OCTAVE SPECIALTY GROUP INC 10-K

ambc-20201231 Table of Co ntents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2020 ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 1-10777 AMBAC FINANCIAL GROUP, INC. (Exact name of Registrant as specified in its charter) Delaware 13-3621676 (State of incorporation) (I.R.S. employer identification no.) One World Trade Center New York NY 10007 (Address of principal executive offices) (Zip code) (212) 658-7470 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Trading Symbols Name of each exchange on which registered Common Stock, par value $0.01 per share AMBC New York Stock Exchange Warrants AMBC WS New York Stock Exchange Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☒ No ☐ Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☒ Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”and"emerging growth company" in Rule 12b-2 of the Exchange Act): (Check one): Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐ If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒ Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ The aggregate market value of voting stock held by non-affiliates of the Registrant as of the close of business on June 30, 2020 was $ 655,986,870 . As of February 26, 2021, there were 45,850,468 shares of Common Stock, par value $ 0.01 per share, were outstanding. Documents Incorporated By Reference Portions of the Registrant’s proxy statement for its 2021 annual meeting of stockholders are incorporated by reference in this Form 10-K in response to Part III Items 10, 11, 12, 13, and 14. Table of Co ntents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES TABLE OF CONTENTS Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995 1 Item Number Page Item Number Page PART I PART II (CONTINUED) 1 Business 2 7A Quantitative and Qualitative Disclosures about Market Risk 62 Introduction 2 8 Financial Statements and Supplementary Data 65 Description of the Business 2 9 Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 142 Insurance Regulatory Matters and Other Restrictions 7 9A Controls and Procedures 142 Investments and Investment Policy 9 9B Other Information 142 Employees 10 PART III 1A Risk Factors 10 10 Directors, Executive Officers and Corporate Governance 142 1B Unresolved Staff Comments 24 11 Executive Compensation 143 2 Properties 24 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 143 3 Legal Proceedings 24 13 Certain Relationships and Related Transactions, and Director Independence 143 4 Mine Safety Disclosures 24 14 Principal Accountant Fees and Services 143 PART II PART IV 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 24 15 Exhibits, Financial Statement Schedules 144 6 Selected Financial Data 26 Schedule I—Summary of Investments Other Than Investments in Related Parties 148 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 27 Schedule II—Condensed Financial Information of Registrant (Parent Company Only) 149 Company Overview 27 Schedule IV—Reinsurance 154 Executive Summary 27 Critical Accounting Policies and Estimates 31 SIGNATURES 155 Financial Guarantees in Force 33 Results of Operations 43 Liquidity and Capital Resources 48 Balance Sheet 52 Accounting Standards 58 Ambac Assurance Statutory Basis Financial Results 58 Ambac UK Financial Results Under UK Accounting Principles 59 Non-GAAP Financial Measures 60 Table of Co ntents CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 In this Annual Report, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. 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. We caution readers that these statements are not guarantees of future performance. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, which may by their nature be inherently uncertain and some of which may be outside our control. 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. 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 this Annual Report on Form 10-K. Any or all of management’s forward-looking statements here or in other publications may turn out to be incorrect and are based on management’s current belief or opinions. Ambac’s actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among events, risks, uncertainties or factors that could cause actual results to differ materially are: (1) the highly speculative nature of AFG’s common stock and volatility in the price of AFG’s common stock; (2) Ambac's inability to realize the expected recoveries, including RMBS litigation recoveries, included in its financial statements which would have a materially adverse effect on Ambac Assurance Corporation's ("AAC") financial condition and may lead to regulatory intervention; (3) failure to recover claims paid on Puerto Rico exposures or realization of losses in amounts higher than expected; (4) increases to loss and loss expense reserves; (5) inadequacy of reserves established for losses and loss expenses and possibility that changes in loss reserves may result in further volatility of earnings or financial results; (6) uncertainty concerning the Company’s ability to achieve value for holders of its securities, whether from AAC and its subsidiaries or from transactions or opportunities apart from AAC and its subsidiaries, including new business initiatives relating to the specialty property and casualty program insurance business, the managing general agency/underwriting business, or related businesses; (7) potential of rehabilitation proceedings against AAC; (8) increased fiscal stress experienced by issuers of public finance obligations or an increased incidence of Chapter 9 filings or other restructuring proceedings by public finance issuers, including an increased risk of loss on revenue bonds of distressed public finance issuers due to judicial decisions adverse to revenue bond holders; (9) our inability to mitigate or remediate losses, commute or reduce insured exposures or achieve recoveries or investment objectives, or the failure of any transaction intended to accomplish one or more of these objectives to deliver anticipated results; (10) insufficiency or unavailability of collateral to pay secured obligations; (11) credit risk throughout Ambac’s business, including but not limited to credit risk related to residential mortgage-backed securities, student loan and other asset securitizations, public finance obligations and exposures to reinsurers; (12) the impact of catastrophic environmental or natural events, including catastrophic public health events like the COVID-19 pandemic, on significant portions of our insured and investment portfolios; (13) credit risks related to large single risks, risk concentrations and correlated risks; (14) the risk that 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; (16) Ambac’s substantial indebtedness could adversely affect its financial condition and operating flexibility; (17) 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; (18) 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; (19) restrictive covenants in agreements and instruments may impair Ambac’s ability to pursue or achieve its business strategies; (20) adverse effects on operating results or the Company’s financial position resulting from measures taken to reduce risks in its insured portfolio; (21) disagreements or disputes with Ambac's insurance regulators; (22) default by one or more of Ambac's portfolio investments, insured issuers or counterparties; (23) loss of control rights in transactions for which we provide insurance due to a finding that Ambac has defaulted; (24) adverse tax consequences or other costs resulting from the characterization of the AAC’s surplus notes or other obligations as equity; (25) risks attendant to the change in composition of securities in the Ambac’s investment portfolio; (26) adverse impacts from changes in prevailing interest rates; (27) our results of operation may be adversely affected by events or circumstances that result in the impairment of our intangible assets and/or goodwill that was recorded in connection with Ambac’s acquisition of 80% of the membership interests of Xchange; (28) risks associated with the expected discontinuance of the London Inter-Bank Offered Rate; (29) factors that may negatively influence the amount of installment premiums paid to the Ambac; (30) market risks impacting assets in the Ambac’s investment portfolio or the value of our assets posted as collateral in respect of interest rate swap transactions; (31) risks relating to determinations of amounts of impairments taken on investments; (32) the risk of litigation and regulatory inquiries or investigations, and the risk of adverse outcomes in connection therewith, which could have a material adverse effect on Ambac’s business, operations, financial position, profitability or cash flows; (33) actions of stakeholders whose interests are not aligned with broader interests of the Ambac's stockholders; (34) system security risks, data protection breaches and cyber attacks; (35) changes in accounting principles or practices that may impact Ambac’s reported financial results; (36) regulatory oversight of Ambac Assurance UK Limited ("Ambac UK") and applicable regulatory restrictions may adversely affect our ability to realize value from Ambac UK or the amount of value we ultimately realize; (37) operational risks, including with respect to internal processes, risk and investment models, systems and employees, and failures in services or products provided by third parties; (38) Ambac’s financial position that may prompt departures of key employees and may impact the its ability to attract qualified executives and employees; (39) fluctuations in foreign currency exchange rates could adversely impact the insured portfolio in the event of loss reserves or claim payments denominated in a currency other than US dollars and the value of non-US dollar denominated securities in our investment portfolio; (40) disintermediation within the insurance industry that negatively impacts our managing general agency/underwriting business; (41) changes in law or in the functioning of the healthcare market that impair the business model of our accident and health managing general underwriter; and (42) other risks and uncertainties that have not been identified at this time. | Ambac Financial Group, Inc. 1 2020 FORM 10-K | Table of Co ntents PART I Item 1. Business INTRODUCTION Ambac Financial Group, Inc. ("AFG"), headquartered in New York City, is a financial services holding company incorporated in the State of Delaware on April 29, 1991. References to “Ambac,” the “Company,” “we,” “our,” and “us” are to AFG and its subsidiaries, as the context requires. Ambac's business operations include: • Financial Guarantee ("FG") Insurance — Ambac Assurance Corporation ("Ambac Assurance" or "AAC") and its wholly owned subsidiary Ambac Assurance UK Limited (“Ambac UK”), legacy financial guarantee businesses, both of which have been in runoff since 2008. • Specialty Property & Casualty Program Insurance — Currently includes admitted carrier Everspan Insurance Company and nonadmitted carrier Everspan Indemnity Insurance Company (collectively, "Everspan" or the "Everspan Group"). This platform, which received an A- Financial Strength Rating from A.M. Best in February 2021, is expected to launch new underwriting programs in 2021. • Managing General Agency / Underwriting — Currently includes Xchange Benefits, LLC and Xchange Affinity Underwriting Agency, LLC (collectively, “Xchange”) a property and casualty Managing General Underwriter of which AFG acquired 80% on December 31, 2020. Refer to Note 3. Business Combination for further information relating to this acquisition. AFG has $366 million in net assets (excluding its investment in subsidiaries) and net operating loss carry-forwards of $3,639 million ($2,182 million of which is allocated to AAC) at December 31, 2020. See Schedule II for more information on the holding company. As of and for the year ended December 31, 2020, management reviewed financial information, allocated resources and measured financial performance on a consolidated basis and accordingly the Company had a single reportable segment. As a result of the acquisition of Xchange and the expected launch of the Everspan Group platform, segments will be re-evaluated in 2021. Corporate Strategy: The Company's primary goal is to maximize shareholder value through executing the following key strategies: • Active runoff of AAC and its subsidiaries through transaction terminations, commutations, restructurings, and reinsurance with a focus on our watch list credits and known and potential future adversely classified credits, that we believe will improve our risk profile, and maximizing the risk-adjusted return on invested assets; • Ongoing rationalization of Ambac's capital and liability structures; • Loss recovery through active litigation management and exercise of contractual and legal rights; • Ongoing review of the effectiveness and efficiency of Ambac's operating platform; and • Further expanding into specialty property and casualty program insurance, managing general agency/underwriting and potentially other insurance and insurance related businesses that will generate long-term shareholder value with attractive risk-adjusted returns and meet other preestablished criteria. DESCRIPTION OF THE BUSINESS Financial Guarantee Insurance Business: Ambac's Financial Guarantee strategy is to increase the value of its investment in AAC and Ambac UK. With regards to AAC, this strategy is subject to the restrictions set forth in the Settlement Agreement, dated as of June 7, 2010 (the "Settlement Agreement"), by and among AAC, Ambac Credit Products LLC ("ACP"), AFG and certain counterparties to credit default swaps with ACP that were guaranteed by AAC, as well as the Stipulation and Order (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K) and in the indenture for the Tier 2 Notes (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K), each of which requires OCI (as defined below) and, under certain circumstances, holders of the debt instruments benefiting from such restrictions, to approve certain actions taken by or in respect of AAC. In exercising its approval rights, OCI will act for the benefit of policyholders, and will not take into account the interests of AFG. See Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information. Financial guarantee insurance policies provide an unconditional and irrevocable guarantee which protects the holder of a debt obligation against non-payment when due of the principal and interest on the obligations guaranteed. Pursuant to such guarantees, AAC and Ambac UK make payments if the obligor responsible for making payments fails to do so when due. Financial guarantee revenues consist mostly of premiums earned from insurance contracts, net of reinsurance. Financial guarantee expenses consist of: (i) loss and commutation payments; (ii) loss adjustment expenses; (iii) interest expense on debt and (iv) insurance intangible amortization. AAC and Ambac UK have been working toward reducing uncertainties within their insured portfolios such as exposures to financially stressed municipal entities (including Puerto Rico) and asset-backed securities (including residential mortgage-backed securities ("RMBS") and student loan-backed securities). Additionally, AAC and Ambac UK are actively prosecuting legal claims (including RMBS-related lawsuits brought by AAC), managing their regulatory frameworks, seeking to optimize capital allocation in a challenging environment that includes long duration obligations and attempting to retain key employees. Opportunities for remediating losses on poorly performing insured transactions also depend on market conditions, including the perception of AAC’s creditworthiness, the structure of the underlying risk and associated policy as well as other | Ambac Financial Group, Inc. 2 2020 FORM 10-K | Table of Co ntents counterparty specific factors. AAC's ability to commute policies or purchase certain investments may also be limited by available liquidity. The deterioration of AAC's and Ambac UK's financial condition beginning in 2007 has prevented these companies from being able to write new financial guaranty business. Not writing new business has and continues to negatively impact Ambac’s operations and financial results. AAC’s ability to pay dividends and, as a result, AFG’s liquidity, have been significantly restricted by the deterioration of AAC’s financial condition and by regulatory, legal and contractual restrictions. It is highly unlikely that AAC will be able to make dividend payments to AFG for the foreseeable future. Refer to "Dividend Restrictions, Including Contractual Restrictions" below and Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K, for more information on dividend payment restrictions. Interest rate derivative transactions are executed through Ambac Financial Services (“AFS”), a wholly-owned subsidiary of AAC. The primary activity of AFS is to partially hedge interest rate risk in the financial guarantee insurance and investment portfolios. Accordingly, interest rate derivatives are positioned to benefit from rising rates. Under agreements governing interest rate derivative positions, AFS generally must post collateral or margin in excess of the market value of the swaps and futures contracts. All AFS derivative contracts containing ratings-based downgrade triggers that could result in collateral or margin posting or a termination have been triggered. A termination of AFS’s derivatives could result in losses. AFS has borrowed cash and securities from AAC to help support its collateral and margin posting requirements, previous termination payments and other cash needs. Credit risks relating to interest rate derivative positions primarily relate to the default of a counterparty. AFS's interest rate derivatives generally consist of centrally cleared swaps, US treasury futures and some over-the-counter ("OTC") swaps with financial guarantee customers or bank counterparties. Counterparty default exposure is mitigated through the use of industry standard collateral posting agreements or margin posting requirements. • Cleared swaps, futures and OTC derivatives with bank counterparties require margin or collateral to be posted up to or in excess of the market value of the interest rate derivatives. Interest rate derivative contracts entered into with financial guarantee customers are not subject to collateral posting agreements. In some cases, interest rate derivatives between Ambac and financial guarantee customers are placed through a third party financial intermediary and similarly do not require collateral posting. • Credit risk associated with financial guarantee customer derivatives and credit derivatives, is managed through the risk management processes described in the Risk Management Group section below. Ambac manages a variety of market risks inherent in its businesses, including credit, market, liquidity, operational and legal. These risks are identified, measured, and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization. See “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, Item 7A in this Form 10-K for further information. Segregated Account In March 2010, AAC established a segregated account pursuant to Wisconsin Stat. §611.24(2) (the “Segregated Account”) to segregate certain segments of AAC’s liabilities. The Office of the Commissioner of Insurance for the State of Wisconsin (“OCI” (which term shall be understood to refer to such office as regulator of AAC and to refer to the Commissioner of Insurance for the State of Wisconsin as rehabilitator of the Segregated Account (the “Rehabilitator”), as the context requires)) commenced rehabilitation proceedings in the Wisconsin Circuit Court for Dane County (the “Rehabilitation Court”) with respect to the Segregated Account (the “Segregated Account Rehabilitation Proceedings”) in order to permit OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account pursuant to the provisions of the Wisconsin Insurers Rehabilitation and Liquidation Act. AAC, itself, did not enter rehabilitation proceedings. A plan of rehabilitation for the Segregated Account, as amended (the "Segregated Account Rehabilitation Plan"), became effective on June 12, 2014. On September 25, 2017 the Rehabilitator filed a motion in the Rehabilitation Court seeking entry of an order approving an amendment to the Segregated Account Rehabilitation Plan (the "Second Amended Plan of Rehabilitation"). Following the conclusion of a Confirmation Hearing on January 22, 2018, the Rehabilitation Court entered an order granting the Rehabilitator's motion and confirming the Second Amended Plan of Rehabilitation. On February 12, 2018 (the "Effective Date"), the Second Amended Plan of Rehabilitation became effective. Consequently, the rehabilitation of the Segregated Account was concluded. Refer to Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K, for more information on the Segregated Account and the Segregated Account Rehabilitation Proceedings. Risk Management Ambac’s financial guarantee insurance policies and credit derivative contracts expose the Company to the direct credit risk of the assets and/or obligor supporting the guaranteed obligation. In addition, insured transactions expose Ambac to indirect risks that may increase our overall risk, such as credit risk separate from, but correlated with, our direct credit risk; market; model; economic; natural disaster and mortality or other non-credit type risks. Please refer to Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Guarantees in Force” section below for details on the financial guarantee insured portfolio. The Risk Management Group ("RMG") is primarily responsible for the development, implementation and oversight of loss mitigation strategies, surveillance and remediation of the insured financial guarantee portfolio (including through the pursuit of recoveries in respect of paid claims and commutations of policies). Our ability to execute certain risk management activities may be limited by the restrictions set forth in the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes. See Note 1. Background and | Ambac Financial Group, Inc. 3 2020 FORM 10-K | Table of Co ntents Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information. Ambac’s RMG has an organizational structure designed around four primary areas of focus: Surveillance, Risk Remediation, Credit Risk Management and Loss Reserving and Analytics. Surveillance This group's focus is on the early identification of potential stress or deterioration in connection with credit exposures in the insured portfolio and the related credit analysis associated with these and other insured portfolio exposures. Additionally, Surveillance will evaluate the impact of changes in the economic, regulatory or political environment on the insured portfolio. Analysts in this group perform periodic credit reviews of insured exposures according to a schedule based on the risk profile of the guaranteed obligations or as necessitated by specific credit events or other macro-economic variables. Risk-adjusted surveillance strategies have been developed for each bond type with review periods and scope of review based upon each bond type’s risk profile. The risk profile is assessed regularly in response to our own experience and judgments or external factors such as the economic environment and industry trends. The focus of a credit review is to assess performance, identify credit trends and recommend appropriate credit classifications, ratings and changes to a transaction or bond type’s review period and surveillance requirements. Please refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of the various credit classifications utilized by Ambac. If a problem is detected, the Surveillance group will then work with the Risk Remediation group on a loss mitigation plan, as necessary. The insured portfolio contains exposures that are correlated and/or concentrated. RMG's surveillance activities include identifying these types of exposures and identifying the risks that would or could trigger credit deterioration across these related exposures. This is the case with student loans and RMBS, for example, which have several correlations including those associated with consumer lending, unemployment and home prices. In the future, Ambac’s portfolio may be subject to similar credit deterioration arising from concentrated and/or correlated risks. Examples of other such risks that could impact our portfolio, and that our surveillance is designed to monitor include the impact of potential municipal bankruptcy contagion, the impact of tax reform on state and municipal bond issuers, or the impact of large scale domestic military cutbacks on our privatized military housing portfolio or event risk such as pandemics (e.g., COVID-19), natural disasters or other regional stresses. Most such risks cannot be predicted and may materialize unexpectedly or develop rapidly. Although our surveillance allows us to connect the event and stress to the related exposures and assign an adverse credit classification and estimate losses across the affected credits, when necessary, we may not have adequate resources or contractual rights and remedies to mitigate loss arising from such risks. Risk Remediation Risk Remediation's focus is on exposure reduction, loss mitigation, avoiding defaults, and restructuring related to the insured portfolio. In particular, this group focuses on reducing exposure to credits that have current negative developing trends, have the potential for future adverse development or are already adversely classified by, among other things, securing rights and remedies, both of which may help to mitigate losses in the event of further deterioration or event of default, or, as available, working with an issuer to refinance or retire debt. Loss mitigation and restructuring focuses on the analysis, implementation and