherent in the assumptions used in estimating the amount of such recoveries.

The amount of these subrogation recoveries is significant and if we are unable to recover any amounts or recover materially less than our estimated recoveries, our future available liquidity to pay claims, debt service and meet our other obligations would be reduced materially.

The amount of these subrogation recoveries is significant and if we are unable to recover any amounts or recover materially less

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than our estimated recoveries, our future available liquidity to pay claims, debt service and meet our other obligations would be reduced materially.

See Part I, Item 1A.

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The following table summarizes the net cash flows for the periods presented.

Six Months Ended June 30,

Nine Months Ended September 30,

($ in million) 2020 2019

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Operating activities

$ (167) $ (296)

Investing activities

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Net cash flow

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$ (31) $ (16)

Operating activities

The following represents the significant cash activities during the six months ended June 30, 2020 and 2019 :

Cash used in operating activities relating to debt service on the Ambac Note was $58 million and $74 million for the six months ended June 30, 2020 and 2019 , respectively.

Cash used in operating activities related to interest rate derivatives was $19 million and $51 million for the six months ended June 30, 2020 and 2019 , respectively.

Cash used by operating activities relating to operating expenses was $44 million and $46 million for the six months ended June 30, 2020 and 2019 , respectively.

Cash provided by operating activities relating to the investment portfolio was $58 million and $73 million for the six months ended June 30, 2020 and 2019 , respectively.

Net loss and loss expenses paid, includin g commutation payments, during the six months ended June 30, 2020 and 2019 are detailed below:

Six Months Ended June 30,

The following represents the significant cash operating activity during the nine months ended September 30, 2020 and 2019:

• Debt service on the Ambac Note was $83 million and $110 million for the nine months ended September 30, 2020 and 2019, respectively.

• In September 2019, Ambac Assurance received $142.2 million in connection with an SEC settlement with Citibank Global Markets Inc.

• Cash used related to interest rate derivatives was $20 million and $81 million for the nine months ended September 30, 2020 and 2019, respectively.

• Operating expenses was $60 million and $66 million for the nine months ended September 30, 2020 and 2019, respectively.

• Cash provided by the investment portfolio was $82 million and $110 million for the nine months ended September 30, 2020 and 2019, respectively.

• Net loss and loss expenses paid, including commutation payments, during the nine months ended September 30, 2020 and 2019 are detailed below:

Nine Months Ended September 30,

($ in million) 2020 2019

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Net cash flow

Net losses paid include commutation payments of $2 and $213 for the six months ended June 30, 2020 and 2019 , respectively.

For or the six months ended June 30, 2019 , subrogation received includes $36 of settlement proceeds related to Lehman sponsored RMBS transactions and $23 related to the COFINA Plan of Adjustment.

Future operating cash flows will primarily be impacted by the level of premium collections, investment coupon receipts and claim and expense payments.

(1) Net losses paid include commutation payments of $13 and $214 for the nine months ended September 30, 2020 and 2019, respectively.

(2) For or the nine months ended September 30, 2019, subrogation received includes $36 of settlement proceeds related to Lehman sponsored RMBS transactions and $23 related to the COFINA Plan of Adjustment.

Future operating cash flows will primarily be impacted by interest payments on outstanding debt, claim and expense payments, investment coupon receipts and premium collections.

Financing Activities

Financing activities for the six months ended June 30, 2020 , include paydowns of the Ambac Note of $103 million and paydowns / maturities of VIE debt obligations of $99 million .

Financing activities for the six months ended June 30, 2019 , include paydowns of the Ambac Note of $22 million and paydowns of VIE debt obligations of $92 million , proceeds of $19 million from the re-issuance of 1,386 shares of Ambac owned AMPS and proceeds of $12 million from issuance of Ambac UK debt.

Financing activities for the nine months ended September 30, 2020, include paydowns of the Ambac Note of $115 million and paydowns / maturities of VIE debt obligations of $143 million.

Financing activities for the nine months ended September 30, 2019, include paydowns of the Ambac Note of $29 million and paydowns of VIE debt obligations of $510 million, proceeds of $19 million from the re-issuance of 1,386 shares of Ambac owned AMPS and proceeds of $12 million from issuance of Ambac UK debt.

AFS hedges a portion of the interest rate risk in the financial guarantee and investment portfolio, along with legacy customer interest rate swaps, with standardized derivative contracts, including financial futures contracts, which contain collateral or margin requirements.

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In addition, AFS is required to post collateral or margin in excess of the amounts needed to cover unrealized losses.

All AFS derivative

contracts containing ratings-based downgrade triggers that could result in collateral or margin posting or a termination have been triggered.

All AFS derivative contracts containing ratings-based downgrade triggers that could result in collateral or margin posting or a termination have been triggered.

If terminations were to occur, AFS would be required to make termination payments but would also receive a return of collateral or margin in the form of cash or U.S.

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All collateral and margin obligations are currently met.

Collateral and margin posted by AFS totaled a net amount of $165 million (cash and securities collateral of $10 million and $155 million , respectively), including independent amounts, under these contracts at June 30, 2020 .

Collateral and margin posted by AFS totaled a net amount of $154 million (cash and securities collateral of $1 million and $152 million, respectively), including independent amounts, under these contracts at September 30, 2020.

Ambac Credit Products (“ACP”) is not required to post collateral under any of its outstanding credit derivative contracts.