execution of commutation and related claims reduction, defeasance or workout strategies for policies with potential future claims. Efforts are focused on minimizing claims and maximizing recoveries, typically following an event of default. The emphasis on reducing risk is centered on reducing exposure on a prioritized basis. For certain adversely classified, survey list and watch list credits, RMG analysts will develop and implement a remediation or loss mitigation plan that could include actions such as working with the issuer, trustee, bond counsel, servicer and other interested parties in an attempt to remediate the problem and minimize AAC’s exposure to potential loss. Other actions could include working with bond holders and other economic stakeholders to negotiate, structure and execute solutions, such as commutations. In addition, reinsurance is used as a remediation tool to reduce exposure to certain targeted policies and large concentrations. Adversely classified, survey list and watch list credits are tracked closely by RMG analysts as part of the risk remediation process and are discussed at regularly scheduled meetings with Credit Risk Management (see discussion following in “Credit Risk Management”). In some cases, the RMG will engage restructuring or workout experts, attorneys and/or other consultants with appropriate expertise in the targeted loss mitigation area to assist management in examining the underlying contracts or collateral, providing industry specific advice and/or executing strategies. We have established cross-functional teams in key areas of focus, comprised of personnel both within the RMG and in other departments, to target proactive mitigation and remediation of losses and potential future losses associated with certain credits and sectors in the insured portfolio. An example of such efforts includes the teams of professionals focused on the review and enforcement of contractual representations and warranties ("R&W") supporting RMBS policies. Members of these cross-functional teams will often work with external experts in the pursuit of risk reduction efforts. Credit Risk Management ("CRM") The CRM function manages the decision process for all material matters that affect credit exposures within the insured portfolio. CRM provides a forum for independent assessments, reviews and approvals and drives consistency and timeliness. The scope of credit matters under the purview of CRM includes material amendments, consents and waivers, evaluation of remediation or loss mitigation plans, credit review scheduling, credit classifications, rating designations, review of watch list or adversely classified credits, sector reviews and overall portfolio | Ambac Financial Group, Inc. 4 2020 FORM 10-K | Table of Co ntents reviews. Formal plans or transactions that relate to risk remediation, loss mitigation or restructuring may also require Risk Committee approval. Control Rights In structured transactions, including certain structured public finance transactions, AAC may be the control party as a result of insuring the transaction’s senior class or tranche of debt obligations. The control party may direct specified parties, usually the trustee, to take or not take certain actions following contractual defaults or trigger events. Control rights and the scope of direction and remedies vary considerably among our insured transactions. Because Ambac is party to and/or has certain rights in documents supporting transactions in the insured portfolio, Ambac frequently receives requests for amendments, consents and waivers (“ACWs”). RMG reviews, analyzes and processes all requests for ACWs. The decision to approve or reject ACWs is based upon certain credit factors, such as the issuer’s ability to repay the bonds and the bond’s security features and structure. As part of the CRM process, members of the RMG review, analyze and process all requests for ACWs. As a part of the Segregated Account Rehabilitation Proceedings, the Rehabilitation Court enjoined certain actions by other parties to preserve AAC’s control rights that could otherwise have lapsed or been compromised. Pursuant to the Second Amended Plan of Rehabilitation and orders of the Rehabilitation Court, such protections continue after the conclusion of the Segregated Account Rehabilitation Proceedings. Watch List and Adversely Classified Credits Watch list and adversely classified credits are tracked closely by the appropriate RMG teams and discussed as part of the CRM process. Adversely classified credit meetings include members of RMG and other groups within the Company, as necessary. As part of the review, relevant information, along with the plan for corrective actions and a reassessment of the credit’s rating and credit classification is considered. Internal and/or external counsel generally review the documents underlying any problem credit and, if applicable, an analysis is prepared outlining Ambac’s rights and potential remedies, the duties of all parties involved and recommendations for corrective actions. Ambac also meets with relevant parties to the transaction as necessary. The review schedule for adversely classified credits is tailored to the remediation plan to track and prompt timely action and proper internal and external resourcing. A summary of developments regarding adversely classified credits and credit trends is also provided to AFG’s, AAC’s and Ambac UK's Board of Directors no less than quarterly. Ambac assigns internal credit ratings to individual exposures as part of the surveillance process. These internal credit ratings, which represent Ambac’s independent judgments, are based upon underlying credit parameters consistent with the exposure type. Loss Reserving and Analytics ("LRA") LRA manages the quarterly loss reserving process for insured portfolio credits with projected policy claims. It also supports the development, operation and/or maintenance of various analytical models used in the loss reserving process as well as in other risk management functions. LRA works with surveillance and risk remediation analysts responsible for a particular credit on the development, review and implementation of loss reserve scenarios and related analysis. Specialty Property & Casualty Program Insurance The specialty property & casualty program insurance business currently includes admitted carrier Everspan Insurance Company and nonadmitted carrier Everspan Indemnity Insurance Company (collectively, “Everspan Group”). Everspan Group received a Class VIII, A- Financial Strength Rating from A.M. Best Rating Services, Inc. in February 2021, has capital in excess of $100 million, and is expected to begin writing new property and casualty specialty insurance programs in the first half of 2021. Everspan Group is pursuing a sustainable, long term niche property/casualty program strategy with diverse classes of risks and plans to source business through diverse channels including Managing General Agents, brokers, producers and others. Everspan Group's business model will rely on third party producers or capacity providers to provide the infrastructure associated with policy administration, claims handling and other insurance company services. Everspan Group may retain up to 30% of it gross written premiums and, to the extent applicable, will reinsure the remainder to reinsurers and other providers of risk capital. With its strong capital base, Everspan Group will be differentiated in the specialty program insurance market with its focus on underwriting results, risk retention, long-term relationships, and the avoidance of channel conflicts. Everspan Group hired a management team with a successful track record in specialty program insurance business and relationships with Managing General Agents, brokers, producers and third party claims administrators. The specialty property & casualty program insurance business will generate income from (i) ceding fees, by offering carrier capacity to specialty general agents and other producers who sell, control and administer books of insurance business that are supported by third parties that assume reinsurance risk and (ii) net insurance underwriting income from any retained risk. Its core expenses will include compensation, agent commissions and other overhead costs. Everspan Group will face competition from long standing program business market participants such as State National as well as more recent entrants such as Clear Blue Insurance Group, Spinnaker Insurance Company, Trisura and Accredited Surety and Casualty Company, Inc. Everspan Group will also compete with new companies that continue to be formed to enter the insurance markets, particularly companies with new or "disruptive" technologies or business models. Competition may take the form of lower prices, broader coverages, greater product flexibility, higher coverage limits, higher quality services or higher ratings by independent rating agencies. Few barriers exist to prevent insurers from entering target markets within the property and casualty industry. Market conditions and capital capacity influence the degree of competition at any point in time. During periods of excess underwriting capacity, as defined by the availability of capital, competition can result in lower pricing and less favorable policy terms and conditions for insurers. During periods of reduced | Ambac Financial Group, Inc. 5 2020 FORM 10-K | Table of Co ntents underwriting capacity, pricing and policy terms and conditions are generally more favorable for insurers. Historically, the performance of the property and casualty insurance industries has tended to fluctuate in cyclical periods of price competition and excess underwriting capacity, followed by periods of high premium rates and shortages of underwriting capacity. At any given time, Everspan Group's portfolio of insurance products could experience varying combinations of these characteristics. This cyclical market pattern can be more pronounced in the specialty insurance and reinsurance markets in which Everspan Group competes than the standard insurance market. Managing General Agency / Underwriting On December 31, 2020, Ambac acquired 80% of the membership interests of Xchange. Formed in 2010, Xchange is a specialty-niche, property and casualty Managing General Underwriter ("MGU") focused on accident and health ("A&H") products. Below is a description of its largest products for which it provides underwriting services: Employer Stop Loss ("ESL") — provides protection for self-insured employers by serving as a reimbursement mechanism for catastrophic claims exceeding pre-determined levels. Limited Medical ("LM") — designed for those not covered by traditional medical programs and sold primarily through affinity groups, providing a variety of medically related benefits such as hospital or physician visits. Short-term Medical ("STM") — sold primarily through affinity groups, providing comprehensive medical coverage for short periods of time (i.e. less than one year). Xchange's management team, which retained 20% ownership of the business, has significant longstanding relationships with carriers, agents, policyholders, affinity groups and reinsurers. Xchange conducts business through approximately seven insurance carriers and dozens of agents and other distributors. Xchange is compensated for its services primarily by commissions paid by insurance companies for underwriting, structuring and/or administering polices and, in the case of ESL, managing claims under an agency agreement. Commission revenues are usually based on a percentage of the premiums paid by the insured. Xchange is also eligible to receive profit sharing contingent commissions on certain programs (mostly LM and STM) based on the underwriting results of the policies it writes, which may cause some variability in revenue and earning recognition. Business written by Xchange is generally concentrated in January and July, which may result is revenue and earnings concentrations in the first and third quarters each calendar year. Xchange's core expenses include commissions it pays to its independent agents and compensation for its management and staff, which currently total 20 individuals. The MGU business is highly competitive and a number of firms actively compete with Xchange for customers and insurance carrier capacity. However, the ESL market is increasing in size as large companies continue to transition from fully insured to self-funded. As the market size increases, capital is flowing into the market, but prices and margins remain stable. For LM and STM, overall market conditions remain stable. The market as a whole remains vast, as entrepreneurs and the unemployed seek options for individual insurance. Competition for Xchange's business comes from both direct carriers and other intermediaries and, depending on the product, may include Blue Cross, UnitedHealth, CIGNA, Aetna, Tokyo Marine, Houston Casualty Company, Sun Life, United Health, Axis, Chubb, and National General. Xchange is one component of Ambac's broader Managing General Agent ("MGA")/MGU business strategy. Ambac expects to grow the MGA/MGU business using several strategies, including (i) organic growth, (ii) additional acquisitions and/or partnerships, and (iii) establishing de-novo platforms. Future expansion of the MGA/MGU business is expected to include other property and casualty products and services in addition to A&H. Insurance underwritten through Ambac's MGA/MGUs may utilize the Everspan Group as an insurance carrier, but will not necessarily be required to do so, depending on a number of strategic and operational considerations. ENTERPRISE RISK MANAGEMENT The Company's policies and procedures relating to risk assessment and risk management are overseen by its Board of Directors. The Board of Directors takes an enterprise-wide approach to risk management oversight that is designed to support the Company's business plans at a level of risk considered by the Board to be reasonable. A fundamental part of risk assessment and risk management is not only understanding the risks the Company faces and what steps management is taking to manage those risks, but also understanding what level of risk is appropriate for the Company. The Board of Directors periodically reviews the Company's business plan, factoring risk management into account. It also approves the Company's risk appetite statements, which articulate the Company's tolerance for certain risks and describes the general types of risk that the Company accepts, within certain parameters, or attempts to avoid. While the Board of Directors has the ultimate oversight responsibility for the risk management process, various committees of the Board also have responsibilities related to risk assessment and risk management, and management has responsibility for managing the risks to which the Company is exposed and reporting on such matters to the Board of Directors and applicable Board committees. • The Audit Committee oversees the management of risks associated with the integrity of Ambac’s financial statements and its compliance with legal and regulatory requirements. In addition, the Audit Committee discusses policies with respect to risk assessment and risk management, including major financial risk exposures and the steps management has taken to monitor and control such exposures. The Audit Committee reviews with management, internal auditors and independent auditors Ambac's critical accounting policies, Ambac's system of internal controls over financial reporting and the quality and appropriateness of disclosure and content in the financial statements and other external financial communications. • The Compensation Committee oversees the management of risk primarily associated with our ability to attract, | Ambac Financial Group, Inc. 6 2020 FORM 10-K | Table of Co ntents motivate and retain quality talent (particularly executive talent) and with setting financial incentives that do not motivate undue risk-taking. • The Governance and Nominating Committee oversees the management of risk primarily associated with Ambac’s ability to attract and retain quality directors, Ambac’s corporate governance programs and practices and our compliance therewith. Additionally, the Governance and Nominating Committee oversees the processes for evaluation of the performance of the Board of Directors and its committees each year and considers risk management effectiveness as part of its evaluation. The Governance and Nominating Committee also performs oversight of the business ethics and compliance program, and reviews compliance with Ambac’s Code of Business Conduct. • The Strategy Committee oversees the management of risk and risk appetite primarily with respect to strategic plans and initiatives. The Board of Directors also receives quarterly updates from Board committees, and the Board provides guidance to individual committee activities as appropriate. In order to assist the Board of Directors in overseeing Ambac’s risk management, Ambac uses enterprise risk management, a company-wide process that involves the Board of Directors, management and other personnel in an integrated effort to identify, assess and manage a broad range of risks (e.g., credit, financial, legal, liquidity, market, model, operational, regulatory, reputational and strategic), that may affect the Company’s ability to execute on its corporate strategy and fulfill its business objectives. The Enterprise Risk Committee (“ERC”), which is a management committee, is comprised of senior level management responsible for assisting in the management of the Company’s risks on an individual and aggregate basis. The ERC produces the relevant risk management information for senior management and the Board of Directors. Ambac management has established management committees to assist in managing the risks throughout the enterprise. These committees will meet monthly or as needed on an ad hoc basis. • The AAC Risk Committee's objective is to establish an interdisciplinary team of professionals to provide oversight of the key risk remediation issues impacting AAC and Ambac UK. The purview of the committee is to review and approve risk remediation activities for the financial guarantee insured portfolio. Additionally, the Risk Committee will provide oversight and review new risk remediation structures or approaches in connection with risk remediation plans or anticipated transactions. Members of the Risk Committee include the Chief Executive Officer, Head of Risk Management, Chief Financial Officer and senior managers from throughout risk, corporate services, operations, investment management, legal and finance. • The Asset Liability Management Committee's (“ALCO”) objective is to foster an enterprise wide culture and approach to liquidity management, asset management, asset valuation and hedging. Members of ALCO include the Chief Executive Officer, Chief Financial Officer, Head of Risk Management and senior managers from investment management and the Risk Management Group. • The Disclosure Committee's objective is to assist the CEO and CFO in their responsibilities to design, establish, maintain and evaluate the effectiveness of disclosure controls and procedures. Members of the Disclosure Committee include the Chief Executive Officer, Chief Financial Officer, Chief Accounting Officer, Head of Risk Management and senior managers from throughout finance, legal, risk and corporate services. Everspan Group established an Underwriting Committee in 2021 to review the strategy, and provide oversight of the active underwriting operations of Everspan Group, and to assist the Boards of the Everspan Group companies in overseeing the integrity and effectiveness of Everspan Group’s underwriting risk management framework. Members of the committee include Ambac's Chief Executive Officer, key members of Everspan Group management and other senior managers or advisors of Ambac. Xchange established an Underwriting Committee in 2021 for the purpose of reviewing and approving any new business initiative or product line proposed to be undertaken by Xchange. Members of the Underwriting Committee include Ambac's Chief Executive Officer, Chief Financial Officer, key members of Xchange management and other senior managers or advisors of Ambac. AVAILABLE INFORMATION Our Internet address is www.ambac.com. We make available through the investor relations section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission. Our Investor Relations Department can be contacted at Ambac Financial Group, Inc., One World Trade Center, 41st Floor, New York, New York 10007, Attn: Investor Relations, telephone: 212-208-3222 email: ir@ambac.com. The reference to our website address does not constitute inclusion or incorporation by reference of the information contained on our website in this Form 10-K or other filings with the SEC and the information contained on our website is not part of this document. INSURANCE REGULATORY MATTERS AND OTHER RESTRICTIONS Regulatory Matters United States Ambac Assurance is domiciled in the state of Wisconsin and is therefore subject to the insurance laws and regulations of the State of Wisconsin and regulated by the Wisconsin Office of the Commissioner of Insurance (“OCI”). Everspan Indemnity Insurance Company ("Everspan Indemnity") and its wholly owned subsidiary, Everspan Insurance Company ("Everspan Insurance") are domiciled in the state of Arizona and are therefore subject to the insurance laws and regulations of the | Ambac Financial Group, Inc. 7 2020 FORM 10-K | Table of Co ntents State of Arizona and regulated by the Arizona Department of Insurance and Financial Institutions (“DIFI”). AAC and Everspan Insurance are also subject to the insurance laws and regulations of the other jurisdictions in which they are licensed. See Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on regulatory restrictions. Xchange is a property and casualty managing general underwriter, specializing in accident and health insurance. Xchange, like other managing general agents and program administrators, is subject to licensing requirements and regulation by insurance regulators in various states in which they conduct business. Every state and Washington, D.C. have enacted a version of the NAIC Model Managing General Agents Act, which governs licensing and the relationship between insurers and managing general agents. In addition, pursuant to the terms of the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes, AAC must seek prior approval by OCI of certain corporate actions. The Settlement Agreement, Stipulation and Order and indenture for the Tier 2 Notes include covenants which restrict the operations of AAC. The Settlement Agreement will remain in force until the surplus notes issued thereunder have been redeemed, repurchased or repaid in full. The Stipulation and Order will remain in force for so long as OCI determines it to be necessary. The indenture for the Tier 2 Notes will remain in force until the Tier 2 Notes have been redeemed, repurchased or repaid in full. Certain of the restrictions in the Settlement Agreement and indenture for the Tier 2 Notes may be waived with the approval of the OCI and/or the requisite percentage of holders of debt securities issued thereunder. Cybersecurity and Privacy Regulation Ambac and its subsidiaries are subject to various U.S. Federal and state laws and regulations with respect to privacy, data protection and cybersecurity that require financial institutions, including insurance companies and agencies, to safeguard personal and other sensitive information, and may provide for notice of their practices relating to the collection, disclosure and processing of personal information, and any related security breaches. For example, the National Association of Insurance Commissioners (“NAIC”), an organization of state insurance regulators, adopted the Insurance Data Security Model Law (“NAIC Model Law”) that creates rules for insurers and other covered entities addressing data security and the investigation and notification of cybersecurity events involving unauthorized access to, or the misuse of, certain nonpublic information. This includes maintaining an information security program based on ongoing risk assessment, overseeing third-party service providers, investigating data breaches and notifying regulators of a cybersecurity event. Legislation based on the NAIC Model Law has been enacted in eleven states and may be enacted in other states. Our subsidiaries, as insurance companies and agencies licensed in the State of New York, are also required to comply with the New York Department of Financial Services (“NYDFS”) cybersecurity regulation, which establishes requirements for covered financial services institutions to implement a cybersecurity program designed to protect the confidentiality, integrity and availability of information systems of regulated entities, and information stored on those systems. The regulation imposes a governance framework for cybersecurity program, risk based minimum standards for technology systems for data protection, monitoring and testing, third-party service provider reviews, security incident response and reporting to NYDFS of certain security incidents, annual certifications of regulatory compliance to NYDFS, and other requirements. United Kingdom The Prudential Regulatory Authority ("PRA") and Financial Conduct Authority ("FCA") (and their predecessor regulator the Financial Services Authority (“FSA”)) exercise significant oversight of Ambac UK. In 2009, the FSA limited Ambac UK’s license to undertaking only run-off related activity. As such, Ambac UK is authorized to run-off its insurance portfolio in the United Kingdom and a number of other EU countries. EU legislation allowed Ambac UK to conduct business in EU states other than the United Kingdom through a “passporting” arrangement, which eliminated the necessity of additional licensing or authorization in those other EU jurisdictions. On December 31, 2020, Ambac UK's authorization to run-off insurance policies in the EU through passporting arrangements ceased. This was a consequence of the end of the transition period agreed between the UK Government and the EU following the UK's exit from the EU on January 31, 2020. Ambac UK's outstanding policies in the EU were either commuted or the benefits of those policies were transferred to UK entities during the year. Ambac UK therefore no longer services any insurance policies in the EU. Ambac UK maintained a branch in Milan, Italy until December 18, 2020, but closed the branch on that date following the transfer of the last remaining policy in the branch to the UK on 1 December 2020. See Item 1A. Risk Factors in Part I, Item 1A and Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on Brexit related developments as well as other regulatory restrictions. Regulation of change in control Under applicable Wisconsin and Arizona law, any acquisition of control of AFG, or any other direct or indirect acquisition of control of Ambac Assurance or the Everspan Group, requires the prior approval of OCI and DIFI, respectively. “Control” is defined as the direct or indirect power to direct or cause the direction of the management and policies of a person. Any purchaser of 10% or more of the outstanding voting stock of a corporation is presumed to have acquired control of that corporation and its subsidiaries unless the OCI or DIFI, as applicable, upon application, determines otherwise. For purposes of this test, AFG believes that a holder of common stock having the right to cast 10% or more of the votes which may be cast by the holders of all shares of common stock of AFG would be deemed to have control of Ambac Assurance, Everspan Indemnity and Everspan Insurance within the meaning of the applicable Wisconsin and Arizona insurance laws and regulations. The United Kingdom has similar requirements applicable in respect of AFG, as the ultimate holding company of Ambac UK. | Ambac Financial Group, Inc. 8 2020 FORM 10-K | Table of Co ntents Dividend Restrictions, Including Contractual Restrictions Due to contractual and regulatory restrictions, AAC has been unable to pay ordinary dividends to AFG since 2008 and will be unable to pay ordinary dividends in 2021. AAC’s ability to pay dividends is further restricted by the Settlement Agreement, the Stipulation and Order, the indenture for the Tier 2 Notes and the terms of its Auction Market Preferred Shares ("AMPS"). See Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on dividends. As a result of these restrictions, AAC is not expected to pay dividends to AFG for the foreseeable future. Everspan Indemnity and Everspan Insurance are also subject to regulatory restrictions on their ability to pay dividends. Everspan Indemnity and Everspan Insurance do not have sufficient earned surplus at this time to pay ordinary dividends under the insurance laws and regulations of Arizona. While the UK insurance regulatory laws impose no statutory restrictions on an insurer’s ability to declare a dividend, the PRA’s and FCA’s capital requirements in practice act as a restriction on the payment of dividends, where a firm has a lower level of regulatory capital than its regulatory capital requirement as is the case for Ambac UK. Further, the FSA amended Ambac UK’s license in 2010 such that the PRA must specifically approve any transfer of value and/or assets from Ambac UK to AAC or any other Ambac group company, other than in respect of certain disclosed contracts between the two parties (such as in respect of a management services agreement between AAC and Ambac UK). As a result, Ambac UK is not expected to pay any dividends to AAC for the foreseeable future. Pursuant to the Settlement Agreement and the indenture for the Tier 2 Notes, AAC may not make any “Restricted Payment” (which includes dividends from AAC to AFG) in excess of $5 million in the aggregate per annum, other than Restricted Payments from AAC to AFG in an amount up to $7.5 million per annum solely to pay operating expenses of AFG. Concurrent with making any such Restricted Payment, a pro rata amount of AAC's surplus notes would also need to be redeemed at par. Any such payment on surplus notes would require either payment or collateralization of a proportional amount of the Tier 2 Notes (or interest thereon) in accordance with the terms of the Tier 2 Note indenture. The Stipulation and Order requires OCI approval for the payment of any dividend or distribution on the common stock of AAC. Under the terms of AAC’s AMPS, dividends may not be paid on the common stock of AAC unless all accrued and unpaid dividends on the AMPS for the then current dividend period have been paid, provided that dividends on the common stock may be made at all times for the purpose of, and only in such amounts as are necessary for, enabling AFG (i) to service its indebtedness for borrowed money as such payments become due or (ii) to pay its operating expenses. If dividends are paid on the common stock as provided in the prior sentence, dividends on the AMPS become cumulative until the date that all accumulated and unpaid dividends have been paid on the AMPS. INVESTMENTS AND INVESTMENT POLICY As of December 31, 2020, the consolidated non-VIE investments of Ambac had an aggregate fair value of approximately $3,544 million. Investments are managed both internally by experienced investment managers and externally by investment management firms. All investments are made in accordance with the general objectives, policies, and guidelines for investments reviewed or overseen by the Board of Directors of the applicable subsidiary. These policies and guidelines include liquidity, credit quality, diversification and duration objectives and are periodically reviewed and revised as appropriate. Additionally, senior credit personnel monitor the portfolio on a continuous basis. As of December 31, 2020, the AAC and Everspan Group non-VIE investment portfolios had an aggregate fair value of approximately $2,603 million. The investment objective is to achieve the highest risk-adjusted after-tax return on a diversified portfolio of fixed maturity investments and pooled investment funds consistent with the respective company's risk tolerance while employing active asset/liability management practices to satisfy all operating and strategic liquidity needs. In addition to internal investment policies and guidelines, the investment portfolio of each company is subject to limits on the types and quality of investments imposed by applicable insurance laws and regulations of the jurisdictions in which it is licensed. The Board of Directors of each respective subsidiary approves any changes to the investment policy. Within its guidelines, AAC opportunistically purchases and sells AAC and Ambac UK insured securities given their relative risk/reward characteristics. In certain instances, AAC may exceed its established credit rating or concentration limits with appropriate regulatory approval. Changes to AAC’s investment policies are subject to approval by OCI pursuant to covenants made by AAC in the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes. See Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for more information about the Settlement Agreement, the Stipulation and Order and the indenture for the Tier 2 Notes. Such requirements could adversely impact the performance of the investment portfolio. As of December 31, 2020, the non-VIE Ambac UK investment portfolio had an aggregate fair value of approximately $651 million. Ambac UK’s investment policy is designed with the primary objectives of ensuring a reasonable risk-adjusted return over the remaining runoff of the insured portfolio and that Ambac UK is able to meet its financial obligations as they fall due, in particular with respect to policy holder claims. Ambac UK’s investment portfolio is primarily diversified fixed maturity 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 its regulator. The Board of Directors of Ambac UK approves any changes or exceptions to Ambac UK’s investment policy. As of December 31, 2020, the non-VIE AFG (parent company only, excluding investments in subsidiaries) investment portfolio had an aggregate fair value of approximately $290 million. The primary investment objective is to preserve capital for strategic uses while maximizing income. The investment portfolio is | Ambac Financial Group, Inc. 9 2020 FORM 10-K | Table of Co ntents subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits. Included in the investment portfolio is AFG's investment in securities insured or issued by AAC, including surplus notes ($59 million fair value at December 31, 2020) that are eliminated in consolidation. The following table provide certain information concerning the consolidated investments of Ambac: 2020 2019 Investment Category ($ in millions) December 31, Carrying Value (2) Weighted Average Yield (1) Carrying Value (2) Weighted Average Yield (1) Municipal obligations $ 358 4.8 % $ 215 5.4 % Corporate securities 1,077 3.9 % 1,430 4.6 % Foreign obligations 98 0.2 % 44 0.8 % U.S. government obligations 121 1.6 % 156 2.0 % Residential mortgage-backed securities 302 6.6 % 248 8.9 % Asset-backed securities 377 5.7 % 484 5.6 % Total long-term fixed maturity investments 2,332 4.3 % 2,577 5.0 % Short-term investments 617 0.1 % 737 1.5 % Other investments (3) 595 — % 478 — % Total $ 3,544 3.4 % $ 3,792 4.2 % (1) Yields are stated on a pre-tax basis, based on average amortized cost for both long and short term fixed-maturity investments. (2) Includes investments guaranteed by AAC and Ambac UK ("Ambac insured"). Refer to Note 11. Investments of the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of Ambac insured securities held in the investment portfolio. (3) Other investments include interests in pooled investment funds that are either classified as trading securities or are reported under the equity method and Ambac's interests in an unconsolidated trust created in connection with its sale of junior surplus notes on August 28, 2014. EMPLOYEES As of December 31, 2020, Ambac had 115 employees in the United States and 10 employees in the United Kingdom. Our 2020 voluntary turnover rate was approximately 3.3%. Ambac considers its employee relations to be satisfactory. Ambac’s focus has been on identifying and retaining key talent through individual development programs following skills assessments. Ambac’s succession planning has identified internal candidates that could fill senior management and mid-level management positions as the need arises. The Company has established a senior advisory team to work with, and advise, senior management on key initiatives, and invested in both personal and professional growth programs to identify and prepare executives for promotion within the Company. The Company continues to rely on compensation components (such as salary, long-term incentive plan awards, deferred cash awards and short-term incentive plan awards) to support employee retention and discourage excessive risk taking. The Company incorporates performance metrics as part of the annual short-term incentive bonus offering with increased bonus potential for exceptional results. We utilize third-party benchmark data to establish market-based compensation levels. We believe that our current compensation and incentive levels reflect high performance expectations as part of our merit pay philosophy. The targeted use of long-term equity incentive plan awards for key talent is an important element of Ambac’s long-term retention strategy. Item 1A. Risk Factors Capitalized terms used but not defined in this section shall have the meanings ascribed thereto in Part I, Item 1 in this Form 10-K or in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K unless otherwise indicated. Our risk factors are organized in the following sections. Page Risks Related to AFG Common Shares 10 Risks Related to FG Insured Portfolio Losses 11 Risks Related to Indebtedness 15 Risks Related to Capital, Liquidity and Markets 17 Risks Related to Financial and Credit Markets 19 Risks Related to the Company's Business 20 Risks Related to International Business 21 Risks Related to Taxation 21 Risks Related to Strategic Plan 22 Risks Related to Managing General Underwriting Business 23 Risks Related to AFG Common Shares Investments in AFG's common stock are highly speculative and the price per share of AFG's common stock may be subject to a high degree of volatility, including significant price declines. Ambac's principal business is in run-off and faces significant risks and uncertainties described elsewhere in Part I, Item 1A. Risk Factors. Although AFG's common stock is listed on the New York Stock Exchange ("NYSE"), there can be no assurance as to the liquidity of the trading market or the price at which such shares can be sold. The price of the shares may decline substantially in response to a number of events or circumstances, including but not limited to: • adverse developments in our financial condition or results of operations; • actual or perceived adverse developments with regards to AAC's residential mortgage-backed securities ("RMBS") litigations; • changes in the actual or perceived risk within our FG insured portfolio, particularly with regards to concentrations of credit risk, such as in Puerto Rico; • changes to regulatory status; • changes in investors’ or analysts’ valuation measures for our stock; • market perceptions of our success, or lack thereof, in pursuing our business strategy; | Ambac Financial Group, Inc. 10 2020 FORM 10-K | Table of Co ntents • the impact or perceived impact of any acquisition, disposition or other strategic transaction, including entry into a new line of business, on the value or long-term prospects of the Company; and • results and actions of other participants in our industry. In addition, the price of AFG's shares may be affected by the additional risks described below, including risks associated with AAC’s ability to deliver value to AFG. Investments in AFG's common stock should be considered highly speculative and may be subject to a high degree of volatility. The occurrence of certain events could result in the initiation of rehabilitation proceedings against AAC, with resulting adverse consequences to holders of our securities. Increased loss development in the FG insured portfolio or significant losses or other events resulting from litigation, including the failure to achieve expected recoveries from existing litigations concerning insured RMBS, may prompt OCI to determine that it is in the best interests of policyholders to initiate rehabilitation proceedings with respect to AAC, either preemptively or in response to any such event. If OCI were to decide to initiate rehabilitation proceedings with respect to AAC, adverse consequences may result, including, without limitation and absent enforceable protective injunctive relief, the assertion of damages by counterparties, the acceleration of losses based on early termination triggers, and the loss of control rights in insured transactions. Any such consequences may reduce any residual value of AAC. Additionally, the rehabilitator would assume control of all of AAC’s assets and management of AAC. In exercising control, the rehabilitator would act for the benefit of policyholders, and would not take into account the interests of our security holders, which may result in material adverse consequences for our security holders. AFG may not be able to realize value from AAC or generate earnings apart from AAC. The value of AFG's common stock is partially dependent upon realizing residual value and/or receiving dividends from AAC; the receipt of payments to be made by AAC pursuant to the intercompany expense sharing and cost allocation agreement (the "Cost Allocation Agreement"); the receipt of payments on investments made in surplus notes issued by AAC; and the receipt of payments on other investments. There can be no assurance that AFG will be able to realize residual value and/or receive dividends from AAC, which is in run-off. AFG's ability to realize residual value and/or receive dividends from AAC will depend upon, amongst other considerations, AAC's ability to satisfy all of its obligations that are senior to AFG's equity interests, including obligations to policyholders, holders of its indebtedness (including surplus notes, the Ambac Note and the Tier 2 Notes) and holders of its preferred stock. AAC's ability to satisfy all of its obligations is dependent on a number of considerations including its ability to achieve recoveries and mitigate losses from its insured portfolio, which is subject to significant risks and uncertainties, including as a result of varying potential perceptions of the value of AAC’s guarantees and securities. Due to the above considerations, as well as applicable legal and contractual restrictions described elsewhere herein, it is highly unlikely that AAC will be able to pay AFG any dividends for the foreseeable future. Furthermore, the payments to be made to AFG under the intercompany Cost Allocation Agreement are subject to, in certain instances, OCI approval, making the amount and timing of such payments uncertain. Specifically, the Cost Allocation Agreement provides that AAC's reimbursement of certain AFG operating expenses is subject to the approval of OCI and limited to $4.0 million per annum. We can provide no assurance as to whether OCI will approve such reimbursement or any portion thereof. The value of AFG's common stock also depends upon the ability of Ambac to generate earnings apart from AAC. As noted below in Risks Related to Strategic Plan , Ambac is exploring further expansion into specialty property and casualty program insurance, managing general agent/underwriter, and potentially other insurance and insurance related businesses that, among other things, may permit utilization of Ambac’s net operating loss carry-forwards, but there are no assurances regarding its ability to acquire or develop any material businesses or the prospects for any such businesses. Risks Related to FG Insured Portfolio Losses Loss reserves may not be adequate to cover potential losses, and changes in loss reserves may result in further volatility of net income and comprehensive income. Loss reserves are established when management has observed credit deterioration in its insured credits. Loss reserves established with respect to our non-derivative financial guarantee insurance policies are based upon estimates and judgments by management, including estimates and judgments with respect to the probability of default; the severity of loss upon default; management’s ability to execute policy commutations, restructurings and other loss mitigation strategies; and estimated remediation recoveries for, among other things, breaches by RMBS issuers of representations and warranties. The objective of establishing loss reserve estimates is not to, and our loss reserves do not, reflect the worst possible outcome. While our reserving scenarios reflect a wide range of possible outcomes (on a probability weighted basis), reflecting the significant uncertainty regarding future developments and outcomes, our loss reserves may change materially based on future developments. As a result of inherent uncertainties in the estimates and judgments made to determine loss reserves, there can be no assurance that either the actual losses in our financial guarantee insurance portfolio will not exceed such reserves or that our reserves will not increase or decrease materially over time as circumstances, our assumptions, or our models change. Additionally, inherent in our estimates of loss severities and remediation recoveries is the assumption that AAC or its subsidiaries, as applicable, will retain control rights in respect of our insured portfolio. However, according to the terms of relevant transaction documents, AAC or its subsidiaries, as applicable, may lose control rights in many insured transactions if, among other things, the relevant insurer is the subject of delinquency proceedings and/or other regulatory actions. If AAC or its subsidiaries lose control rights, their ability to mitigate loss severities and realize remediation recoveries will | Ambac Financial Group, Inc. 11 2020 FORM 10-K | Table of Co ntents be compromised, and actual ultimate losses in the insured portfolio could exceed current loss reserves. Some issuers of public finance obligations insured by AAC are experiencing fiscal stress that could result in increased losses on those obligations or increased liquidity claims, including losses or claims resulting from payment defaults, Chapter 9 bankruptcy or other restructuring proceedings or loss of market access. Some issuers of public finance obligations insured by AAC have reported, or may report, budget shortfalls, significantly underfunded pensions or other fiscal stresses that imperil their ability to pay debt service or will require them to significantly raise taxes and/or cut spending in order to satisfy their obligations. Furthermore, over time, the consequences of poor public policy decisions by state and local governments or increases in tax burdens can impact demographic trends, such as out-migration from one state or municipality to another, that may negatively impact the creditworthiness of related issuers. Some issuers of obligations insured by AAC have declared a payment moratorium, defaulted or filed for bankruptcy or similar debt adjustment proceedings, raising concerns about their ultimate ability or willingness to service the debt insured by AAC and AAC's ability to recover claims paid in the future. If the issuers of the obligations in the public finance portfolio are unable to raise taxes, cut spending, or receive federal or state assistance, or if such issuers default or file for bankruptcy under Chapter 9 or for similar relief under other laws that allow for the adjustment of debts, AAC may experience liquidity claims and/or ultimate losses on those obligations, which could adversely affect the Company's business, financial condition and results of operations. Catastrophic public health or environmental events, like the COVID-19 pandemic or those associated with hurricanes, earthquakes, wildfires and droughts, that result in material disruption of economic activity, loss of human life or significant property damage, can have a materially negative impact on the financial performance of issuers of public finance, structured finance, investor owned utility, privatized military housing and other obligations insured by AAC. Such stresses could result in liquidity claims and/or permanent losses on obligations of those obligations. The emergence of the COVID-19 pandemic and the resulting containment measures have caused economic and financial disruptions that have adversely affected, and are expected to continue to materially adversely affect, our business and results of operations. Ambac insures the obligations of a number of issuers that have been, or may in the future be, substantially affected by the economic effects of COVID-19, such as municipalities and securitizations, including those backed by consumer loans such as mortgages or student loans. As described more fully in Management's Discussion and Analysis of Financial Condition and Results of Operations, municipalities and their authorities, agencies and instrumentalities, especially those dependent on narrow revenue streams flowing from particular economic activities, have suffered, and are expected to continue to suffer, from severely depressed revenues due to shelter-in-place orders, social distancing guidelines, travel bans and restrictions, and business shutdowns as well as an economic recession brought about by the COVID-19 pandemic. Furthermore, securitizations dependent on cash flows from payments on mortgage loans, student loans or other assets have experienced, and are expected to continue to experience, shortfalls in receipts due to borrower nonpayments. See Part II, Item 7 of this Form 10-K, Management's Discussion and Analysis of Financial Condition and Results of Operations, Executive Summary, Financial Guarantees in Force, Liquidity and Capital Resources and Balance Sheet for further detail. The U.S. Federal government and other governments globally have taken certain measures to aid consumers, businesses, state and local governments, and the financial markets, but the impact of such aid remains unclear. U.S. Federal and State governments and their agencies have also adopted policies or guidelines to provide emergency relief to consumers, such as limiting debt collection efforts, encouraging or requiring extensions, modifications or forbearance with respect to certain loans and fees, and establishing foreclosure and eviction moratoriums. Several of these policies or guidelines have been extended beyond their initial terms and could be expanded over time as the economic effects of the pandemic become more well known. To the extent such measures cause greater incidences of missed mortgage loan, student loan or other debt service payments than would have occurred without governmental intervention, Ambac may experience higher losses in its insured portfolio of asset-backed securities. AAC also insures the obligations of a number of issuers that have been, or may in the future be, substantially affected by environmental or other public health events, including flooding, hurricanes, earthquakes, wildfires and drought. In addition, certain catastrophic environmental events, notably wildfires, can result in significant potential liabilities for issuers such as investor-owned utilities that increase bankruptcy risk and the potential default on obligations of the issuer insured by AAC. The ultimate impact of a catastrophic public health event like COVID-19 or a catastrophic environmental event on issuers and