BALANCE SHEET

Total assets decreased by approximately $558 million from December 31, 2019 , to $12,761 million at June 30, 2020 , primarily due to the negative total return for the non-VIE investment portfolio, payment of loss and loss adjustment expenses, and interest and operating expenses, lower valuation of certain VIE assets caused by the economic effects of the COVID-19 pandemic, as well as the decrease to consolidated VIE assets as a result of currency changes (strengthening of the US Dollar).

Other significant changes during the six months ended June 30, 2020 , were higher subrogation recoverables primarily related to increases in excess spread on RMBS as a result of lower interest rates and lower premium receivables and intangible assets from the continued runoff of the financial guarantee insurance portfolio.

Total liabilities decreased by approximately $151 million from December 31, 2019 , to $11,632 million as of June 30, 2020 , primarily due to lower consolidated VIE liabilities as a result of price and currency changes, as noted above, and lower long-term debt due to partial redemption of the Ambac Note, partially offset by higher loss reserves and increases in interest rate derivative obligations as a result of reductions in forward interest rates.

As of June 30, 2020 , total stockholders’ equity was $1,129 million , compared with total stockholders’ equity of $1,536 million at December 31, 2019 .

This decrease was primarily due to a Total Comprehensive Loss during 2020 .

The Comprehensive Loss was primarily driven by the net loss attributable to common stockholders for the six months ended June 30, 2020 , of $315 million , unrealized losses on available-for-sale investment securities of $42 million and translation losses on the consolidation of AFG's foreign subsidiaries of $48 million.

Total assets decreased by approximately $507 million from December 31, 2019, to $12,812 million at September 30, 2020, primarily due to the payment of loss and loss adjustment expenses;

interest and operating expenses;

redemptions of long-term debt;

and lower VIE assets caused by redemptions, the economic effects of the COVID-19 pandemic on certain consolidated VIEs and the impact of currency changes (weakening of pound sterling).

Other significant changes during the nine months ended September 30, 2020, were higher subrogation recoverables primarily related to increases in excess

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66 2020 Third Quarter FORM 10-Q |

spread on RMBS, as a result of lower interest rates, and lower premium receivables and intangible assets from the continued runoff of the financial guarantee insurance portfolio.

Total liabilities decreased by approximately $66 million from December 31, 2019, to $11,718 million as of September 30, 2020, primarily due to lower long-term debt from partial redemptions of the Ambac Note and lower consolidated VIE liabilities, resulting from redemptions, fair value and currency changes (as noted above), partially offset by higher loss reserves and increases in interest rate derivative obligations, as a result of reductions in forward interest rates.

As of September 30, 2020, total stockholders’ equity was $1,095 million, compared with total stockholders’ equity of $1,536 million at December 31, 2019.

This decrease was primarily due to a Total Comprehensive Loss during 2020.

The Comprehensive Loss was primarily driven by the net loss attributable to common stockholders for the nine months ended September 30, 2020, of $423 million and translation losses on the consolidation of AFG's foreign subsidiaries of $20 million.

Investment Portfolio .

Ambac Assurance’s investment objective is to achieve the highest risk-adjusted after-tax return on a diversified portfolio of primarily fixed income investments and pooled investment funds while employing asset/liability management practices to satisfy operating and strategic liquidity needs.

Ambac Assurance’s investment portfolio is subject to internal investment guidelines and is subject to limits on types and quality of investments imposed by the insurance laws and regulations of the jurisdictions in which it is licensed, primarily the States of Wisconsin and New York.

Ambac Assurance’s investment objective is to achieve the highest risk-adjusted after-tax return on a diversified portfolio of fixed income investments and pooled investment funds while employing asset/liability management practices to satisfy operating and strategic liquidity needs.

Ambac Assurance’s investment portfolio is subject to internal investment guidelines and is subject to limits on the types and quality of investments imposed by the insurance laws and regulations of the jurisdictions in which it is licensed, primarily the States of Wisconsin and New York.

Such guidelines set forth minimum credit rating requirements and credit risk concentration limits.

Within these guidelines, which in certain instances may be exceeded with the approval of the applicable regulatory authority, Ambac Assurance opportunistically purchases or sells Ambac Assurance insured securities given their relative risk/reward characteristics.

Within these guidelines, which in certain instances may be exceeded with the approval of the applicable regulatory authority, Ambac Assurance opportunistically purchases and sells Ambac Assurance and Ambac UK insured securities given their relative risk/reward characteristics.

Ambac Assurance’s investment policies are subject to oversight by OCI pursuant to the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes.

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Ambac UK’s investment policy is designed with the primary objective of ensuring that Ambac UK is able to meet its financial obligations as they fall due, in particular with respect to policyholder claims.

Ambac UK’s investment portfolio is primarily fixed income investments and diversified holdings of pooled investment funds.

Ambac UK’s investment portfolio is primarily diversified fixed income securities and pooled investment funds.

The portfolio is subject to internal investment guidelines and may be subject to limits on types and quality of investments imposed by the PRA as regulator of Ambac UK.

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Refer to Note 8.

Investments to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for information about Ambac's consolidated investment portfolio.

Investments to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for information about Ambac's consolidated investment

Ambac's investment policies and objectives do not apply to the assets of VIEs consolidated as a result of financial guarantees written by its insurance subsidiaries.

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including corporate securities rated below the 'A' rated category, all directly owned CMBS (other than Military Housing bonds), and approximately 50% of all CLOs (all rated investment grade) and acquired additional distressed Ambac-insured securities.