their obligations, and the economy in general, is by its very nature uncertain, and will be determined by a number of factors including, but not limited to, the depth and duration of the crisis; the extent to which affected consumers, businesses, municipal entities and other debtors or sources of revenues recover from depressed economic circumstances, and the timelines for such recoveries; the level and efficacy of government intervention or support for municipal entities, consumers, businesses and the financial markets via emergency relief measures; the availability of insurance; the availability of cost-effective financing; management of public health crisis remediation efforts, including the availability, utilization and efficacy of vaccinations; the effectiveness of other public or private crisis management efforts, mitigation measures or support; and certain socio-economic variables, such as unemployment levels. Consequently, if issuers affected by such catastrophic events do not have sufficient resources or financial flexibility, receive adequate measures of support or realize the appropriate level of economic recovery, their ultimate ability to service the debt insured by Ambac could be materially impaired and Ambac could suffer material permanent losses. At this time, there are significant uncertainties surrounding the ultimate number of claims and the extent of losses Ambac will face as a result of the economic effects of the COVID-19 pandemic. Actual losses may vary materially from Ambac's loss | Ambac Financial Group, Inc. 12 2020 FORM 10-K | Table of Co ntents and loss expense reserves due to the factors described above and the inherent uncertainties in estimating losses given the evolving nature of the pandemic and its impact on issuers of Ambac insured debt and the economy in general. Potential ultimate losses from the economic consequences of the COVID-19 pandemic could be material and therefore may have an adverse effect on our results of operations and financial condition. AAC insures obligations of the Commonwealth of Puerto Rico, including certain of its authorities and public corporations that are either subject to a Title III bankruptcy protection proceeding under the Puerto Rico Oversight, Management and Stability Act ("PROMESA") or have otherwise suspended debt service payments. AAC has made and may continue to be required to make significant amounts of policy payments over the next several years, the recoverability of which is subject to great uncertainty, which may lead to material permanent losses. While we believe our reserves are adequate to cover losses on Puerto Rico insured bonds, there can be no assurance that AAC may not incur additional losses in the future, particularly given the uncertainty related to the ongoing Title III proceedings and the developing economic, political and legal circumstances in Puerto Rico. Such losses may have a material adverse effect on AAC's results of operation and financial condition. AAC has exposure to the Commonwealth of Puerto Rico (the "Commonwealth"), including its authorities and public corporations. Each has its own credit risk profile attributable to, as applicable, discrete revenue sources, direct general obligation pledges and/or general obligation guarantees. AAC had approximately $1,070 million of net par exposure to the Commonwealth and these instrumentalities at December 31, 2020. Components of the overall Puerto Rico net par outstanding include capital appreciation bonds that 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. The outstanding net insured amount including accretion on capital appreciation bonds is approximately $1,284 million at December 31, 2020. Total net insured lifetime debt service (net par and interest) to the Commonwealth of Puerto Rico and its instrumentalities was approximately $2,540 million at December 31, 2020. As a result of the developments described in these Risk Factors and elsewhere in this 10-K (see Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Guarantees in Force, and Note 7. Financial Guarantee Insurance Contracts to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K), the Commonwealth of Puerto Rico and certain of its instrumentalities are continuing to default on debt service payments, including payments owed on bonds insured by AAC. AAC has made, and may continue to be required to make, significant amounts of policy payments over the next several years, the recoverability of which is subject to great uncertainty, which may lead to material permanent losses. Our exposure to Puerto Rico is impacted by the amount of monies available for debt service, which is in turn affected by a number of factors including variability in economic growth and demographic trends, tax revenues, changes in law or the effects thereof, essential services expense, federal funding of Commonwealth needs as well as interpretation of legislation, legal documents, and updated financial information (when available). Substantial uncertainty also exists with respect to the ultimate outcome for creditors in Puerto Rico due to the Commonwealth Plan of Adjustment or changes thereto, as well as legislation enacted by the Commonwealth and the United States, including PROMESA, as well as actions taken in reliance on such laws, including Title III filings. AAC is involved in multiple litigations relating to such actions and other issues and may not be successful in pursuing claims or protecting its interests. Given the numerous uncertainties and risks existing with respect to the restructuring process, outcomes associated with the Commonwealth Plan of Adjustment or any changes thereto and relevant litigation, no assurance can be given that ultimate debt service discounts will not be very severe and cause Ambac to experience losses materially exceeding current reserves. It is possible that certain restructuring process solutions, together with associated legislation, budgetary, and/or public policy proposals could be adopted and could significantly further impair our exposures. In addition, there are possible final legal determinations, including failing to recognize or properly differentiate legal structures and protections applicable to such exposures, that could result in losses exceeding our current reserves by a material amount and further increases to our loss reserves. In particular, in a Title III process, should court-approved plans of adjustment for the Commonwealth, Puerto Rico Highways and Transportation Authority ("PRHTA"), the Puerto Rico Public Buildings Authority ("PBA") or any other issuers of Ambac-insured debt that may or may not file for Title III protection contemplate discounts to debt service implied by, or even worse than, the Commonwealth Fiscal Plan (May 27, 2020) or Ambac receive unfavorable judgments in the litigations to which it is a party, Ambac’s financial condition would be materially adversely affected. For example, the amended disclosure statement and plan of adjustment ("Amended POA") to restructure $35 billion of debt and other claims against the Commonwealth of Puerto Rico, PBA, and Employees Retirement Systems ("ERS"), as well as more than $50 billion in pension liabilities that was filed by the Federal Oversight Management Board for Puerto Rico ("Oversight Board") on February 28, 2020, provides for an average of 3.9% recoveries on claims for non-General Obligation and PBA bonds, including revenue bonds insured by Ambac. If the Amended POA was confirmed in its current form, Ambac's financial condition would be materially adversely affected. It is also possible that economic or demographic outcomes may be as, or worse than, forecasted in the Commonwealth Fiscal Plan or under proposals or plans promulgated by the Commonwealth or its instrumentalities in or in connection with a Title III process or otherwise. Even a negotiated restructuring to which Ambac agrees as part of mediation or other process may involve material losses in excess of current reserves. While our reserving scenarios reflect a wide range of possible outcomes reflecting the significant uncertainty regarding future developments and outcomes, given our exposure to Puerto Rico and the economic, fiscal, legal and political uncertainties associated therewith, our loss reserves may ultimately prove to be insufficient to cover our losses, potentially by a material amount, and may be subject to material volatility. | Ambac Financial Group, Inc. 13 2020 FORM 10-K | Table of Co ntents Certain judicial decisions related to the Commonwealth of Puerto Rico's PROMESA Title III proceedings may materially adversely affect our Public Finance insured portfolio. On January 13, 2020, the U.S. Supreme Court denied a petition for Writ of Certiorari to review decisions in March and June 2019 by the U.S. Court of Appeals for the First Circuit that affirmed decisions by the U.S. District Court overseeing the PROMESA Title III proceedings for the PRHTA, decisions which found that under Sections 928(a) and 922(d) of the U.S. Bankruptcy Code, municipal issuers of revenue bonds secured by special revenues are permitted, but not required, to apply special revenues to pay debt service on such revenue bonds during the pendency of bankruptcy proceedings for such municipal issuers. The complainants, including AAC, had sought an order compelling PRHTA, as the debtor, to continue to make debt service payments on its revenue bonds from pledged special revenues during the pendency of its Title III case, but the First Circuit affirmed the District Court’s dismissals of the complaints, holding that it could not compel the issuer to make such payments. The First Circuit's decisions challenge what had been a commonly understood notion in the municipal finance marketplace that municipal revenue bondholders secured by special revenues (as defined in Chapter 9 of the U.S. Bankruptcy Code) would continue to receive payment during a bankruptcy of the municipal issuer. Although the First Circuit’s decisions are binding only on federal district and bankruptcy courts in Maine, Massachusetts, New Hampshire, Puerto Rico and Rhode Island, they introduce significant uncertainty into the public finance market, may make it more difficult for municipal instrumentalities to procure revenue bond financings in the future and increase the credit risk to bondholders of existing special revenue bonds, particularly those from weaker issuers. It is unclear how these rulings may ultimately impact Ambac's revenue bond municipal exposures, inclusive of Puerto Rico. However, potential impacts could include ratings downgrades, decreased or more costly access to capital markets for certain issuers to refinance their insured debt or raise new debt, and lower recoveries in a restructuring or bankruptcy. At December 31, 2020, AAC insured approximately $3,644 million of net par of special revenue issuers, including $1,235 million net par of watch list exposure and $1,333 million net par of adversely classified exposure, $490 million of which was Puerto Rico exposure. We are subject to credit risk and other risks in our insured portfolio, including related to RMBS and securities backed by student loans. We are also subject to risks associated with adverse selection as our insured portfolio runs off. Measures taken to reduce such risks may have an adverse effect on the Company's operating results or financial position. Performance of our insured transactions, including (but not limited to) RMBS transactions and those involving securities backed by student loans, can be adversely affected by general economic conditions, such as recession, rising unemployment rates, underemployment, home prices that decline or do not increase in the patterns assumed in our models, increasing foreclosure rates and unavailability of consumer credit, mortgage product attributes, such as interest rate adjustments and balloon payment obligations, borrower and/or originator fraud, mortgage and student loan servicer performance or underperformance and financial difficulty, such as risks related to whether the servicer may be required to delay the remittance of any cash collections held by it or received by it after the time it becomes subject to bankruptcy or insolvency proceedings. While further deterioration in the performance of consumer assets, including mortgage-related assets and student loans, may occur, the timing, extent and duration of any future deterioration of the credit markets is unknown, as is the impact on potential claim payments and ultimate losses on the securities within our portfolio. In addition, there can be no assurance that any governmental or private sector initiatives designed to address such credit deterioration in the markets will be successful or inure to the benefit of the transactions we insure. For example, any initiative which permits the discharge of student loan debt in bankruptcy may adversely affect our portfolio. Similarly, servicer settlements with governmental authorities regarding foreclosure or servicing irregularities are generally designed to protect borrowers and may increase losses on securities we insure. In particular, the student loan industry and, specifically, trusts with securities insured by AAC have been subject to heightened Consumer Finance Protection Bureau (CFPB) scrutiny and enforcement action over servicing and collections practices and potential chain of title issues and, consequently, any settlements, orders, consents or penalties resulting from CFPB actions, or any failure on the part of servicers or other parties asserting claims against delinquent borrowers to establish title to the loans, could lead to increased losses on securities we insure. Risks such as these are potentially heightened by Democratic control of the United States Congress and executive branch. In addition, there can be no assurance that AAC would be successful, or that it would not be delayed, in enforcing the subordination provisions, credit enhancements or other contractual provisions of the RMBS that AAC insures. As the runoff of the insured portfolio continues, the proportion of exposures we rate as below investment grade relative to the aggregate insured portfolio is likely to continue to increase, leaving the portfolio increasingly concentrated in higher risk exposures. This risk may result in greater volatility or have adverse effects on the Company's results from operations and on our financial condition. One of our primary goals is to create shareholder value through transaction terminations, policy commutations, reinsurance, settlements and restructurings that we believe will improve our risk profile. As we take such actions to reduce known and potential risks, such actions may negatively impact our operating results or financial position in one or more reporting periods. Our credit risk management policies and practices may not adequately identify significant risks. As described in Part I, Item 1, “Risk Management” in this Form 10-K, we have established risk management policies and practices which seek to mitigate our exposure to credit risk in our insured portfolio. Ongoing surveillance of credit risks in our insured portfolio is an important component of our risk management process. These policies and practices in the past have not insulated us from risks that were unforeseen and which had unanticipated loss severity, and such policies and practices | Ambac Financial Group, Inc. 14 2020 FORM 10-K | Table of Co ntents may not do so in the future. There can be no assurance that these policies and practices will be adequate to avoid future losses. If we are not able to identify significant risks, we may not be able to timely remediate such risks, thereby increasing the amount of losses to which we are exposed. An inability to identify significant risks could also result in the failure to establish loss reserves that are sufficient in relation to such risks. We use analytical models and tools to assist our projection of performance of our insured obligations and our investment portfolio but actual results could differ materially from the model and tool outputs and related analyses. We rely on internally and externally developed complex financial models, including default models related to RMBS and a waterfall tool provided by a nationally recognized vendor for RMBS and student loan exposures, to project performance of our insured obligations and similar securities in our investment portfolio. These models and tools assume various conditions, probability scenarios, facts and circumstances, and there can be no assurance that such models or tools accurately predict or measure the quantum of losses, loss reserves and timing of losses. Differences in the models and tools that we employ, uncertainties or flaws in these financial models and tools, or faulty assumptions inherent in these financial models and tools or those determined by management could lead to material changes in projected outcomes, and could include increased losses, loss reserves and/or other than temporary investment impairments. Moreover, estimates of transaction performance depend in part on the interpretation of contracts and other bases of our legal rights. Such interpretations may prove to be incorrect or different interpretations may be employed by bond trustees and other transaction participants and, ultimately courts, which could lead to increased losses, loss reserves and/or investment impairments. Political developments may materially adversely affect our insured portfolio. Our insured exposures and our results of operations can be materially affected by political developments at the federal, state and/or local government levels. Government shutdowns, trade disputes, political turnover, judicial decisions, adverse changes in federal funding, or poor public policy decision making could disrupt the national and local economies where we have insured exposures. In addition, we are exposed to correlation risk as a result of the possibility that multiple credits may concurrently and/or consecutively experience losses or increased stress as a result of any such event or series of events. Risks Related to Indebtedness AAC's ability to generate the significant amount of cash needed to service its debt and financial obligations and its ability to refinance all or a portion of its indebtedness or obtain additional financing depends on many factors beyond our control. AAC is highly leveraged. AAC’s ability to make payments on and/or refinance its debt and to fund its operations will depend on its ability to generate substantial operating cash flow and on the performance of the insured portfolio. AAC’s cash flow generation will depend on receipt of premiums, investment returns, earnings from subsidiaries and potential litigation recoveries offset by policyholder claims, commutation payments, reinsurance premiums, operating and loss adjustment expenses, and interest expense, which will be subject to prevailing economic conditions and to financial, business and other factors, many of which are beyond our control and many of which are event-driven. There is substantial risk that AAC may not have the financial resources necessary to pay its debts in full and on time due to risks associated with its cash flow, expected litigation recoveries and insured portfolio, as discussed elsewhere in these Risk Factors. As of December 31, 2020, AAC had approximately $1,947 million of indebtedness outstanding (the Tier 2 Notes and the Ambac Note) that are senior to its surplus notes. AAC had $573 million principal balance of surplus notes outstanding plus $365 million principal balance of junior surplus notes outstanding as of December 31, 2020. The Tier 2 Notes and the Ambac Note are secured by potential litigation recoveries (and in the case of the Ambac Note, other assets), the receipt of which is highly uncertain, as more fully discussed in Part I, Item 1A. Risk Factors. Failure to achieve litigation recoveries in an amount sufficient to repay the Tier 2 Notes and the Ambac Note would materially weaken AAC’s ability to service its indebtedness. If AAC cannot pay its policyholders’ claims or service its debt, it will have to take actions such as selling assets, restructuring or refinancing its debt or seeking additional capital. Any of these remedies may not, if necessary, be effected on commercially reasonable terms, or at all. Because of these and other factors beyond our control, AAC may be unable to pay the principal, interest or other amounts on its indebtedness when due or ever. We have substantial indebtedness, which could adversely affect our financial condition, operational flexibility and our ability to obtain financing in the future. Our substantial indebtedness could have significant consequences for our financial condition and operational flexibility. For example, it could: • increase our vulnerability to general adverse economic, competitive and industry conditions; • limit our ability to obtain additional financing in the future for working capital, capital expenditures, payment of policyholder claims, debt service requirements, acquisitions, general corporate purposes or other purposes on satisfactory terms or at all; • require us to dedicate a substantial portion of our cash flow from operations to the payment of our indebtedness, thereby reducing the funds available to us for operations and to fund the execution of our key strategies; • limit or restrict us from making strategic acquisitions or cause us to make non-strategic divestitures; • limit our ability or increase the costs to refinance indebtedness or repay such indebtedness due to ongoing interest accretion; • limit our ability to attract and retain key employees; and • limit our ability to enter into hedging transactions by reducing the number of counterparties with whom we can enter into such transactions, as well as the volume of those transactions. | Ambac Financial Group, Inc. 15 2020 FORM 10-K | Table of Co ntents Despite current indebtedness levels, we may incur additional debt. While restrictive covenants in certain of our contracts may limit the amount of additional indebtedness AAC may incur, we may obtain waivers of those restrictions and incur additional indebtedness in the future. In addition, if Ambac incurred indebtedness, its ability to make scheduled payments on, or refinance, any such indebtedness may depend on the ability of our subsidiaries to make distributions or pay dividends, which in turn will depend on their future operating performance and contractual, legal and regulatory restrictions on the payment of distributions or dividends to which they may be subject. There can be no assurance that any such dividends or distributions would be made. This could further exacerbate the risks associated with our substantial leverage. There may not be sufficient collateral to pay any or all of the Secured Notes or Tier 2 Notes. In addition to AAC’s right to representation and warranty ("R&W") recoveries in respect of the RMBS litigations, which is inherently uncertain, the Ambac Note is also secured by cash and securities having an estimated fair market value of approximately $178 million. However, there can be no assurance that the fair market value of these securities will not decrease significantly. The value of the securities collateral in the event of liquidation will depend on market and economic conditions, the availability of buyers and other factors. Consequently, when combined with potential R&W recoveries, liquidating the securities collateral securing the Ambac Note may not produce proceeds in an amount sufficient to pay all amounts due on the Secured Notes. The ability of the holders of the Secured Notes or Tier 2 Notes to realize upon any of the collateral securing the Ambac Note and the Secured Notes or Tier 2 Notes, as the case may be, may also be subject to bankruptcy and insolvency law limitations or similar limitations applicable in insurance company rehabilitation or liquidation proceedings. In the event of rehabilitation, liquidation, conservation, dissolution or other insolvency proceeding, AAC cannot assure holders that the proceeds from any sale or liquidation of the securities collateral will be sufficient to pay any or all of AAC’s obligations under the Ambac Note. Moreover, the rehabilitator, liquidator or court overseeing such a proceeding may not assign value to the collateral with respect to the Ambac Note or the Tier 2 Notes, including AAC’s rights to recoveries in respect of the RMBS litigations, in an amount sufficient to discharge all or a substantial portion of AAC's obligations under or with respect to the Ambac Note, the Secured Notes and/or the Tier 2 Notes. AAC has not made regular interest or principal payments on surplus notes and can not provide any assurance as to when payments will be made, if ever. Payments of interest and principal on surplus notes are subject to the prior approval of the OCI. Since the issuance of the surplus notes in 2010, OCI has declined to approve regular payments of interest on surplus notes, although the OCI has permitted exceptional payments in connection with (a) increasing the percentage of deferred policy payments of the Segregated Account of AAC from 25% to 45% in 2014 and (b) a one-time payment of approximately six months of interest on the surplus notes outstanding immediately after the consummation of the Rehabilitation Exit Transactions in 2018. AAC also did not receive approval from OCI to make payment of the surplus notes on their scheduled maturity date of June 7, 2020, and therefore the scheduled maturity date was extended until OCI grants approval to make payment, in part or in full. Interest will accrue, compounded on each anniversary of the original scheduled maturity date, on any unpaid principal and interest through the actual date of payment, at 5.1% per annum. Holders of surplus notes have no rights to enforce the payment of the principal of, or interest on, surplus notes in the