These actions resulted in changes to the credit rating distribution of available-for-sale investments from December 31, 2019, to June 30, 2020, illustrated in the charts below.

The following table summarizes the composition of Ambac’s investment portfolio, excluding VIE investments, at carrying value at June 30, 2020 and December 31, 2019 :

($ in millions)

In the third quarter of 2020, Ambac began acquiring corporate securities rated below 'A' again.

These actions resulted in changes to the credit rating distribution of available-for-sale investments from December 31, 2019, to September 30, 2020, illustrated in the charts below.

The following table summarizes the composition of Ambac’s investment portfolio, excluding VIE investments, at carrying value at September 30, 2020 and December 31, 2019:

($ in millions) September 30,

2020 December 31,

Fixed income securities

$ 2,311 $ 2,577

Other investments

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Total investments (1)

Includes investments denominated in non-US dollar currencies with a fair value of £278 ( $344 ) and €28.3 ( $31.8 ) as of June 30, 2020 , and £257 ( $341 ) and €2 ( $2 ) as of December 31, 2019 .

Ambac invests in various asset classes in its fixed income securities portfolio, including securities covered by guarantees issued by Ambac Assurance and Ambac UK and other financial guarantors ("insured securities").

$ 3,551 $ 3,792

(1) Includes investments denominated in non-US dollar currencies with a fair value of £287 ($370) and €38.7 ($45.3) as of September 30, 2020, and £257 ($341) and €2 ($2) as of December 31, 2019.

Ambac invests in various asset classes in its fixed income securities portfolio, including securities covered by guarantees issued by Ambac Assurance, Ambac UK and other financial guarantors ("insured securities").

Other investments include diversified interests in pooled funds.

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Investments to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for information about insured securities and fixed income and pooled funds by asset class.

The following table represents the fair value of other asset-backed securities, included in fixed income securities above, at June 30, 2020 and December 31, 2019 , by classification:

($ in millions)

The following table represents the fair value of other asset-backed securities, included in fixed income securities above, at September 30, 2020 and December 31, 2019, by classification:

($ in millions) September 30,

2020 December 31,

Other asset-backed securities

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The following charts provide the ratings (1) distribution of the fixed income investment portfolio based on fair value at June 30, 2020 and December 31, 2019 :

67 2020 Third Quarter FORM 10-Q |

The following charts provide the ratings (1) distribution of the fixed income investment portfolio based on fair value at September 30, 2020 and December 31, 2019:

(1) Ratings are based on the lower of Moody’s or S&P ratings.

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If guaranteed, rating represents the higher of the underlying or guarantor’s financial strength rating.

Below investment grade and not rated bonds insured by Ambac represent 38% and 33% of the June 30, 2020 and December 31, 2019 combined fixed income portfolio, respectively.

(2) Below investment grade and not rated bonds insured by Ambac represent 39% and 33% of the September 30, 2020 and December 31, 2019 combined fixed income portfolio, respectively.

Premium Receivables .

Ambac's premium receivables decreased to $392 million at June 30, 2020 , from $416 million at December 31, 2019 .

Ambac's premium receivables decreased to $372 million at September 30, 2020, from $416 million at December 31, 2019.

As further discussed in Note 6.

Financial Guarantee Insurance Contracts , the decrease is due to premium receipts, changes to the allowance for credit losses, and changes in foreign currencies, partially offset by changes in expected and contractual cash flows and accretion of premium receivable discount.

Financial Guarantee Insurance Contracts, the decrease is due to premium receipts and increases to the allowance for credit losses, partially offset by accretion of the premium receivable discount.

Premium receivables by payment currency were as follows:

(Amounts in millions)

Premium Receivable in

Payment Currency

Premium Receivable in

(Amounts in millions) Premium Receivable in

Payment Currency Premium Receivable in

Dollars $ 239 $ 239

British Pounds £ 87 112

Euros € 18 21

Reinsurance Recoverable on Paid and Unpaid Losses .

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and (iii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of rating agency downgrades of a reinsurer (among other events and circumstances).

Ambac Assurance benefited from letters of credit and collateral amounting to approximately $129 million from its reinsurers at June 30, 2020 .

As of June 30, 2020 and December 31, 2019 , reinsurance recoverable on paid and unpaid losses were $36 million and $26 million , respectively.

Ambac Assurance benefited from letters of credit and collateral amounting to approximately $132 million from its reinsurers at September 30, 2020.

As of September 30, 2020 and December 31, 2019, reinsurance recoverable on paid and unpaid losses were $37 million and $26 million, respectively.

The increase was primarily a result of adverse development in public finance and student loan insured exposures.

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At the Fresh Start Reporting Date, an insurance intangible asset was recorded which represented the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities.

As of June 30, 2020 and December 31, 2019 , the net insurance intangible asset was $392 million and $427 million , respectively.

As of September 30, 2020 and December 31, 2019, the net insurance intangible asset was $383 million and $427 million, respectively.

Other than through amortization, variance in the insurance intangible asset is solely from translation gains (losses) from the consolidation of Ambac's foreign subsidiary (Ambac UK).

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The interest rate derivative portfolio is positioned to benefit from rising rates as a partial economic hedge against interest rate exposure in the financial guarantee and investment portfolios.

Derivative assets increased from $75 million at December 31, 2019, to $97 million as of June 30, 2020 .

Derivative liabilities increased from $90 million at December 31, 2019 , to $134 million as of June 30, 2020 .