absence of OCI approval to pay such amount. If OCI does not approve regular payments on the surplus notes within the next several years, the total amount due for surplus notes may exceed AAC's financial resources and holders of surplus notes may not ever be paid in full. Surplus notes are subordinated in right of payment to other claims, which could impair the right of the holders of such notes to receive interest and principal in the event of our insolvency or a similar occurrence. Surplus notes are unsecured obligations of AAC and are expressly subordinated in right of payment to all of AAC’s existing and future indebtedness and policy claims. The surplus notes are subject to provisions of Wisconsin insurance law, which establishes the priority of distribution of claims from the estate of an insolvent insurance company. In the event that AAC becomes subject to rehabilitation, liquidation, conservation or dissolution, holders of AAC’s senior indebtedness and policy claims would be afforded a higher priority of distribution than holders of the surplus notes, and accordingly would have the right to be paid in full before holders of the surplus notes would be paid. Due to the nature of AAC’s business, the amount of such higher priority claims in any rehabilitation, liquidation, conservation or dissolution is likely to be many times greater than any free and divisible surplus and it is likely that the holders of surplus notes would not recover any payment in such circumstances. In addition, claims of holders of the surplus notes will be subordinated to certain liabilities of the Company’s subsidiaries that are guaranteed by AAC. The amount of interest payable on the Secured Notes is set only once per interest period based on the three-month LIBOR rate on the applicable interest determination date, which rate may fluctuate substantially; increases in interest rates will increase the cost of servicing our debt reducing our profitability and may affect our ability to make payment on the Secured Notes. The Secured Notes will bear interest at floating rates that could rise significantly, increasing AAC’s interest expense and reducing its cash flow and profitability. Each one percentage point increase in interest rates would result in a $6 million increase in the annual cash interest payments due on the Secured Notes. If AAC’s interest expense increases significantly, whether due to changes in LIBOR or increased borrowing costs when it refinances its current indebtedness, AAC may not be able to make payments with respect to the Secured Notes or its other indebtedness. Ambac’s estimated R&W recovery may be reduced, causing the perceived value of the collateral securing the Secured Notes and Tier 2 Notes to change, and any such change may be material. | Ambac Financial Group, Inc. 16 2020 FORM 10-K | Table of Co ntents Ambac reevaluates its estimated R&W recoveries on a quarterly basis in connection with the preparation of its financial statements. See “Critical Accounting Policies and Estimates” in Part II, Item 7, Note 2. Basis of Presentation and Significant Accounting Policies and Note 8. Financial Guarantee Insurance Contracts to the Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K for the fiscal year ended December 31, 2020. As a result of any reevaluation, the estimated amount of Ambac’s R&W recovery may be adjusted downward due to, among other things, changes in management's view of such estimated recoveries and/or changes in the loss reserves related to such recoveries, and any adjustment may be material. A reduction in estimated R&W recoveries may result in material changes in Ambac’s financial condition, including its capital and liquidity. In addition, any reduction to estimated R&W recoveries may alter the perceived value of the collateral securing the Secured Notes and Tier 2 Notes before payment on the Secured Notes or Tier 2 Notes is made in full, which may affect the value of, and trading market, if any, for, the Secured Notes or Tier 2 Notes. Management makes no representation that the estimated R&W recoveries will not be reduced, materially, including in the near term. There can be no assurance that the estimated R&W recoveries securing the Secured Notes and Tier 2 Notes will equal or exceed the principal amount of the Secured Notes and Tier 2 Notes, respectively, at all times prior to maturity. Risks Related to Capital, Liquidity and Markets Our inability to realize the expected recoveries included in our financial statements could adversely impact our liquidity, financial condition and results of operations and the value of our securities, including the Secured Notes and Tier 2 Notes. AAC is pursuing claims in litigation with respect to certain RMBS transactions that it insured. These claims are based on, among other things, representations with respect to the characteristics of the securitized loans, the absence of borrower fraud in the underlying loan pools or other misconduct in the origination process, the compliance of loans with the prevailing underwriting policies, and compliance of the RMBS transaction counterparties with policies and procedures related to loan origination and securitization. In such cases, where contract claims are being pursued, the sponsor of the transaction is contractually obligated to repurchase, cure or substitute collateral for any loan that breaches the representations and warranties. However, generally the sponsors have not honored those obligations and have vigorously defended claims brought against them. As of December 31, 2020, we have estimated RMBS R&W subrogation recoveries of $1,725 million (net of reinsurance) included in our financial statements. These estimated recoveries are based on the contractual claims brought in the aforementioned litigations and represent a probability-weighted estimate of amounts we expect to recover under various possible scenarios. The estimated recoveries we have recorded do not represent the best or the worst possible outcomes with respect to any particular transaction or group of transactions. There can be no assurance that AAC will be successful in prosecuting its claims in the RMBS litigations. The outcome of any litigation, including the RMBS litigations, is inherently unpredictable, including because of risks intrinsic in the adversarial nature of litigation. Motions made to the court, rulings and appeals - in the cases being prosecuted by AAC or in other relevant cases - could delay or otherwise impact any recovery by AAC. Moreover, rulings that may be adverse to AAC (in any of its RMBS litigations, as well as in other RMBS cases in which it is not a party) could adversely affect AAC’s ability to pursue its claims or the amount or timing of any recovery, or negatively alter settlement dynamics with RMBS litigation defendants. Any litigation award or settlement may be for an amount less than the amount necessary (even when combined with other pledged collateral) to pay the Secured Notes or the Tier 2 Notes, which could have a material adverse effect on our financial condition or results of operations and make it more difficult for AAC to repay the Ambac Note (and therefore make it more difficult for the issuer of the Secured Notes to repay the Secured Notes) and/or the Tier 2 Notes and/or AAC’s outstanding surplus notes, on a timely basis or at all. In the event that AAC is unable to satisfy its obligations with respect to the Secured Notes or Tier 2 Notes, holders will have the right to foreclose on any available collateral and to sue AAC for failure to make required payments; however, there can be no assurance that the sale of collateral will produce proceeds in an amount sufficient to pay any or all amounts due on the Secured Notes or Tier 2 Notes, as the case may be, or that holders will be successful in any litigation seeking payments. Additionally, while AAC may pursue settlement negotiations, there can be no assurance that any settlement negotiations will materialize or that any settlement agreement can be reached on terms acceptable to AAC, or at all. Depending on the length of time required to resolve these litigations, either through settlement or at trial, AAC could incur greater litigation expenses than currently projected. If a case is brought to trial, AAC’s ultimate recovery would be subject to the additional risks inherent in any trial, including adverse findings or determinations by the trier of fact or the court, which could adversely impact the value of our securities, including the Secured Notes and Tier 2 Notes. Any litigation award is subject to risks of recovery, including that the sponsor is unable pay a judgment that AAC may obtain in litigation. In some instances, AAC also has claims against a parent or an acquirer of the counterparty. However, AAC may not be successful in enforcing its claims against any successor entity. The RMBS litigations could also be adversely affected if AAC does not have sufficient resources to actively prosecute its claims or becomes subject to rehabilitation, liquidation, conservation or dissolution, or otherwise impaired by actions of OCI. Our ability to realize the estimated RMBS R&W subrogation recoveries included in our financial statements and the time of the recoveries, if any, is subject to significant uncertainty, including the risks described above and uncertainties inherent in the assumptions used in estimating such recoveries. The amount of these subrogation recoveries is significant and if we were unable to recover all such amounts, our stockholders’ equity as of December 31, 2020 would decrease from $1,140 million to $(585) million. We expect to recover material amounts of claims payments through remediation measures including the litigation described above as well as through cash flows in the securitization | Ambac Financial Group, Inc. 17 2020 FORM 10-K | Table of Co ntents structures of transactions that AAC insures. Realization of such expected recoveries is subject to various risks and uncertainties, including the rights and defenses of other parties with interests that conflict with AAC's interests, the performance of the collateral and assets backing the obligations that AAC insures, and the performance of servicers involved in securitizations in which AAC participates as insurer. Additionally, our ability to realize recoveries in insured transactions may be impaired if the continuing orders of the Rehabilitation Court are not effective. Adverse developments with respect to such variables may cause our recoveries to fall below expectations, which could have a material adverse effect on our financial condition, including our capital and liquidity, and may result in adverse consequences such as impairing the ability of AAC to honor its financial obligations; the initiation of rehabilitation proceedings against AAC; decreased likelihood of AAC delivering value to AFG, through dividends or otherwise; diminished business prospects due to third party concerns about our ability to recover losses; and a significant drop in the value of securities issued or insured by AFG or AAC, including the Secured Notes and Tier 2 Notes. Ambac’s estimate of RMBS litigation recoveries is subject to significant uncertainty and changes to the estimate could adversely impact its liquidity, financial condition and results of operations. For Ambac’s RMBS cases for which it records an RMBS R&W subrogation recovery in its financial statements, Ambac has obtained loan files from the relevant original pool and has conducted loan file re-underwriting to derive a breach rate that is extrapolated to estimate the damages Ambac expects to recover. Ambac does not estimate an RMBS R&W subrogation recovery for litigations where its sole claim is for fraudulent inducement. The amount estimated for purposes of Ambac’s RMBS R&W subrogation recovery and the amount Ambac may ultimately receive is subject to significant uncertainty, as described in the immediately preceding risk factor. Ambac’s findings and assumptions regarding collateral performance and Ambac’s expectations with respect to the outcome of the RMBS litigations have a significant impact on Ambac’s estimated RMBS R&W subrogation recovery. If these findings, assumptions or estimates prove to be incorrect or otherwise do not support our claims, actual recoveries could differ materially from those estimated. Actual recoveries will ultimately depend on future events and there can be no assurance that our view of collateral performance or our estimated RMBS R&W subrogation recoveries will not differ from actual events. Although Ambac believes that its methodology for estimating recoveries is appropriate, the methodologies Ambac uses to estimate expected collateral losses and specific transaction performance may not be similar to methodologies used by Ambac’s competitors, counterparties or other market participants. The determination of expected RMBS R&W subrogation recoveries is an inherently subjective and complex process involving numerous estimates and assumptions and judgments by management, using both internal and external data sources to derive a specific transaction's cash flows. As a result, Ambac’s current estimates may not reflect Ambac’s ultimate recovery, and management makes no representation that the actual amounts recovered, if any, will not differ materially from those estimated. The failure of Ambac’s actual recoveries to meet or exceed its current estimates could result in a material adverse effect on Ambac’s financial condition, including its capital and liquidity. We may not be able to commute or reduce FG insured exposures. In pursuing the objective of improving our financial position, we are seeking to commute or reduce FG insured exposures. De-risking transactions may not be feasible or economically viable. We cannot provide any assurance that any such transaction will be consummated in the future, or if it is, as to the timing, terms or conditions of any such transaction. Even if we consummate one or more of such transactions, doing so may ultimately prove to be unsuccessful in creating value for any or all of our stakeholders and may adversely affect our operating results or financial position. Revenues and cash flow would be adversely impacted by a decline in realization of installment premiums. A significant percentage of our premium revenue is attributable to installment premiums. The amount of installment premiums we actually realize could be reduced in the future due to factors such as early termination of insurance contracts, accelerated prepayments of underlying obligations or insufficiency of cash flows (by the premium paying entity). Such reductions would result in lower revenues. The composition of the securities in our investment portfolio exposes us to greater risk than before we invested in "alternative assets." Each of AAC and Ambac UK maintains a portion of its investment portfolio in below investment grade securities, equities and/or “alternative assets” with the objective to increase risk-adjusted portfolio returns. Investments in below investment grade securities, equities and “alternative assets” could expose AAC and/or Ambac UK to greater earnings volatility, increased losses and decreased liquidity in the investment portfolio. We may have future capital needs and may not be able to obtain third-party financing or raise additional third-party capital on acceptable terms, or at all. An inability to obtain third-party debt financing or raise additional third-party capital, when required by us or when business conditions warrant, could have a material adverse effect on our business, financial condition and results of operations. The economic conditions affecting our industry, as well as other factors, may constrain our financing abilities. Our ability to secure third-party financing, if available, and to satisfy or refinance our financial obligations under indebtedness outstanding from time to time will depend upon regulatory conditions, our future operating performance, the availability of credit generally, economic conditions and financial, business and other factors, many of which are beyond our control. The market conditions and the macroeconomic conditions that affect our industry could have a material adverse effect on our ability to secure third-party financing on favorable terms, if at all. If third-party financing is not available when needed, or is available on unfavorable terms, we may be unable to take advantage of business opportunities, respond to competitive pressures or refinance our outstanding indebtedness, any of | Ambac Financial Group, Inc. 18 2020 FORM 10-K | Table of Co ntents which could have a material adverse effect on our business, financial condition and results of operations. AAC may in the future report a policyholders’ deficit or become insolvent. While the Rehabilitation Exit Transactions and related transactions were designed to improve our financial condition, we will continue to be subject to risks and uncertainties that could materially affect our financial position, including those relating to our exposures in Puerto Rico, our efforts to recover losses on insured RMBS through litigation, and other risks described in the Risk Factors set forth in this Item 1A. Therefore, even following consummation of the Rehabilitation Exit Transactions, circumstances may occur that would cause AAC to report a policyholders’ deficit, not comply with the statutory minimum policyholders’ surplus, undergo rehabilitation and/or become insolvent. The determination of the amount of credit impairments taken on our investments is highly subjective and could materially impact our results of operations or financial position. The determination of the amount of credit impairments on our investments varies by investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in impairments as such evaluations are revised. There can be no assurance that management has accurately assessed the level of impairments taken in our financial statements. Furthermore, additional impairments may need to be taken in the future and historical trends may not be indicative of future impairments. We use financial models and tools to project impairments. Differences and flaws in these models and tools, and/or faulty assumptions inherent in these models and tools and those determined by management, could lead to increased impairments. Risks Related to the Financial and Credit Markets Changes in prevailing interest rate levels and market conditions could adversely impact our business results and prospects. Increases in prevailing interest rate levels can adversely affect the value of our investment portfolio and, therefore, our financial strength. In the event that investments must be sold in order to pay claims, to pay debt obligations, to meet collateral posting requirements or to meet other liquidity needs, such investments would likely be sold at discounted prices. Additionally, increasing interest rates would have an adverse impact on our insured portfolio. For example, increasing interest rates could result in higher claim payments in respect of defaulted obligations that bear floating rates of interest. Higher interest rates can also lead to increased credit stress on consumer asset-backed transactions (as the securitized assets supporting a portion of these exposures are floating rate consumer obligations), slower prepayment speeds and resulting “extension risk” relative to such consumer asset-backed transactions in our insured and investment portfolios, and decreased refinancing activity. Decreasing interest rates could result in early terminations of financial guarantee insurance policies in respect of which we are paid on an installment basis and do not receive a termination premium, thus reducing premium earned for these transactions. Decreases in prevailing interest rates may also limit growth of, or reduce, investment income and may adversely impact our interest rate swap portfolio. Our investment portfolio may also be adversely affected by credit rating downgrades, ABS and RMBS prepayment speeds, foreign exchange movements, spread volatility, and credit losses. We are subject to credit risk throughout our businesses, including large single risks, risk concentrations, correlated risks and reinsurance counterparty credit risk. We are exposed to the risk that issuers of debt which we have insured, issuers of debt which we hold in our investment portfolio, reinsurers and other contract counterparties (including derivative counterparties) may default in their financial obligations, whether as the result of insolvency, lack of liquidity, operational failure, fraud or other reasons. These credit risks could cause increased losses and loss reserves, and/or estimates of credit impairments and mark-to-market losses with respect to credit derivatives in our financial guarantee business; and we could experience losses and decreases in the value of our investment portfolio and, therefore, our financial strength. Such credit risks may be in the form of large single risk exposures to particular issuers, reinsurers or counterparties; losses caused by catastrophic events (including public health crises, terrorist acts and natural disasters); losses caused by increases in municipal defaults; losses in respect of different, but correlated, credit exposures; or other forms of credit risk. Uncertainties regarding the expected discontinuance of the London Inter-Bank Offered Rate or any other interest rate benchmark could have adverse consequences. In 2017, the U.K. Financial Conduct Authority (“FCA”), which regulates the London Interbank Offered Rate ("LIBOR"), announced that it will no longer persuade or compel banks to submit rates for the calculation of LIBOR after 2021. On November 30, 2020, the ICE Benchmark Administration and the FCA announced that most tenors of USD LIBOR are now expected to be published only through June 2023. However, Non-USD LIBOR, certain less common tenors of USD-LIBOR and certain other indices which are utilized as benchmarks are not expected to be published after 2021. AAC and Ambac UK insure securities, own assets, are party to certain derivative contracts and have issued debt and other obligations that reference LIBOR. While regulators and market participants have suggested substitute benchmark rates for LIBOR, such as the Secured Overnight Financing Rate, the impact of the discontinuance and replacement of LIBOR is uncertain. It is not currently possible to know with certainty whether LIBOR will continue to be viewed as an acceptable benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views and alternatives may have on the financial markets for LIBOR-linked financial instruments for the periods preceding and following LIBOR's cessation. Differences in contractual provisions of certain legacy assets and liabilities and other factors, may cause the consequences of the discontinuance of LIBOR to vary by instrument. Legislation has been introduced in both the UK and the United States, including | Ambac Financial Group, Inc. 19 2020 FORM 10-K | Table of Co ntents at the New York State level, to address issues with respect to legacy LIBOR-linked assets and liabilities, however it is unclear whether these initiatives will be passed and if so, whether they will fully address the issues associated with legacy transactions. As a result, the value of our assets, derivatives and liabilities; costs to operate our business; and the losses associated with our insured portfolio may be affected in a way that may ultimately materially adversely impact Ambac’s results of operations and financial condition. In addition, Ambac may experience adverse tax and accounting impacts, system and model disruption, and increased liquidity demands in connection with the transition away from LIBOR that may have adverse operational consequences resulting in further adverse impacts on Ambac’s results of operations and financial condition. Ambac continues to actively monitor developments surrounding the transition from LIBOR-based indices and evaluate the potential impact. In addition to reviewing several hundred transactions involving various LIBOR-based indices, Ambac has made, or is in the process of making, adjustments to its reporting and analytical infrastructures to facilitate the transition from LIBOR. Risks Related to the Company's Business We are subject to the risk of litigation and regulatory inquiries or investigations, and the outcome of proceedings we are or may become involved in could have a material adverse effect on our business, operations, financial position, profitability or cash flows. AAC is defending or otherwise involved in various lawsuits relating to its financial guarantee business. In addition, the Company from time to time receives various regulatory inquiries and requests for information. Please see Note 17. Commitments and Contingencies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for information on these various proceedings. It is not possible to predict whether additional suits involving AFG, AAC or one or more other subsidiaries will be filed or whether additional regulatory inquiries or requests for information will be made, and it is also not possible to predict the outcome of litigation, inquiries or requests for information. It is possible that there could be unfavorable outcomes in these or other proceedings. Management is unable to make a meaningful estimate of the amount or range of loss that could result from unfavorable outcomes or of the expenses that will be incurred in defending these lawsuits. Under some circumstances, adverse results in any such proceedings and/or the incurring of significant litigation expenses could be material to our business, operations, financial position, profitability or cash flows. The Settlement Agreement, Stipulation and Order and Indenture for the Tier 2 Notes contain restrictive covenants that may impair our ability to pursue our business strategies. Pursuant to the terms of the Settlement Agreement, Stipulation and Order and indenture for the Tier 2 Notes, AAC must seek prior approval by OCI of certain corporate actions. The Settlement Agreement, Stipulation and Order and indenture for the Tier 2 Notes also include covenants which restrict the operations of AAC which, (i) in the case of the Settlement Agreement, remain in force until the surplus notes that were issued pursuant to the Settlement Agreement have been redeemed, repurchased or repaid in full, (ii) in the case of the Stipulation and Order, remain in place until the OCI decides to relax such restrictions, and (iii) in the case of the indenture for the Tier 2 Notes, remain in force until the Tier 2 Notes have been redeemed, repurchased or repaid in full. Certain of these restrictions may be waived with the approval of holders of the applicable debt securities and/or OCI. If we are unable to obtain the required consents under the Settlement Agreement, the Stipulation and Order and/or the indenture for the Tier 2 Notes, we may not be able to execute our planned business strategies. OCI has certain enforcement rights with respect to the Settlement Agreement and Stipulation and Order. Disputes may arise over the interpretation of such agreements, the exercise or purported exercise of rights thereunder, or the performance of or failure or purported failure to perform obligations thereunder. Any such dispute could have material adverse effects on the Company, whether through litigation, administrative proceedings, supervisory orders, failure to execute transactions sought by management, interference with corporate strategies, objectives or prerogatives, inefficient decision-making or execution, forced realignment of resources, increased costs, distractions to management, strained working relationships or otherwise. Such effects would also increase the risk that OCI would seek to initiate rehabilitation proceedings against AAC. Impairment of the intangible and goodwill assets, which resulted from the acquisition of Xchange, could adversely affect our results of operations. In connection with Ambac’s acquisition of 80% of the membership interests of Xchange, Ambac recorded the fair value of identifiable intangible assets (primarily related to distribution relationships) and goodwill. The intangible assets will be amortized over their useful lives (weighted average of 14 years). The Company will test intangible assets for impairment if certain events occur or circumstances change indicating that the carrying amount of the intangible asset may not be recoverable. Goodwill reflects the excess purchase consideration over net assets acquired and will be tested for impairment annually or whenever events occur or circumstances change that may indicate impairment. Intangible asset and goodwill impairments are driven by a variety of factors, which could include, among other things, declining future cash flows of the acquired business as addressed in other risk factors related to the Managing General Underwriting Business. Any intangible asset or goodwill impairment could adversely affect the Company's operating results and financial condition. System security risks, data protection breaches and cyber-attacks could adversely affect our business and results of operations. We rely on our information technology systems for many enterprise-critical functions and a prolonged failure or interruption of these systems for any reason could cause significant disruption to our operations and have a material adverse effect on our business, financial condition and operating results. Our information technology and application systems may be vulnerable to threats from computer viruses, natural disasters, unauthorized access, cyber-attack and other similar disruptions. Computer hackers may be able to penetrate our network’s system security and misappropriate or compromise confidential information, create system disruptions or cause shutdowns. In addition to our own confidential information, we sometimes receive and are required to protect confidential information obtained from third parties and personally | Ambac Financial Group, Inc. 20 2020 FORM 10-K | Table of Co ntents identifiable information of individuals. To the extent any disruption or security breach results in a loss or damage to our data, or inappropriate disclosure of our confidential information or that of others, or personally identifiable information of individuals, it could cause significant financial losses that are either not, or not fully, insured against, cause damage to our reputation, affect our relationships with third parties, lead to claims against us, result in regulatory action, or otherwise have a material adverse effect on our business or results of operations. In addition, we may be required to incur significant costs to mitigate the damage caused by any security breach, or to protect against future damage. Moreover, although we have disaster recovery and business continuity plans in place, we may not be able to adequately execute these plans in a timely fashion in the event of a disruption to our information technology and application systems. We may be adversely affected by failures in services or products provided by third parties. We have outsourced and may continue to outsource certain activities of our operations and business, and rely upon third-party vendors for other essential services and information, such as the provision of data used in setting loss reserves and the provision of risk management information and services. A material failure by an external service or information provider or a material defect in the products, services or information provided thereby could adversely affect our financial condition and results of operations. Our inability to attract and retain qualified executives and employees or the loss of any of these personnel could negatively impact our business. Our ability to execute on our business strategies depends on the retention and recruitment of qualified executives and other professionals. We rely substantially upon the services of our current executive team. In addition to these officers, we require key staff with risk mitigation, structured finance, insurance, credit, investment, accounting, finance, legal and technical skills. As a result of Ambac’s financial situation, there is a higher risk that executive officers and other key staff will leave the Company and replacements may not be motivated to join the Company. The loss of the services of members of our senior management team or our inability to hire and retain other talented personnel could delay or prevent us from succeeding in executing our strategies, which could further negatively impact our business. Our business could be negatively affected by actions of stakeholders whose interests may not be aligned with the broader interests of our stockholders. Ambac could be negatively affected as a result of actions by stakeholders whose interests may not be aligned with the broader interests of our stockholders, and responding to any such actions could be costly and time-consuming, disrupt operations and divert the attention of management and employees. Such activities could interfere with our ability to execute on our strategic plans. Risks Related to International Business Actions of the PRA and FCA could reduce the value of Ambac UK realizable by AAC, which would adversely affect our securityholders. Ambac’s international business is operated by Ambac UK, which is regulated by the Prudential Regulation Authority (“PRA”) for prudential purposes and the Financial Conduct Authority (“FCA”) for conduct purposes. The terms of Ambac UK’s regulatory authority are now restricted and Ambac UK is in run-off. Among other things, Ambac UK may not write any new business, and, with respect to any entity within the Ambac group of affiliates, commute, vary or terminate any existing financial guaranty policy, transfer certain assets, or pay dividends, without the prior approval of the PRA and FCA. The PRA and FCA act generally in the interests of Ambac UK policyholders and will not take into account the interests of securityholders of Ambac when considering whether to provide any such approval. Accordingly, determinations made by the PRA and FCA, in their capacity as Ambac UK’s regulators, could potentially result in adverse consequences for our securityholders and also reduce the value realizable by AAC for Ambac UK. Regulatory uncertainty in relation to Ambac UK’s capital position could adversely affect the value of Ambac UK and affect our securityholders. Under applicable regulatory capital rules (“Solvency II”) Ambac UK remains deficient in terms of capital. Ambac UK does not have a remedial plan other than to build its assets over time by on-going premium collections and earned investment income, as well as attempting to accelerate the run-off of its exposures. Further, there currently is no prospect of any capital support from the Ambac group of affiliates. The PRA is aware of Ambac UK’s position and prospects. The PRA supervisory statement SS7/15 “Supervision of firms in difficulty or run-off” notes that “there are many circumstances in which a run-off strategy is in the best interests of policyholders” and notes that the PRA will review such firms and that they “may be permitted to continue activities necessary to carry out existing contracts in a manner, and for so long as, the PRA considers necessary in order to afford an appropriate degree of protection to policyholders”. Ambac UK clearly falls into this category and therefore Ambac UK’s current run-off approach remains at all times subject to the PRA continuing to take no action in relation to its capital deficit and related Solvency II requirements. Alternative courses of action open to the PRA could adversely impact the anticipated run-off trajectory of Ambac UK and impact its value. Risks Related to Taxation Surplus notes received in the AMPS Exchange and by holders of Deferred Amounts pursuant to the Second Amended Plan of Rehabilitation along with other debt reissued by Ambac may not be fungible for U.S. federal income tax purposes with other surplus notes and debt currently outstanding. Surplus notes received in the AMPS Exchange and by holders of Deferred Amounts pursuant to the Second Amended Plan of Rehabilitation along with other debt reissued by Ambac (together "Reissued Debt") have different issue prices for U.S. federal income tax purposes than the originally issued | Ambac Financial Group, Inc. 21 2020 FORM 10-K | Table of Co ntents outstanding surplus notes and other debt and, therefore, are expected to accrue original issue discount (“OID”) in an amount that differs from the amounts of OID accruing on the originally issued surplus notes and other debt currently outstanding, as the case may be. Therefore, Reissued Debt may not be fungible with the other outstanding surplus notes and debt, as applicable, for U.S. federal income tax purposes. Because Reissued Debt has the same CUSIP numbers as other related surplus notes and debt currently outstanding, the Reissued Debt will not be readily distinguishable from the other outstanding surplus notes and debt, as applicable. This could create uncertainty in the market and could adversely affect the liquidity and/or trading values of surplus notes and other debt. Certain surplus notes or other obligations of AAC may be characterized as equity of AAC and as a result, AAC may no longer be a member of the U.S. federal income tax consolidated group of which AFG is the common parent. It is possible that certain surplus notes or other obligations of AAC may be characterized as equity of AAC for U.S. federal income tax purposes. If such surplus notes or other obligations are characterized as equity of AAC that is taken into account for tax affiliation purposes and it is determined that such “equity” represented more than twenty percent of the total value of the stock of AAC, AAC may no longer be characterized as an includable corporation that is affiliated with AFG. As a result, AAC would no longer be characterized as a member of the U.S. federal income tax consolidated group of which AFG is the common parent (the “Ambac Consolidated Group”) and AAC would be required to file a separate consolidated tax return as the common parent of a new U.S. federal income tax consolidated group including AAC as the new common parent and AAC’s affiliated subsidiaries (the “AAC Consolidated Tax Group”). To the extent AAC is no longer a member of the Ambac Consolidated Group, AAC’s net operating loss carry-forwards ("NOLs") (and certain other available tax attributes of AAC and the other members of the AAC Consolidated Tax Group) may no longer be available for use by the AAC Consolidated Tax Group or any of the remaining members of the AAC Consolidated Tax Group to reduce the U.S. federal income tax liabilities of the AAC Consolidated Tax Group. AFG, AAC and their affiliates entered into a tax sharing agreement that would require AFG to make certain tax elections that could mitigate the loss of NOLs and other tax attributes resulting from a deconsolidation of AAC from the Ambac Consolidated Group. However, in the event of a deconsolidation, certain other benefits resulting from U.S. federal income tax consolidation may no longer be available to the Ambac Consolidated Group, including certain favorable rules relating to transactions occurring between members of the Ambac Consolidated Group and members of the AAC Consolidated Tax Group. If surplus notes or other obligations are characterized as equity of AAC, the AAC NOLs (and certain other tax attributes or tax benefits of the Ambac Consolidated Group) may be subject to limitation under Section 382 of the Tax Code. It is possible that certain surplus notes or other obligations may be characterized as equity of AAC for U.S. federal income tax purposes. Such characterization could result in an “ownership change” of AAC for purposes of Section 382 of the Tax Code. If such an ownership change were to occur, the value and amount of the AAC NOLs would be substantially impaired, increasing the U.S. federal income tax liability of AAC and materially reducing the value of AAC’s stock owned by AFG and the potential for future dividend payments from AAC to AFG. Deductions with respect to interest accruing on certain surplus notes may be eliminated or deferred until payment. To the extent certain surplus notes are characterized as equity for U.S. federal income tax purposes, accrued interest will not be deductible by AAC. In addition, even if such surplus notes are characterized as debt for U.S. federal income tax purposes, the deduction of interest accruing on such surplus notes may be deferred until paid or eliminated in part depending upon (i) the terms of any deferral and payment provisions provided in such surplus notes, (ii) whether such surplus notes have “significant original issue discount,” and (iii) the yield to maturity of surplus notes. To the extent deductions with respect to interest are eliminated or deferred, the U.S. federal income tax of the members of the Ambac Consolidated Group or the members of the AAC Consolidated Tax Group as the case may be, could be increased reducing the amount of cash available to pay its obligations. Risks Related to Strategic Plan Ambac is planning to further develop and expand the Specialty Property and Casualty Program Insurance business and the Managing General Agency/Underwriting business, which may permit utilization of Ambac’s net operating loss carry-forwards; however, such plans may not be realized, or if realized, may not create value and may negatively impact our financial results. Ambac is planning to further develop and expand the Specialty Property and Casualty Program Insurance Business and the Managing General Agency/Underwriting business which may, amongst other things, permit utilization of its net operating loss carry-forwards. Such plans may involve additional acquisitions of assets or existing businesses and the development of businesses through new or existing subsidiaries. It is not possible at this time to fully predict the future prospects or other characteristics of such businesses. Although we intend to conduct business, financial and legal due diligence in connection with the evaluation of any future business or acquisition opportunities, there can be no assurance our due diligence investigations will identify every matter that could have a material adverse effect on us. Efforts to pursue certain business opportunities may be unsuccessful or require significant financial or other resources, which could have a negative impact on our operating results and financial condition. No assurance can be given that Ambac will be able to successfully execute its plans for new business, generate any earnings from new businesses or be able to successfully integrate any such business into our current operating structure. Moreover, Ambac’s ability to enter into new businesses apart from AAC is subject to some doubt, given the financial condition of AAC, counterparty or rating agency concerns about our ability to mitigate insured portfolio losses or recover losses in litigation, the difficulty of leveraging or monetizing Ambac’s other assets, and the uncertainty of its ability to raise capital. Due to these factors, as well as those relating to AAC as | Ambac Financial Group, Inc. 22 2020 FORM 10-K | Table of Co ntents described in this Item 1A. Risk Factors, the value of our securities is speculative. Ambac’s current strategy and initiatives have been derived from, and created as a consequence of, the Company’s current financial condition and circumstances. Should changes in Ambac’s circumstances or financial condition or in the political, economic and/or legal environment occur, there can be no assurance that all or any part of such strategy and/or initiatives will not be abandoned or amended to take account of such changes. Any such adjustment or abandonment may have an adverse effect on our securities. Risks Related to the Managing General Underwriting Business Xchange derives a significant portion of its commission revenues from a limited number of insurance companies, the loss of any of which could result in lower commissions or loss of business production. For the year ended December 31, 2020, a majority of Xchange’s total commissions was derived from insurance policies underwritten by a limited number of insurance companies. Should one or more of these insurance companies terminate its arrangements with Xchange or otherwise decrease the number of insurance policies underwritten for it, Xchange may lose significant commission revenues or lose significant business production while it seeks other insurance companies to underwrite the business. Xchange’s business, results of operation, financial condition and liquidity may be materially adversely affected by certain potential claims, regulatory actions or proceedings. Xchange is subject to various potential claims, regulatory actions and other proceedings, including those relating to alleged errors and omissions in connection with the placement or servicing of insurance and/or the provision of services in the ordinary course of business, of which we cannot, and likely will not be able to, predict the outcome with certainty. Because Xchange often assists customers with matters involving substantial amounts of money, including the placement of insurance and the handling of related claims that customers may assert, errors and omissions, claims against it may arise alleging potential liability for all or part of the amounts in question. Also, the failure of an insurer with whom Xchange places business could result in errors and omissions claims against it by its customers, which could adversely affect Ambac’s results of operations and financial condition. Claimants may seek large damage awards, and these claims may involve potentially significant legal costs and damages. In addition, regardless of monetary costs, these matters could have a material adverse effect on Xchange's reputation and cause harm to its carrier, customer or employee relationships, or divert personnel and management resources. Xchange’s current market share may decrease because of disintermediation within the insurance industry, including increased competition from insurance companies, technology companies and the financial services industry, as well as the shift away from traditional insurance markets. The MGU business is highly competitive and Xchange actively competes with numerous firms for customers and insurance companies, many of which have relationships with insurance companies or have a significant presence in niche insurance markets that may give them an advantage over it. Other competitive concerns may include the quality of Xchange’s products and services, its pricing and the entrance of technology companies into the MGU business. A number of insurance companies are engaged in the direct sale of insurance and do not pay commissions to agents and brokers. In addition, and to the extent that banks, securities firms, private equity funds, and insurance companies affiliate, the financial services industry may experience further consolidation, and Xchange therefore may experience increased competition from insurance companies and the financial services industry, as a growing number of larger financial institutions increasingly, and aggressively, offer a wider variety of financial services, including MGU services. While Xchange collaborates and competes in these segments on a fee-for-service basis, we cannot be certain that such alternative markets will provide the same level of insurance coverage or profitability as traditional insurance markets. Changes in law or in the functioning of the healthcare market could significantly impair Xchange’s business and therefore negatively impact Ambac’s financial condition and results of operation. Adoption of a single payer healthcare system or a public health insurance option would likely adversely impact the entire healthcare industry. While Xchange has historically demonstrated an ability to adjust its products to major changes in the healthcare industry, given its focus on A&H products, Xchange would likely be adversely impacted by such a material change in the U.S. healthcare system particularly if private health insurance is eliminated, materially limited, or is rendered noncompetitive. Material adverse developments to Xchange's business would have a negative impact on Ambac's financial condition and results of operations which could be material. Xchange’s business and results of operation and financial condition may be adversely affected by conditions that result in reduced insurer capacity. Xchange’s results of operations depend on the continued capacity of insurance carriers to underwrite risk and provide coverage, which depends in turn on those insurance companies’ ability to procure reinsurance. Capacity could also be reduced by insurance companies failing or withdrawing from writing certain coverages that Xchange offers to its customers. Xchange has no control over these matters. To the extent that reinsurance becomes less widely available or significantly more expensive, Xchange may not be able to procure the amount or types of coverage that its customers desire and the coverage Xchange is able to procure for its customers may be more expensive or limited. Variations in Xchange’s commissions that result from the timing of policy renewals and the net effect of new and lost business production may have unexpected effects on our results of operation. Xchange’s commission income can vary quarterly or annually due to the timing of policy renewals and the net effect of new and lost business production. Xchange does not control the factors that cause these variations. Specifically, customers’ demand for insurance products can influence the timing of | Ambac Financial Group, Inc. 23 2020 FORM 10-K | Table of Co ntents renewals, new business and lost business (which includes policies that are not renewed), and cancellations. Quarterly and annual fluctuations in revenues based upon increases and decreases associated with the timing of new business, policy renewals and payments from insurance companies may adversely affect our financial condition, results of operations and cash flows. Profit-sharing contingent commissions are paid by insurance companies based upon the profitability of the business placed with such companies. In the past these commissions have accounted for a material amount of Xchange’s total commissions and fees. Due to, among other things, the inherent uncertainty of loss in Xchange’s industry and changes in underwriting criteria by insurance companies, there will be a level of uncertainty related to the payment of profit-sharing contingent commissions. Item 1B. Unresolved Staff Comments — No matters require disclosure. Item 2. Properties The executive office of Ambac is located at One World Trade Center, New York, New York 10007, and consists of 46,927 square feet of office space, under a sublease agreement that expires in January 2030. Ambac continues to hold a lease at One State Street Plaza that expires in December 2029 (25,871 square feet). Ambac has sublet this space through its expiration date. During 2020, Ambac leased additional office space in New Jersey that expires in May 2021. Additionally, Ambac maintains a disaster recovery site as part of its Disaster Recovery Plan under a lease that expires in March 2024. This remote warm-back-up facility is capable of serving the needs of the disaster recovery team to support all business operations. Ambac UK maintains an office in London, England, which consists of 3,514 square feet of office space, under a lease agreement that expires in October 2025. Xchange maintains office space in (i) Armonk, NY which consists of 2,754 square feet under a lease agreement that expires