The net increases resulted primarily from lower interest rates during the six months ended June 30, 2020, with the effect on assets partially offset by higher counterparty credit adjustments.

Derivative assets increased from $75 million at December 31, 2019, to $95 million as of September 30, 2020.

Derivative liabilities increased from $90 million at December 31, 2019, to $126 million as of September 30, 2020.

The net increases resulted primarily from lower interest rates during the nine months ended September 30, 2020, with the effect on assets partially offset by higher counterparty credit adjustments.

Loss and Loss Expense Reserves and Subrogation Recoverable .

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The evaluation process for determining the level of reserves is subject to certain estimates and judgments.

Refer to the "Critical Accounting Policies and Estimates" and “Results of Operations” sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations, in addition to Basis of Presentation and Significant Accounting Policies and Loss Reserves sections included in Note 2.

Basis of Presentation and

Refer to the "Critical Accounting Policies and Estimates" and “Results of Operations” sections of Management’s Discussion and Analysis of Financial

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Significant Accounting Policies and Note 6.

68 2020 Third Quarter FORM 10-Q |

Condition and Results of Operations, in addition to Basis of Presentation and Significant Accounting Policies and Loss Reserves sections included in Note 2.

Basis of Presentation and Significant Accounting Policies and Note 6.

Financial Guarantee Insurance Contracts, respectively, of the Consolidated Financial Statements included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, for further information on loss and loss expenses.

The loss and loss expense reserves, net of subrogation recoverables and before reinsurance as of June 30, 2020 and December 31, 2019 , were $(401) million and $(482) million , respectively.

The loss and loss expense reserves, net of subrogation recoverables and before reinsurance as of September 30, 2020 and December 31, 2019, were $(393) million and $(482) million, respectively.

Loss and loss expense reserves are included in the Unaudited Consolidated Balance Sheets as follows:

Present Value of Expected

Net Cash Flows

Net Cash Flows Unearned

Revenue Gross Loss

($ in millions)

Balance Sheet Line Item

Recoveries (1)

June 30, 2020:

Balance Sheet Line Item Claims and

Expenses Recoveries (1)

September 30, 2020:

Loss and loss expense reserves $ 2,116 $ (235) $ (80) $ 1,801

Subrogation recoverable 109 (2,303) — (2,194)

Totals $ 2,225 $ (2,538) $ (80) $ (393)

December 31, 2019:

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Subrogation recoverable 131 (2,160) — (2,029)

Present value of future recoveries includes R&W subrogation recoveries of $1,757 and $1,727 at June 30, 2020 and December 31, 2019 , respectively.

Totals $ 1,966 $ (2,394) $ (54) $ (482)

(1) Present value of future recoveries includes R&W subrogation recoveries of $1,757 and $1,727 at September 30, 2020 and December 31, 2019, respectively.

Ambac has exposure to various bond types issued in the debt capital markets.

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These bond types represent 94% of our ever-to-date insurance claims recorded, with RMBS comprising 75%.

The table below indicates gross par outstanding and the components of gross loss and loss expense reserves related to policies in Ambac’s gross loss and loss expense reserves at June 30, 2020 and December 31, 2019 :

The table below indicates gross par outstanding and the components of gross loss and loss expense reserves related to policies in Ambac’s gross loss and loss expense reserves at September 30, 2020 and December 31, 2019:

Outstanding (1)(2)

Present Value of Expected

Net Cash Flows

Net Cash Flows Unearned

Revenue Gross Loss

Reserves (1)(3)

($ in millions)

June 30, 2020:

($ in millions) Claims and

Expenses Recoveries

September 30, 2020:

RMBS $ 2,672 $ 702 $ (2,151) $ (13) $ (1,462)

Domestic Public Finance 3,783 1,140 (352) (52) 736

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Loss expenses — 80 — — 80

Totals $ 7,752 $ 2,225 $ (2,538) $ (80) $ (393)

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Outstanding (1)(2)

Present Value of Expected

Net Cash Flows Unearned

Revenue Gross Loss

Reserves (1)(3)

($ in millions) Claims and

Expenses Recoveries

December 31, 2019:

$ 3,027 $ 634 $ (2,013) $ (13) $ (1,392)

Domestic Public Finance

2,398 1,007 (344) (36) 627

Student Loans

472 248 (36) (4) 208

Ambac UK and Other Credits

271 4 — (1) 3

Loss expenses

Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $866 and $35 respectively, at June 30, 2020 , and $511 and $26, respectively at December 31, 2019 .

$ 6,168 $ 1,966 $ (2,394) $ (54) $ (482)

(1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $859 and $36 respectively, at September 30, 2020, and $511 and $26, respectively at December 31, 2019.

Ceded loss and loss expense reserves are included in Reinsurance recoverable on paid and unpaid losses.

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(3) Loss reserves are included in the balance sheet as Loss and loss expense reserves or Subrogation recoverable dependent on if a policy is in a net liability or net recoverable position.

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Variability of Expected Losses and Recoveries

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We have attempted to identify possible cash flows related to losses and recoveries using more stressful assumptions than the probability-weighted outcome recorded.

The possible net cash flows consider the highest stress scenario that was utilized in the development of our probability-weighted expected loss at June 30, 2020 , and assumes an inability to execute any commutation transactions with issuers and/or investors.