in July 2028 and (ii) Indianapolis, IN which consists of 3,678 square feet under a lease agreement that expires in March 2024. Item 3. Legal Proceedings Refer to Notes to the Consolidated Financial Statements—Note 17. Commitments and Contingencies included in Part II, Item 8 in this Form 10-K for a discussion on legal proceedings against Ambac. Item 4. Mine Safety Disclosures — Not applicable. PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Market Information On February 3, 2020, the Company 's common stock and warrants began trading on the NYSE under the symbol “AMBC" and "AMBC WS," respectively. Prior to being listed on the NYSE, the Company's common stock and warrants were listed on NASDAQ under the symbols “AMBC” and "AMBCW," respectively. Holders On February 26, 2021, there were 20 stockholders of record of AFG’s common stock and 60 holders of record of AFG's warrants. Dividends The Company did not pay cash dividends on its common stock during 2020 and 2019. Information concerning restrictions on the payment of dividends from Ambac's insurance subsidiaries is set forth in Item 1 above under the caption “Dividend Restrictions, Including Contractual Restrictions" and in Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. Purchases of Equity Securities By the Issuer and Affiliated Purchasers There were no repurchases of equity securities during the fourth quarter of 2020. Ambac does not have a stock repurchase program. Warrants Each warrant represents the right to purchase one share of AFG common stock. The warrants are exercisable for cash at any time on or prior to April 30, 2023 at an exercise price of $16.67 per share. The warrants also have a cashless exercise provision. On June 30, 2015, the Board of Directors of AFG authorized the establishment of a warrant repurchase program that permits the repurchase of up to $10 million of warrants. On November 3, 2016, the Board of Directors of AFG authorized an additional $10 million to the warrant repurchase program. AFG repurchased 985,331 warrants at a cost of $8.1 million and then reissued 824,307 of the repurchased warrants on August 3, 2018 in connection with the AMPS Exchange (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K). The remaining aggregate authorization at December 31, 2020 is $11.9 million. Refer to Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of the AMPS Exchange. Ambac currently has 4,877,749 warrants outstanding. | Ambac Financial Group, Inc. 24 2020 FORM 10-K | Table of Co ntents Stock Performance Graph The following graph compares the performance of an investment in our common stock from the close of business on December 31, 2015 through December 31, 2020, with the Russell 2000 Index and S&P Completion Index. The graph assumes $100 was invested on December 31, 2015 in our common Stock at the closing price of $14.09 per share and at the closing price for the Russell 2000 Index and S&P Completion Index. It also assumes that dividends (if any) were reinvested on the date of payment without payment of any commissions. The performance shown in the graph represents past performance and should not be considered an indication of future performance. ` December 31, 2015 2016 2017 2018 2019 2020 Ambac Financial Group, Inc. $100 $160 $113 $122 $153 $109 Russell 2000 Index $100 $120 $136 $119 $148 $175 S&P Completion Index $100 $114 $133 $119 $150 $195 | Ambac Financial Group, Inc. 25 2020 FORM 10-K | Table of Co ntents Item 6. Selected Financial Data The following financial information for the five years ended December 31, 2020, has been derived from Ambac’s Consolidated Financial Statements. This information should be read in conjunction with the Consolidated Financial Statements and related notes located in Part II, Item 8 in this Form 10-K. Year Ended December 31, ($ in millions, except per share data) 2020 2019 2018 2017 2016 Total Comprehensive Income (Loss) Highlights: Gross premiums written $ (1) $ (28) $ (24) $ (14) $ (54) Net premiums earned 54 66 111 175 197 Net investment income (2) 122 227 273 361 313 Net realized investment gains 22 81 108 $ (15) 17 Net gains (losses) on derivative contracts (50) (50) 7 76 (30) Net realized (losses) gains on extinguishment of debt (2) — — 3 5 5 Income (loss) on Variable Interest Entities ("VIEs") 5 38 3 20 (14) Other income (3) 3 134 5 — 18 Losses and loss expenses (benefit) (1) (2) 225 13 (224) 513 (11) Operating expenses (2) 92 103 112 122 114 Interest expense (2) 222 269 242 120 124 Insurance intangible amortization 57 295 107 151 175 Pre-tax income (loss) (440) (183) 273 (284) 105 Net income (loss) (437) (216) 267 (329) 74 Net income (loss) attributable to Common Shareholders (437) (216) 186 (329) 75 Total comprehensive income attributable to Ambac Financial Group, Inc. (400) (125) 192 (335) 21 Net income (loss) per share: Basic $ (9.47) $ (4.69) $ 4.07 $ (7.25) $ 1.66 Diluted $ (9.47) $ (4.69) $ 3.99 $ (7.25) $ 1.64 (1) Ambac records the impact of estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties within losses and loss expenses (benefit). The expense (benefit) associated with changes to our estimated recoveries for the years ended December 31, 2020, 2019, 2018, 2017 and 2016 were $(23), $42, $62, $72, and $(71), respectively. (2) On February 12, 2018, AAC executed the Rehabilitation Exit Transactions (as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K). These transactions directly resulted in: (i) a Loss and loss expense benefit of $288; (ii) operating expenses of $17 and (iii) realized gains on extinguishment of debt of $3. Additionally, changes to the investment portfolio and to the composition of long-term debt arising from the transactions significantly impacted net investment income and interest expense for 2018 compared to prior years. Refer to Results of Operations included in Item 7 of this Form 10-K for a further discussion of the Rehabilitation Exit Transactions and their impact on financial results in 2018. (3) Other income also includes proceeds received by AAC in September 2019 in connection with an SEC action against Citigroup Global Markets Inc. in the amount of $142. Refer to Note 17. Commitments and Contingencies located in Part II Item 8 in this Form 10-K for further details on the SEC action. | Ambac Financial Group, Inc. 26 2020 FORM 10-K | Table of Co ntents ($ in millions) December 31 2020 2019 2018 2017 2016 Balance Sheet Highlights: Total non-variable interest entity investments $ 3,544 $ 3,792 $ 3,937 $ 5,741 $ 6,500 Cash and cash equivalents 20 24 63 624 91 Premium receivable 370 416 495 586 661 Insurance intangible asset 409 427 719 847 962 Subrogation recoverable (1) 2,156 2,029 1,933 631 685 Deferred ceded premium 70 82 61 52 70 Total VIE assets 6,398 6,286 7,093 14,501 13,368 Total assets 13,220 13,320 14,589 23,192 22,636 Unearned premiums 456 518 630 783 967 Loss and loss expense reserves (1) 1,759 1,548 1,826 4,745 4,381 Long-term debt (2) 2,739 2,822 2,929 992 1,114 Derivative liabilities 114 90 77 83 319 Total VIE liabilities 6,328 6,212 6,981 14,366 13,235 Total liabilities 12,074 11,783 12,956 21,547 20,658 Total stockholders’ equity 1,140 1,536 1,633 1,645 1,978 Total liabilities and stockholders' equity $ 13,220 $ 13,320 $ 14,589 $ 23,192 $ 22,636 (1) Ambac records as a component of its loss reserves and subrogation recoverable, estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties ("R&W"). Ambac has recorded gross estimated R&W recoveries of $1,751, $1,727, $1,771, $1,834, and $1,907 at December 31, 2020, 2019, 2018, 2017 and 2016, respectively. (2) Long-term debt includes AAC surplus notes and junior surplus notes, the Ambac Note and Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions in 2018 and the Ambac UK debt issued in connection with the Ballantyne commutation in 2019. Long-term debt for all years excludes the portion of long-term debt associated with variable interest entities. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains certain financial measures, in particular the presentation of Adjusted Earnings and Adjusted Book Value, which are not presented in accordance with accounting principles generally accepted in the United States (“GAAP”). We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying drivers of our business. We do not intend for these non-GAAP financial measures to be a substitute for any GAAP financial measures and they may differ from similar reporting provided by other companies. Readers of this Form 10-K should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. Adjusted Earnings and Adjusted Book Value are non-GAAP financial measures that adjust for the impact of certain non-recurring or non-economic GAAP accounting requirements and include the addition of certain items that the Company has or expects to realize in the future, but that are not reported under GAAP. We provide reconciliations to the most directly comparable GAAP measures; Adjusted Earnings to Net income attributable to common stockholders and Adjusted Book Value to Total Ambac Financial Group, Inc. stockholders’ equity. COMPANY OVERVIEW See Part I, Item 1. "Description of the Business" and Note 1. Background and Business Description for a description of the Company and our key strategies to achieve our primary goal to maximize shareholder value. EXECUTIVE SUMMARY AFG During 2020, Ambac made significant progress in the development of its specialty property and casualty program insurance and managing general agency/underwriting businesses: Specialty Property & Casualty Program Insurance — AFG's activities included the following: • Established Everspan Indemnity Insurance Company, which is eligible under the Non-admitted and Reinsurance Reform Act to write surplus lines in all states, subject to satisfying minimum capital requirements, which were met in first quarter 2021. Everspan Indemnity Insurance Company is seeking to be included on state eligibility lists in numerous states. • Completed the re-domestication of Everspan Insurance Company from Wisconsin to Arizona. Additionally, Everspan Insurance Company recently converted its license in Arizona to write property and casualty insurance and is working on similarly converting its licenses in all other states. Everspan Insurance Company has been repositioned as a subsidiary of Everspan Indemnity Insurance Company, forming the Everspan Group. • Neither company has yet issued any new policies. The Everspan Group platform received an A- Financial Strength | Ambac Financial Group, Inc. 27 2020 FORM 10-K | Table of Co ntents Rating from A.M. Best in February 2021 and is expected to launch new underwriting programs in 2021. Managing General Agency/Underwriting — AFG purchased 80% of Xchange Benefits, LLC and Xchange Affinity Underwriting Agency, LLC (collectively, “Xchange”). Refer to Note 3. Business Combination for further information relating to this acquisition. AFG Net Assets As of December 31, 2020 net assets of AFG, excluding its equity investments in subsidiaries, were $366 million. ($ in millions) Cash and short-term investments $ 236 Other investments (1) 120 Other net assets 10 Total $ 366 (1) Includes surplus notes (fair value of $59 million) issued by AAC that are eliminated in consolidation. AAC and Subsidiaries A key strategy for Ambac is to increase the value of its investment in AAC 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. These strategic cash needs include activities associated with Ambac's liability management and loss mitigation programs. Asset Management Investment portfolios are subject to internal investment guidelines, as well as limits on types and quality of investments imposed by insurance laws and regulations. The investment portfolios of AAC and Ambac UK also hold fixed maturity securities and various pooled investment funds. Refer to Note 11. Investments to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for further details of fixed maturity investments by asset category and pooled investment funds by investment type. At December 31, 2020, Ambac and its subsidiaries owned $621 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 internal and regulatory guidelines, market conditions and other constraints, Ambac may continue to opportunistically purchase or sell Ambac-insured securities. Liability and Insured Exposure Management AAC's Risk Management Group focuses on the implementation and execution of risk reduction, defeasance and loss recovery strategies. Analysts evaluate the estimated timing and severity of projected policy claims as well as the potential impact of loss mitigation or remediation strategies in order to target and prioritize policies, or portions thereof, for commutation, reinsurance, refinancing, restructuring or other risk reduction strategies. For targeted policies, analysts will engage with issuers, bondholders and other economic stakeholders to negotiate, structure and execute such strategies. During 2020, successful risk reduction transactions included: • A commutation in January 2020, via a refunding, of a watch list public finance transaction with net par outstanding of $171 million at December 31, 2019; • A refinancing in February 2020 of an adversely classified asset-backed leasing transaction with net par outstanding of $86 million at December 31, 2019; • Purchasing quota share reinsurance in June 2020 on a transportation revenue credit with net par outstanding of $33 million at December 31, 2019; • A refinancing in August 2020 of an international stadium transaction with net par outstanding of $217 million at December 31, 2019; • A refinancing in November 2020 of an international utility transaction with net par outstanding of $298 million at December 31, 2019; and • Partial commutations of $32 million of adversely classified credits over the course of 2020. AAC's RMG had additional successes in the first quarter of 2021 as follows: • In January 2021, AAC completed the purchase of quota share reinsurance on a portfolio of public finance credits with net par outstanding of approximately $823 million at December 31, 2020. Par ceded included general obligation ($347 million), lease and tax-backed revenue ($234 million), higher education ($161 million) and transportation ($81 million) and included $160 million of watch list and adversely classified credits. • In February 2021, AAC's exposure to an adversely classified stadium transaction was reduced by $540 million through the combination of a refinancing and quota share reinsurance. The following table provides a comparison of total, adversely classified ("ACC") and watch list credit net par outstanding in the insured portfolio at December 31, 2020 and 2019. Net par exposure within the U.S. public finance market includes capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds. ($ in billions) December 31, 2020 2019 Variance Total $ 33,888 $ 38,018 $ (4,130) (11) % ACC $ 8,458 $ 7,535 $ 923 12 % Watch List $ 4,720 $ 6,752 $ (2,032) (30) % 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. This overall decrease in total net par outstanding was partially offset by the weakening of the US Dollar compared to the British Pound and the Euro. The increase in ACC exposures is primarily due to the addition of credits impacted by COVID-19 (including $982 million of net par outstanding from the Watch List category), such as hotel tax, stadium, convention center and public house insured | Ambac Financial Group, Inc. 28 2020 FORM 10-K | Table of Co ntents 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, $2,397 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 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. Refer to Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, Financial Guarantees in Force, in this Annual Report on Form 10-K for additional information regarding the different issuing entities that encompass Ambac's exposures to Puerto Rico. COVID-19 In March 2020, the outbreak of COVID-19, caused by a novel strain of the coronavirus, was recognized as a pandemic by the World Health Organization, and the outbreak is widespread globally, including in the markets in which we operate. The COVID-19 outbreak had, and continues to have, a notable impact on general economic conditions, including but not limited to higher unemployment; 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. In the U.S., significant monetary policy actions, fiscal stimulus measures and other relief measures have helped to moderate the economic impact of COVID-19. These measures include monetary policy decisions, such as quantitative easing, providing liquidity to financial institutions, providing liquidity to credit markets, the Paycheck Protection Program Lending Facility and the Main Street Business Lending Program; Congressional actions, such as the $2.4 trillion Coronavirus Aid, Relief and Economic Security ("CARES") Act, the $483 billion Paycheck Protection Program And Health Care Enactment Act, the $190 billion Families First Coronavirus Response Act, and, most recently, the $920 billion 2021 Consolidated Appropriations Act, which, among other things, provides direct payments to households, support for small businesses, renter assistance and funding for transport, airlines, education and state and local governments. In addition, housing measures, such as forbearance on mortgages and suspension of foreclosures and evictions, and various executive orders have helped to provide relief. Outside of the US, and in the United Kingdom and Italy in particular, where Ambac has insured portfolio exposure, various monetary policy, fiscal stimulus measures and other actions have helped to moderate the economic impact. Nonetheless, the U.S. and many large global economies contracted on a full year basis in 2020. In the U.S., the trajectory and sustainability of the economic recovery experienced in the second half of 2020 is uncertain due to, among other things, the magnitude of job losses, uncertainty regarding further government support measures, the acceleration of new COVID-19 cases and the uncertainty related to the timing of a critical mass of COVID-19 vaccines being provided to the broader population. 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. Ambac has implemented a COVID-19 response plan designed to ensure the safety of our staff and business continuity. Our employees transitioned to working remotely in March 2020 while maintaining full operational capabilities. 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. 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. In the insured portfolio, municipal, mortgage-backed, student loan and other asset securitization exposures could be materially adversely impacted, and as a result, with the exception of the mortgage-backed sector, we increased loss reserves across each of these and other sectors during the year ended December 31, 2020. In the mortgage-backed sector, significantly lower interest rates have increased excess spread levels and largely offset the impact of higher mortgage delinquencies and projected 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 willingness and ability of issuers of insured debt and other counterparties to pay their obligations when due; (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. As a result of the COVID-19 related economic impact on issuers and markets where Ambac provides financial guarantees; including lower tax, project, and business revenues and increases in forbearances or delinquencies on mortgage and student loan payments, we have increased our loss reserves and | Ambac Financial Group, Inc. 29 2020 FORM 10-K | Table of Co ntents may further increase them in the future depending on the duration and severity of the crisis. The crisis may also impair certain issuers' ability to pay premiums owed to Ambac; however, we believe such issuers currently have the ability to continue to pay such premiums timely, but this is subject to change. • Ambac has exposure to reinsurance counterparties for their portions of future claim payments. Ambac has reinsured approximately 13.3% of its gross par outstanding to four reinsurance counterparties. Each of these reinsurance counterparties is experienced in the business of reinsuring and/or writing financial guaranty insurance. All have current ratings of A+ (by S&P) or better and have collateralization or replacement triggers upon downgrade. Ambac actively monitors each of these reinsurance entities and currently believes they have the ability to perform under their respective reinsurance policies, but this is subject to change. • Ambac is exposed to the risk that contractual counterparties (including those under our RMBS litigations and derivative counterparties) may default in their financial obligations, whether as the result of insolvency, lack of liquidity, operational failure, fraud or other reasons. At present, Ambac has no concerns about the ability of our contractual counterparties, which include certain regulated exchanges in the case of interest rate swaps and futures, to perform under their contracts, but this is subject to change. • Asset prices declined substantially during the first quarter, particularly in directly affected industries such as tourism, airlines, hospitality, commercial real estate and manufacturing. While Ambac does not have significant investments in these asset classes, we did experience a negative total return for the investment portfolio of approximately (4.4)% during the three month period ending March 31, 2020. We evaluated the investment portfolio at March 31, 2020, and in subsequent quarters, and have not recognized credit impairments. Over the last three quarters of 2020, we have repositioned the investment portfolio to manage credit risk while improving risk adjusted return, including redeploying capital into new asset categories. Ambac recognized a total return for the investment portfolio of approximately 4.1% for the year ended December 31, 2020 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. Refer to "Financial Guarantees In Force," "Results of Operations" and "Balance Sheet Commentary" for further financial details on the current impact from COVID-19. With regard to Ambac's new business strategic objective, we continue to evaluate opportunities in a disciplined manner. Our evaluation process has been revised to incorporate consideration of the impact of COVID-19 on new business prospects as well as Ambac's existing business and operations. Financial Statement Impact of Foreign Currency The impact of foreign currency as reported in Ambac's Consolidated Statement of Total Comprehensive Income (Loss) for the year ended December 31, 2020 included the following: ($ in millions) Net income (1) $ (1) Gain (losses) on foreign currency translation (net of tax) 23 Unrealized gains (losses) on non-functional currency available-for-sale securities (net of tax) (2) Impact on total comprehensive income (loss) $ 20 (1) A portion of Ambac UK's, and to a lesser extent AAC's, assets and liabilities are denominated in currencies other than its functional currency and accordingly, we recognized net foreign currency transaction gains/(losses) as a result of changes to foreign currency rates through our Consolidated Statement of Total Comprehensive Income (Loss). Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report in Form 10-K for further details on transaction gains and losses. Future changes to currency rates, may adversely affect our financial results. Refer to Part II, Item 7A "Quantitative and Qualitative Disclosures about Market Risk" for further information on the impact of future currency rate changes on Ambac's financial instruments. LIBOR Sunset In July 2017, the Financial Conduct Authority, the authority that regulates LIBOR, announced its intention to stop compelling banks to submit rates for the calculation of LIBOR after 2021. The Alternative Reference Rates Committee (‘ARRC’), a group of private-market participants convened by the Federal Reserve Board and the Federal Reserve Bank of New York to help ensure a successful transition from U.S. dollar LIBOR (‘USD-LIBOR’) to a more robust reference rate, proposed that the Secured Overnight Financing Rate (‘SOFR’) represents the best alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR. ARRC has proposed a transition plan with specific steps and timelines designed to encourage the adoption of SOFR and guide the transition to SOFR from USD-LIBOR. The Finanical Conduct Authority in the United Kingdom and other regulatory bodies have issued statements encouraging cessation of new transactions referencing USD LIBOR after December 31, 2021, while supporting extension of the publication of major USD-LIBOR tenors to mid-2023 to allow additional legacy contracts to mature on their existing terms. Organizations are currently working on industry-wide and company-specific transition plans related to derivatives and cash markets exposed to USD-LIBOR. Similar efforts are underway to identify suitable replacement reference rates for LIBOR in other major currencies. As of December 31, 2020, the Company has exposure to LIBOR in the following areas: (i) the financial guarantee insured portfolio, (ii) the Ambac Note included in long-term debt, (iii) certain invested assets and interest rate derivatives. Ambac has reviewed its financial guarantee portfolio to identify insured transactions that it believes may be vulnerable to the transition from LIBOR. The review focused on insured issues that are scheduled or projected to have an outstanding principal | Ambac Financial Group, Inc. 30 2020 FORM 10-K | Table of Co ntents balance as of December 31, 2021. The Company reviewed the governing documents' provisions for the setting of interest rates in the event of unavailability of LIBOR ("fallback language"). The Company has initiated a dialogue with relevant trustees, calculation agents, auction agents, servicers and other parties responsible for implementing the rate change in these transactions. Most have not yet committed to a course of action. Also, whatever interest rate is set by the party responsible may be challenged in the court by other parties. The Ambac Note is referenced to 3-month LIBOR and has a final maturity of February 12, 2023. Recent developments as summarized above indicate that major LIBOR tenors may continue to be published through the maturity date of the Ambac Note. Ambac's investment and derivative portfolios have been evaluated to assess the risk of LIBOR unavailability based on the respective instruments' fallback language and parties responsible for implementing the alternative rates. Investments that are Ambac-insured securities, are being addressed through efforts on the financial guarantee portfolio described above. For other investments, we are working with our investment managers to ensure LIBOR indexed positions in our portfolio contain unambiguous fallback language. Ambac's centrally cleared interest rate swaps are expected to follow LIBOR transition steps outlined by the International Swaps and Derivatives Association, Inc. ("ISDA"). Our non-cleared interest rate swaps either have offsetting LIBOR exposure with a single counterparty that serves as calculation agent responsible for rate changes or have Ambac as the calculation agent. Given the uncertainty of the ultimate timing of the LIBOR sunset, as well as the lack of clarity on decisions that parties responsible for calculating interest rates will make and the reaction of impacted parties as well as the unknown level of interest rates when the change occurs, the Company cannot at this time predict the impact of the discontinuance of LIBOR, if it occurs, on every obligation the Company guarantees or on its other LIBOR indexed financial instruments. For more information, see the the risk factor " Uncertainties regarding the expected discontinuance of the London Inter-Bank Offered Rate or any other interest rate benchmark could have adverse consequences " found in Part I, Item 1A of this Form 10-K. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Ambac's Consolidated Financial Statements have been prepared in accordance with GAAP. This section highlights accounting estimates management views as critical because they are most important to the portrayal of the Company's financial condition; and require management to make difficult and subjective judgments regarding matters that are inherently uncertain and subject to change. These estimates are evaluated on an on-going basis based on historical developments, political events, market conditions, industry trends and other information. There can be no assurance that actual results will conform to estimates and that reported results of operations will not be materially adversely affected by the need to make future accounting adjustments to reflect changes in these estimates from time to time. Management has identified the following critical accounting policies and estimates: (i) valuation of loss and loss expense reserves, (ii) valuation of certain financial instruments and (iii) valuation of deferred tax assets. Management has discussed each of these critical accounting policies and estimates with the Audit Committee, including the reasons why they are considered critical and how current and anticipated future events impact those determinations. Additional information about these policies can be found in Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. Valuation of Losses and Loss Expense Reserves (including Subrogation Recoverables) The loss and loss expense reserves and subrogation recoverable assets (collectively defined as "loss reserves") discussed in this section relate only to Ambac’s non-derivative insurance policies issued to beneficiaries, including unconsolidated VIEs. A loss reserve is recorded on the balance sheet on a policy-by-policy basis based upon the present value ("PV") of expected net claim cash outflows or expected net recovery cash inflows, discounted at risk-free rates. The estimate for future net cash flows consider the likelihood of all possible outcomes that may occur from missed principal and/or interest payments on the insured obligation. This estimate also considers future recoveries related to breaches of contractual representations and warranties by RMBS transaction sponsors, remediation strategies, excess spread and other contractual or subrogation-related cash flows. Ambac’s approach to resolving disputes involving contractual breaches by transaction sponsors or other third parties has included negotiations and/or pursuing litigation. Ambac does not estimate recoveries for litigations where its sole claim is for fraudulent inducement, since any remedies under such claims would be non-contractual. The evaluation process for expected future net cash flows is subject to certain estimates and judgments regarding the probability of default by the issuer of the insured security, probability of remediation and settlement outcomes (which may include commutation, litigation settlements, refinancings and/or other settlement outcomes), probability of a restructuring outcome (which may include payment moratoriums, debt haircuts and/or subsequent recoveries) and the expected loss severity of credits for each insurance contract. As the probability of default for an individual credit increases and/or the severity of loss given a default increases, our loss reserve for that insured obligation will also increase. Political, economic, credit or other unforeseen events could have an adverse impact on default probabilities and loss severities. The loss reserves for many transactions are derived from the issuer’s creditworthiness. For public finance issuers, loss reserves will consider not only creditworthiness but also political dynamics and economic status and prospects. The loss reserves for transactions which have no direct issuer support, such as most structured finance exposures, including RMBS and student loan exposures, are derived from the default activity and loss given default of underlying collateral supporting the transactions. In addition, many transactions have a combination of issuer/entity and collateral support. Loss reserves reflect our assessment of the transaction’s overall structure, support and expected performance. Loss reserve volatility will be a direct | Ambac Financial Group, Inc. 31 2020 FORM 10-K | Table of Co ntents result of the credit performance of our insured portfolio, including the number, size, bond types and quality of credits included in our loss reserves; our ability to execute workout strategies and commutations; economic and market conditions; and management's judgments with regards to the current performance and future developments within the insured portfolio. The number and severity of credits included in our loss reserves depend to a large extent on transaction specific attributes, but will generally increase during periods of economic stress and decline during periods of economic prosperity. Reinsurance contracts mitigate our loss reserves but since Ambac currently has minimal exposure ceded to reinsurers on credits with loss reserves, the existing reinsurance contracts are unlikely to have a significant effect on loss reserve volatility. Loss reserve volatility will also be materially impacted by changes in interest rates from period to period. The table below indicates the gross par outstanding and gross loss reserves (including loss expenses) related to policies in Ambac’s loss and loss expense reserves at December 31, 2020 and 2019: 2020 2019 ($ in millions) December 31 Gross Par Outstanding (1)(2) Gross Loss and Loss Expense Reserves (1)(3)(4) Gross Par Outstanding (1)(2) Gross Loss and Loss Expense Reserves (1)(3)(4) RMBS $ 2,530 $ (1,446) $ 3,027 $ (1,392) Domestic Public Finance 3,016 724 2,398 627 Student Loans 415 234 472 208 Ambac UK and Other Credits 1,612 23 271 3 Loss expenses — 68 — 73 Totals $ 7,573 $ (397) $ 6,168 $ (482) (1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $739 and $33 respectively, at December 31, 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. (2) 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. (3) Loss and Loss Expense reserves at December 31, 2020 of $(397) are included in the balance sheet in the following line items: Loss and loss expense reserves: $1,759 and Subrogation recoverable: $2,156. Loss and Loss Expense reserves at December 31, 2019 of $(482) are included in the balance sheet in the following line items: Loss and loss expense reserves: $1,548 and Subrogation recoverable: $2,029. (4) Ambac records as a component of its loss and loss expense reserves, estimated recoveries related to securitized loans in RMBS transactions that breached certain representations and warranties. Ambac has recorded gross estimated recoveries of $1,751 and $1,727 at December 31, 2020 and 2019, respectively. See Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for a description of the cash flow and statistical methodologies used to develop loss reserves. Most of our reserved credits with large loss reserves utilize the cash flow method of reserving. Alternative cash flow scenarios are developed to represent the range of possible outcomes and resultant future claim payments and timing. Scenarios and probabilities of each are adjusted regularly to reflect changes in status, outlook and our analysis and views. Significant judgment is used to develop the cash flow assumptions and related probabilities, and there can be no certainty that the scenarios or probabilities will not deviate materially from ultimate outcomes. In some cases, such as RMBS and student loans, cash flow projections include the modeling of an issuer or transaction’s future revenues and expenses to determine the resources available to pay debt service on our insured obligations. With respect to RMBS, a component of our loss reserve estimate includes subrogation recoveries related to securitized loans in such transactions that breached certain representations and warranties ("R&W"). In other cases, such as many public finance exposures including our Puerto Rico exposures, we consider the issuers’ overall ability and willingness to pay, as it relates to the existing fiscal, economic, legal, restructuring and/ or political framework relevant to a particular exposure or group of exposures. We then develop multiple scenarios where issuer debt service is paid, missed and/or haircut with claims paid then modeled for any recovery amount and timing. There is no certainty our assumptions as to scenarios or probabilities will not be subject to material changes as developments occur. In estimating loss reserves, we also incorporate scenarios which represent the potential outcome of remediation strategies. Remediation scenarios may include (i) a potential refinancing of the transaction by the issuer; (ii) the issuer’s ability to redeem outstanding securities at a discount, thereby increasing the structure’s ability to absorb future losses; and (iii) our ability to terminate, restructure or commute the policy in whole or in part. The remediation scenarios and the related probabilities of occurrence vary by policy depending on ongoing and expected discussions and negotiations with issuers and/or investors. In addition to commutation negotiations that are underway with various counterparties in various forms, our reserve estimates may also include scenarios which incorporate our ability and/or expectation to commute additional exposure with other counterparties. Valuation of Certain Financial Instruments The Fair Value Measurement Topic of the ASC requires financial instruments to be classified within a three-level fair | Ambac Financial Group, Inc. 32 2020 FORM 10-K | Table of Co ntents value hierarchy. The fair value hierarchy, the financial instruments classified within each level, our valuation methods, inputs, assumptions and the review and validation procedures over quoted and modeled pricing are further detailed in Note 10. Fair Value Measurements to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. The level of judgment in estimating fair value is largely dependent on the amount of observable market information available to fair value a financial instrument, which is also determinative of where the financial instrument is classified in the fair value hierarchy. Level 3 instruments are valued using models which use one or more significant inputs or value drivers that are unobservable and therefore require significant judgment. Level 3 financial instruments which are material include certain invested assets, uncollateralized interest rate swaps and investments and loan receivables of consolidated VIEs. Model-derived valuations of Level 3 financial instruments incorporate estimates of the effects of Ambac's own credit risk and/or counterparty credit risk, which can be complex and judgmental. Furthermore, Level 3 investments and loan receivables of consolidated VIEs incorporate estimates of Ambac's financial guarantee cash flows, including future premiums and losses. Such cash flow estimates require judgments regarding prepayments of VIE debt, loss probabilities and loss severities, all of which are inherently uncertain. All models and related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based on improvements in information and modeling techniques. The re-evaluation process includes a quarterly meeting of senior Finance and Risk personnel to review and approve changes to models and key assumptions. As a result of the significant judgment for the above-described instruments, the actual trade value of the financial instrument in the market, or exit value of the financial instrument owned by Ambac, may be significantly different from its recorded fair value. Valuation of Deferred Tax Assets Our provision for taxes is based on our income, statutory tax rates and tax planning opportunities available to us in the jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions. We review our tax positions quarterly and adjust the balances as new information becomes available. Deferred tax assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss ("NOL"). More specifically, deferred tax assets represent a future tax benefit that results from losses recorded under GAAP in a current period which are only deductible for tax purposes in future periods and NOL carry forwards. Valuation allowances are established to reduce deferred tax assets to an amount that “more likely than not” will be realized. On a quarterly basis, management identifies and considers all available evidence, both positive and negative, in making the determination with significant weight given to evidence that can be objectively verified. Negative evidence includes the potential for unrecognized future insurance tax losses; cumulative pre-tax losses in recent years; uncertainty regarding timing and magnitude of RMBS R&W litigation recoveries; and no new financial guarantee business. The level of deferred tax asset recognition is influenced by management’s assessment of future expected taxable income, which depends on the existence of sufficient taxable income within the carry forward periods available under the tax law. As a result of the above-described risks and uncertainties associated with future operating results, management believes it is more likely than not that the Company will not generate sufficient taxable income to recover the U.S. deferred tax asset and therefore has a full valuation allowance. To the extent such risks and uncertainties are resolved, Ambac may have the ability to establish a history of making reliable estimates of future income which could ultimately result in a reduction to the deferred tax asset valuation allowance. See Note 14. Income Taxes to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for additional information on the Company's deferred income taxes. FINANCIAL GUARANTEES IN FORCE The following table provides a breakdown of guaranteed net par outstanding by market sector at December 31, 2020 and 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. Guaranteed net par outstanding includes the exposures of policies that insure variable interest entities (“VIEs”) consolidated by Ambac in accordance with the Consolidation Topic of the ASC, Consolidation. Guaranteed net par outstanding excludes the exposures of policies that insure bonds which have been refunded or pre-refunded and the policy that insures the notes issued by Ambac LSNI as defined in Note 1. Background and Business Description to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. ($ in millions) December 31, 2020 2019 Public Finance (1)(2) $ 15,497 $ 17,653 Structured Finance 6,337 7,508 International Finance 12,054 12,857 Total net par outstanding $ 33,888 $ 38,018 (1) Includes $5,575 and $5,654 of Military Housing net par outstanding at December 31, 2020 and 2019, respectively. (2) Includes $1,070 and $1,123 of Puerto Rico net par outstanding at December 31, 2020 and 2019, respectively. Components of Puerto Rico net par outstanding as well as other Public Finance exposures include capital appreciation bonds which are reported at the par amount at the time of issuance of the related insurance policy as opposed to the current accreted value of the bonds. | Ambac Financial Group, Inc. 33 2020 FORM 10-K | Table of Co ntents The table below shows Ambac’s ten largest exposures, by repayment source, as a percentage of total financial guarantee net par outstanding at December 31, 2020 (in millions): ($ in millions) Risk Name Bond Type Ambac Ratings (1) Net Par Outstanding (2) % of Total Net Par Outstanding IF AUK Mitchells & Butlers Finance plc-UK Pub Securitisation UK-Asset Securitizations BBB $ 974 2.9 % IF AUK Capital Hospitals plc (3) UK-Infrastructure A- 903 2.7 % IF AUK Aspire Defence Finance plc UK-Infrastructure A- 870 2.6 % IF AUK Anglian Water UK-Utility A- 853 2.5 % IF AUK National Grid Gas UK-Utility A- 788 2.3 % PF AAC New Jersey Transportation Trust Fund Authority - Transportation System US-Lease and Tax-backed Revenue BBB- 767 2.3 % IF AUK Posillipo Finance II S.r.l Italy-Sub-Sovereign BIG 742 2.2 % IF AUK Ostregion Investmentgesellschaft NR 1 SA (3) Austria-Infrastructure BIG 707 2.1 % IF AUK RMPA Services plc UK-Infrastructure BBB+ 575 1.7 % PF AAC Mets Queens Baseball Stadium Project, NY, Lease Revenue (4) US-Stadium Financing BIG 540 1.6 % Total $ 7,719 22.9 % PF = Public Finance, SF = Structured Finance, IF = International Finance AAC = Ambac Assurance, AUK = Ambac UK (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. BIG denotes credits deemed below investment grade. (2) Net Par 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. (3) A portion of this transaction is insured by an insurance policy issued by AAC. AAC 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") (4) In February 2021, the net par outstanding for this transaction was reduced to zero through the combination of a refinancing and quota share reinsurance. Net par related to the top ten exposures increased $79 million from December 31, 2019. Exposures are impacted by changes in foreign exchange rates, certain indexation rates and scheduled and unscheduled paydowns. The increase from 2019 was primarily related to changes in foreign exchange rates partially offset by scheduled paydowns. The concentration of net par amongst the top ten (as a percentage of net par outstanding) has increased to 23% from 20% at December 31, 2019. 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 December 31, 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 $534 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 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 other 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. CARES Act and Other Relief Measures The $2.4 trillion Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") provides relief and stimulus funds for American consumers, businesses and industries impacted by COVID-19. Other Congressional measures, such as the $483 billion Paycheck Protection Program and Health Care Enhancement Act ("PPE & HCE Act") and the recent $920 billion Consolidated 2021 Appropriations Act have provided additional measures to moderate the impact of COVID-19 on the economy. | Ambac Financial Group, Inc. 34 2020 FORM 10-K | Table of Co ntents The CARES Act together with the PPP & HCE Act and the 2021 Consolidated Appropriations Act have several measures that impacted US municipalities and other borrowers, including consumers, such as mortgage and student loan borrowers, represented in our insured portfolio, including: • A program for direct lending, loans, loan guarantees and investments to eligible businesses, states and municipalities, including to passenger airlines and cargo airlines; • Programs for small business loans; • Business tax breaks, including payroll tax deferral; • Allocations of direct aid to state and local governments to reimburse them for the costs of dealing with COVID-19; • The Public Health and Social Services Fund for distribution of grants to healthcare providers and hospitals; • Grants for transit agencies; • Grants for airport authorities; • Funding for transport, airlines, education, state and local governments, health, vaccines, nutrition; • Emergency jobless benefits; • Renter assistance; and • Direct payments to households and for unemployment insurance. Despite the above provisions, which are designed to help mitigate the economic impact of the COVID-19 pandemic generally, the CARES Act contains certain provisions that may adversely affect Ambac. In March 2020, the CARES Act temporarily suspended payments on all student loans held by the Department of Education through September 30, 2020. The moratorium on payments has twice been extended by executive order and is now set to expire on September 30, 2021. Although the CARES Act provision did not include the private student loans owned by special purpose entities that have their securitized obligations guaranteed by AAC, we have incorporated into our loss reserves analysis assumptions related to increased delinquencies for borrowers with private student loans who often also have federal student loans and have elected not to pay altogether. Despite the assumed increase in delinquencies and losses related to this phenomena as well as the general deterioration in consumer credit related to the economic downturn, AAC does not anticipate making substantial claim payments on insured student loan transactions for several years due to the structures governing the insured bonds. Additionally, the federal government has provided temporary relief measures to which servicers of mortgage loans must adhere. 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 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 AAC. Moreover, several State agencies have issued similar guidance to mortgage loan servicers concerning loan forbearances and other relief for borrowers. 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 AAC'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 through the end of the year, albeit to still elevated levels. The ultimate impact of forbearances and other relief measures, such as foreclosure and eviction moratoriums, on AAC'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 mostly compensate for such adverse effects. In the UK all non-essential leisure, food and retail operations, including public houses were closed from March 20, 2020, as a consequence of the COVID-19 pandemic. Premises were allowed to gradually reopen from June 1, 2020, such that by July 4, 2020, the majority of outlets were permitted to reopen. 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, sales tax reductions, business loan schemes and property tax relief. On January 5, 2021, the UK Government reimposed the closure of non-essential leisure food and retail operations until February 15, 2021, with a gradual opening of venues on regional basis thereafter. The mitigating measures noted above will continue through this period before then being slowly withdrawn by April 30, 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 A deep recession during the first half of 2020 was followed by a moderate recovery in the second half of 2020 that still left the U.S. with an overall contraction in GDP for the full year. Economic growth for 2021, while expected to be positive, is also expected to be tempered by the continued uncertainty related to the elevated infection rate of COVID-19 in the U.S. and the uncertain timing related to achieving a critical mass of COVID-19 vaccinations across the populace. Recovery to 2019 levels of economic output are not expected until late 2021 or early 2022. Consequently, we expect pressure will remain on U.S. states and local governments which are currently facing significant budget strains as tax and other revenues have faltered as a result of COVID-19 related shutdowns, job losses and travel restrictions. In addition states may need to cut aid to local municipalities that are also under pressure from lost revenues. | Ambac Financial Group, Inc. 35 2020 FORM 10-K | Table of Co ntents Monetary policy and federal stimulus through the CARES Act 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. 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. Our near-term concerns are concentrated on exposures substantially reliant on narrow, economically sensitive revenue streams. The ability of issuers of these obligations to pay is expected to be stressed although several issuers expressed a willingness to use their balance sheets to support their obligations and avoid defaults in the near-term. Ambac's insured par outstanding, net of reinsurance ("NPO"), to these Public Finance sectors are as follows at December 31, 2020: ($ in millions) Market / Sector Total NPO Total Debt Service Due Next Twelve Months Stadiums $ 634 $ 42 Toll Roads / Bridges 457 43 Dedicated Tax 358 51 Rail / Mass Transit 311 15 Hotels / Convention Centers 248 43 Higher Education Auxiliary 235 25 Airports 111 22 Total Public Finance $