The possible net cash flows consider the highest stress scenario that was utilized in the development of our probability-weighted expected loss at September 30, 2020, and assumes an inability to execute any commutation transactions with issuers and/or investors.

Such stress scenarios are developed based on management’s view about all possible outcomes relating to losses and recoveries.

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See “Risk Factors” in Part I, Item 1A as well as the descriptions of "RMBS Variability," "Public Finance Variability," "Student Loan Variability," and "Other Credits, including Ambac UK, Variability," in Part II, Item 7 of the Company's 2019 Annual Report on Form 10-K for further discussion of the risks relating to future losses and recoveries that could result in more highly stressed outcomes, and "Risk Factors" in Part II, Item 1A of this Quarterly Report on Form 10-Q as well as the descriptions of "RMBS Variability," "Public Finance Variability," "Student Loan Variability," and "Other Credits, including Ambac UK, Variability" appearing below.

The occurrence of these stressed outcomes individually or collectively would have a material adverse effect on our results of operations and financial condition and may result in materially adverse consequence for the Company, including (without limitation) impairing the ability of Ambac Assurance to honor its financial obligations;

honor its financial obligations;

the initiation of rehabilitation proceedings against Ambac Assurance;

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mortgage market primarily through direct financial guarantees of RMBS, including transactions collateralized by first and second liens.

Changes to assumptions that could make our reserves under-estimated include an increase in interest rates, deterioration in housing prices, poor servicing, and the effect of a weakened economy characterized by growing unemployment and wage pressures.

Changes to assumptions that could make our reserves under-estimated include an increase in interest rates, deterioration in housing prices, poor servicing, government intervention into the functioning of the mortgage market and the effect of a weakened economy characterized by growing unemployment and wage pressures.

We utilize a model to project losses in our RMBS exposures and changes to reserves, either upward or downward, are not unlikely if we used a different model or methodology to project losses.

We established a representation and warranty subrogation recovery as further discussed in Note 6.

Financial Guarantee Insurance

Contracts to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q.

Financial Guarantee Insurance Contracts to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q.

Our ability to realize RMBS representation and warranty recoveries is subject to significant uncertainty, including risks inherent in litigation;

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and uncertainty inherent in the assumptions used in estimating such recoveries.

Additionally, our R&W actual subrogation recoveries could be significantly lower than our estimate of $1,731 million , net of reinsurance, as of June 30, 2020 , if the sponsors of these transactions:

Additionally, our R&W actual subrogation recoveries could be significantly lower than our estimate of $1,731 million, net of reinsurance, as of September 30, 2020, if the sponsors of these transactions:

(i) fail to honor their obligations to repurchase the mortgage loans, (ii) successfully dispute our breach findings or claims for damages, (iii) no longer have the financial means to fully satisfy their obligations under the transaction documents, or (iv) our pursuit of recoveries is otherwise unsuccessful.

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Failure to realize R&W subrogation recoveries for any reason or the realization of R&W subrogation recoveries materially below the amount recorded on Ambac's consolidated balance sheet would have a material adverse effect on our results of operations and financial condition.

In the case of both first and second-lien exposures, the possible stress case assumes a lower housing price appreciation projection, which in turn drives higher defaults and severities.

Using this approach, the possible increase in loss reserves for RMBS credits for which we have an estimate of expected loss at June 30, 2020 , could be approximately $35 million .

Using this approach, the possible increase in loss reserves for RMBS credits for which we have an estimate of expected loss at September 30, 2020, could be approximately $40 million.

Combined with the absence of any R&W subrogation recoveries, a possible increase in loss reserves for RMBS could be approximately $1,771 million.

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Additionally, the RMBS portfolio is sensitive to the COVID-19 related forbearances and delinquencies caused by the general economic downturn.

Due to the uncertainties related to the economic effects of the COVID-19 pandemic and other risks associated with RMBS, there can be no assurance that losses may not exceed our stress case estimates.

Due to the uncertainties related to the economic effects of the COVID-19 pandemic and other

risks associated with RMBS, there can be no assurance that losses may not exceed our stress case estimates.

Public Finance Variability:

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however, the portfolio also includes a wide array of non-municipal types of bonds, including financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public purpose facilities and interests.

The increase in public finance gross loss reserves at June 30, 2020 , as compared to December 31, 2019 , was primarily related to declines in discount rates;

The increase in public finance gross loss reserves at September 30, 2020, as compared to December 31, 2019, was primarily related to declines in discount rates;

changes in assumptions on certain credits, particularly Puerto Rico;

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Total public finance gross loss reserves and related gross par outstanding on Ambac insured obligations by bond type were as follows:

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June 30, 2020

December 31, 2019

($ in millions)

September 30, 2020 December 31, 2019

($ in millions) Gross Par

Outstanding (1)

Reserves Gross Par

Outstanding (1)

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General obligation 603 (29) 681 (16)

Housing 454 28 457 29

Transportation revenue 307 31 88 42

Other 922 13 97 11

Total $ 3,783 $ 736 $ 2,398 $ 627

(1) Gross Par Outstanding includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bond.

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Additionally, our loss reserves may be under-estimated as a result of the ultimate scope, duration and magnitude of the effects of COVID-19.

The COVID-19 related economic downturn has put a strain on municipal issuers, particularly those dependent upon narrow sources of revenues or dedicated taxes to support debt services, such as hotel occupancy taxes, sales taxes, parking revenues, tolls, licensing fees, etc.

The COVID-19 related economic downturn has put a strain on municipal issuers, particularly those dependent upon narrow sources of revenues or dedicated taxes to support debt service, such as hotel occupancy taxes, sales taxes, parking revenues, tolls, licensing fees, etc.

A prolonged recovery from the COVID-19 related economic downturn could put additional stresses on these issuers as well as other types of municipal finance issuers and result in increased defaults and potential additional losses for Ambac.

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We agreed to settlements regarding our insured Detroit general obligation bonds that provide better treatment of our exposures than the city planned to include in its plan of adjustment, but nevertheless required us to incur a loss for a significant portion of our exposure.

An additional troubling precedent in the Detroit case, as well as other municipal bankruptcies, is the preferential treatment of certain creditor classes, especially the public pensions.

An additional troubling precedent in the Detroit case, as well as other municipal bankruptcies, is the preferential treatment of certain creditor

classes, especially the public pensions.

The cost of pensions and the need to address frequently sizable unfunded or underfunded pensions is often a key driver of stress for many municipalities and their related authorities, including entities to whom we have significant exposure, such as Chicago's school district, the State of New Jersey and many others.

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In addition, municipal entities may be more inclined to use bankruptcy to resolve their financial stresses if they believe preferred outcomes for various creditor groups can be achieved.

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We expect municipal bankruptcies and defaults to continue to be challenging to project given the unique political, economic, fiscal, legal, governance and public policy differences among municipalities as well as the complexity, long duration and relative infrequency of the cases themselves in forums with a scarcity of legal precedent.

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This decision introduces uncertainty into the public finance market and it may make it more difficult for municipal instrumentalities to procure revenue bond financings in the future and increases the credit risk to bondholders of existing special revenue bonds, particularly those from weaker issuers.

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While our loss reserves consider our judgment regarding issuers’ financial flexibility to adapt to adverse markets, they may not adequately capture sudden, unexpected or protracted uncertainty that adversely affects market conditions, such as the developing COVID-19 related economic downturn.

Our exposures to the Commonwealth of Puerto Rico are under stress arising from the Commonwealth’s poor financial condition, weak economy, loss of capital markets access and the severe damage caused by hurricanes Irma and Maria and other natural disasters.

These factors, taken together with the payment moratorium on debt service of the Commonwealth and its instrumentalities, ongoing PROMESA Title III proceedings, and certain other provisions under PROMESA, the potential for restructurings of debt insured by Ambac Assurance, either with or without its consent, and the possibility of protracted litigation as a result of which its rights may be materially impaired, may cause losses to exceed current reserves in a material manner.

as a result of which its rights may be materially impaired, may cause losses to exceed current reserves in a material manner.

See "Financial Guarantees in Force" section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, for further details on the legal, economic and fiscal developments that have impacted or may impact Ambac Assurance’s insured Puerto Rico bonds.

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Commitments and Contingencies to the Unaudited Consolidated Financial Statements for further updates related to Puerto Rico.

Material additional losses on our public finance credits caused by the aforementioned factors and including the possibility of a protracted recovery related to the COVID-19 crisis would have a material adverse effect on our results of operations and financial condition.

For the public finance credits, including Puerto Rico, for which we have an estimate of expected loss at June 30, 2020 , the possible increase in loss reserves could be approximately $1,200 million .

Material additional losses on our public finance credits caused by the aforementioned factors, including the possibility of a protracted recovery related to the COVID-19 crisis would have a material adverse effect on our results of operations and financial condition.

For the public finance credits, including Puerto Rico, for which we have an estimate of expected loss at September 30, 2020, the possible increase in loss reserves could be approximately $1,200 million.

However, there can be no assurance that losses may not exceed our stress case estimates.

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Such factors may include lower recoveries on defaulted loans or additional losses on collateral or trust assets, including as a result of any enforcement actions by the Consumer Finance Protection Bureau.

For student loan credits for which we have an estimate of expected loss at June 30, 2020 , the possible increase in loss reserves could be approximately $30 million .

For student loan credits for which we have an estimate of expected loss at September 30, 2020, the possible increase in loss reserves could be approximately $30 million.

Additionally, an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately $20 million.

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It is possible our loss reserves on other types of credits, including those insured by Ambac UK, may be under-estimated because of various risks that vary widely, including the risk that we may not be able to recover or mitigate losses through our remediation processes.

For all other credits, including Ambac UK, for which we have an estimate of expected loss, the sum of all the highest stress case loss scenarios is approximately $370 million greater than the loss reserves at June 30, 2020 .

For all other credits, including Ambac UK, for which we have an estimate of expected loss, the sum of all the highest stress case loss scenarios is approximately $375 million greater than the loss reserves at September 30, 2020.

Additionally, our loss reserves may be under-estimated as a result of the ultimate scope, duration and magnitude of the effects of COVID-19.

There can be no assurance that losses may not exceed our stress case estimates.

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Long-term Debt:

Long-term debt consists of senior and junior surplus notes issued by Ambac Assurance, the Ambac Note and Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions, and Ambac UK debt issued in connection with the 2019 Ballantyne commutation.

The carrying value of each of these as of June 30, 2020 and December 31, 2019 is below:

($ in millions)

The carrying value of each of these as of September 30, 2020 and December 31, 2019 is below:

($ in millions) September 30,

2020 December 31, 2019

Surplus notes (1)

Ambac note 1,648 1,763

Tier 2 notes 299 278

Ambac UK debt 13 13

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We do not expect these standards to have a consequential impact on Ambac's financial statements.

Convertible Instruments and Contracts in an Entity's Own Equity

In August 2020, the FASB issued ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity's Own Equity .

The ASU i) simplifies the accounting for convertible debt and convertible preferred stock by reducing the number of accounting models, and amends certain disclosures, ii) amends and simplifies the derivative scope exception guidance for contracts in an entity's own equity, including share-based compensation, and iii) amends the diluted earnings per share calculations for convertible instruments and contracts in an entity's own equity.

The ASU is effective for fiscal years ending after December 15, 2021, with early adoption permitted.

Ambac will adopt this ASU on January 1, 2022.

Defined Benefit and Other Postretirement Plans Disclosures

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Relevant disclosures that will be removed are:

i) amounts in accumulated other comprehensive income expected to be recognized as net

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periodic benefit cost over the next fiscal year and ii) the effects of a one percentage point change in assumed health care cost trend rates on the (a) aggregate of the service and interest cost components of the net periodic pension cost and (b) benefit obligation for postretirement healthcare benefits.

i) amounts in

accumulated other comprehensive income expected to be recognized as net periodic benefit cost over the next fiscal year and ii) the effects of a one percentage point change in assumed health care cost trend rates on the (a) aggregate of the service and interest cost components of the net periodic pension cost and (b) benefit obligation for postretirement healthcare benefits.

Relevant disclosures that will be added are an explanation of the reasons for significant gains and losses related to changes in the benefit obligations for the period.

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Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Ambac Assurance’s statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were $987 million and $1,527 million at June 30, 2020 , respectively, as compared to $1,088 million and $1,618 million at December 31, 2019 , respectively.

As of June 30, 2020 , statutory policyholder surplus and qualified statutory capital included $574 million principal balance of surplus notes outstanding, $365 million principal balance of junior surplus

notes outstanding and $138 million liquidation preference of preferred stock outstanding.

Ambac Assurance’s statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were $933 million and $1,477 million at September 30, 2020, respectively, as compared to $1,088 million and $1,618 million at December 31, 2019,

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respectively.

As of September 30, 2020, statutory policyholder surplus and qualified statutory capital included $573 million principal balance of surplus notes outstanding, $365 million principal balance of junior surplus notes outstanding and $138 million liquidation preference of preferred stock outstanding.

These surplus and junior surplus notes (including related accrued interest of $526 million that is not recorded under statutory basis accounting principles), preferred stock and all other liabilities (including insurance claims and debt issued by Ambac Assurance) are obligations that have claims on the resources of Ambac Assurance that are senior to AFG's equity and therefore impact AFG's ability to realize residual value or receive dividends from Ambac Assurance.

The significant drivers to the net decrease in policyholder surplus are primarily due to a (i) statutory net loss of $58 million for the six months ended June 30, 2020 (excluding dividends from subsidiaries);

(ii) a decrease of $28 million in the fair value of pooled fund investments and investment securities that are recorded at the lower of amortized cost or fair value ;

and (iii) contributions to contingency reserves of $9 million.

The significant drivers to the net decrease in policyholder surplus are statutory net losses of $133 million for the nine months ended September 30, 2020, (excluding dividends from subsidiaries) and contributions to contingency reserves of $14 million.

Ambac Assurance statutory surplus is sensitive to multiple factors, including:

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AMBAC UK FINANCIAL RESULTS UNDER UK ACCOUNTING PRINCIPLES

Ambac UK is required to prepare financial statements under FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland." Ambac UK’s shareholder funds under UK GAAP were £398 million at June 30, 2020 , as compared to £387 million at December 31, 2019 .

At June 30, 2020 , the carrying value of cash and investments was £471 million , an increase from £470 million at December 31, 2019 .

The increase in shareholders’ funds and cash & investments was primarily due to the continued receipt of premiums and foreign exchange gains, partially offset by losses within Ambac UK's investment portfolio and tax and other operating expense payments.

Ambac UK is required to prepare financial statements under FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland." Ambac UK’s shareholder funds under UK GAAP were £391 million at September 30, 2020, as compared to £387 million at December 31, 2019.

At September 30, 2020, the carrying value of cash and investments was £473 million, an increase from £470 million at December 31, 2019.

The increase in shareholders’ funds and cash and investments was primarily due to the continued receipt of premiums and foreign exchange gains, partially offset by insurance losses, losses within Ambac UK's investment portfolio (excluding foreign exchange) and operating expense payments.

Ambac UK is also required to prepare financial information in accordance with the Solvency II Directive.

The basis of preparation of this information is significantly different from both US GAAP and UK GAAP.

Available capital resources under Solvency II were a surplus of £180 million at June 30, 2020 , of which £166 million were eligible to meet solvency capital requirements.

This is a reduction from

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December 31, 2019 , when available capital resources were a surplus of £188 million of which £178 million were eligible to meet solvency capital requirements.

The eligible capital resources at June 30, 2020 , and December 31, 2019 , were in comparison to regulatory capital requirements of £242 million and £208 million respectively.

Ambac UK is therefore deficient in terms of compliance with applicable regulatory capital requirements by £76 million and £30 million at June 30, 2020 , and December 31, 2019 , respectively.

The deficit increased as at June 30, 2020 , due to an increase in regulatory capital requirements for non-life insurers in the credit and surety line of business and due to a reduction in eligible capital resources mainly caused by the fall over the period in long term discount rates.

Available capital resources under Solvency II were a surplus of £183 million at September 30, 2020, of which £170 million were eligible to meet solvency capital requirements.

This is a reduction from December 31, 2019, when available capital resources were a surplus of £188 million of which £178 million were eligible to meet solvency capital requirements.

Eligible capital resources at September 30, 2020, and December 31, 2019, were in comparison to regulatory capital requirements of £234 million and £208 million, respectively.

Therefore, Ambac UK was deficient in terms of compliance with applicable regulatory capital requirements by £64 million and £30 million at September 30, 2020, and December 31, 2019, respectively.

The deficit increased as at September 30, 2020, due to an increase in regulatory capital requirements for non-life insurers in the credit and surety line of business and due to a reduction in eligible capital resources mainly caused by the fall over the period in long term discount rates.

The regulators are aware of the deficiency in capital resources as compared to capital requirements and dialogue between Ambac UK management and its regulators remains ongoing with respect to options for addressing the shortcoming, although such options remain few.

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tax net operating loss (“NOL”) that is offset by a full valuation allowance in the GAAP consolidated financial statements.

As a result of this and other considerations,

we utilized a 0% effective tax rate for non-GAAP adjustments;

As a result of this and other considerations, we utilized a 0% effective tax rate for non-GAAP adjustments;

which is subject to change.

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• Non-credit impairment fair value (gain) loss on credit derivatives:

Elimination of the non-credit impairment fair value gains (losses) on credit derivatives, which is the amount in excess of the present value of the expected estimated credit losses.

Elimination of the non-credit impairment fair value gains (losses) on credit derivatives, which is the

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amount in excess of the present value of the expected estimated credit losses.

Such fair value adjustments are affected by, and in part fluctuate with changes in market factors such as interest rates and credit spreads, including the market’s perception of Ambac’s credit risk (“Ambac CVA”), and are not expected to result in an economic gain or loss.

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Elimination of the amortization of the financial guarantee insurance intangible asset that arose as a result of Ambac’s emergence from bankruptcy and the implementation of Fresh Start reporting.

This adjustment ensures that all financial guarantee contracts are accounted for consistent with the provisions of the Financial Services – Insurance Topic of the ASC.

This adjustment ensures that all financial

guarantee contracts are accounted for consistent with the provisions of the Financial Services – Insurance Topic of the ASC.

• Foreign exchange (gains) losses:

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This adjustment eliminates the foreign exchange gains (losses) on all assets, liabilities and transactions in non-functional currencies, which enables users of our financial statements to better view the results without the impact of fluctuations in foreign currency exchange rates and facilitates period-to-period comparisons of Ambac's operating performance.

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The following table reconciles net income attributable to common stockholders to the non-GAAP measure, Adjusted Earnings (loss) on a dollar amount and per diluted share basis, for all periods presented:

Three Months Ended June 30,

($ in millions, except share data)

Per Diluted Share

Three Months Ended September 30,

($ in millions, except share data) $ Amount Per Diluted Share $ Amount Per Diluted Share

Net income (loss) attributable to common stockholders

$ (108) $ (2.33) $ 66 $ 1.41

Non-credit impairment fair value (gain) loss on credit derivatives — — — (0.01)

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Adjusted earnings (loss) $ (93) $ (2.01) $ 77 $ 1.63

Six Months Ended June 30,

($ in millions, except share data)

Per Diluted Share

Nine Months Ended September 30,

($ in millions, except share data) $ Amount Per Diluted Share $ Amount Per Diluted Share

Net income (loss) attributable to common stockholders

$ (423) $ (9.16) $ (106) $ (2.30)

Non-credit impairment fair value (gain) loss on credit derivatives

1 0.02 (1) (0.02)

Insurance intangible amortization 41 0.88 280 6.09

Foreign exchange (gain) loss

— (0.01) (19) (0.42)

Adjusted earnings (loss) $ (382) $ (8.27) $ 154 $ 3.35

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This adjustment ensures that all financial guarantee contracts are accounted for within Adjusted Book Value consistent with the provisions of the Financial Services—Insurance Topic of the ASC.

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• Net unearned premiums and fees in excess of expected losses:

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This adjustment only allows for such gains and losses in Adjusted Book Value when realized.

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The following table reconciles Total Ambac Financial Group, Inc.

stockholders’ equity to the non-GAAP measure Adjusted Book Value on a dollar amount and per share basis, for all periods presented:

June 30, 2020

December 31, 2019

($ in millions, except share data)

September 30, 2020 December 31, 2019

($ in millions, except share data) $ Amount Per Share $ Amount Per Share

Total Ambac Financial Group, Inc.

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Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income

(152) (3.31) (151) (3.31)

Adjusted book value $ 891 $ 19.44 $ 1,313 $ 28.83

The decrease in Adjusted Book Value was primarily attributable to the Adjusted Loss for the six months ended June 30, 2020 , excluding earned premium previously included in Adjusted Book Value, and the impact of changes in foreign exchange rates resulting from the strengthening of the U.S.

The decrease in Adjusted Book Value was primarily attributable to the Adjusted Loss for the nine months ended September 30, 2020, excluding earned premium previously included in Adjusted Book Value.

Factors that impact changes to Adjusted Book Value include many of the same factors that impact Adjusted Earnings, including the majority of revenues and expenses, but generally exclude components of premium earnings since they are embedded in prior period's Adjusted Book Value through the net unearned premiums and fees in excess of expected losses adjustment.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis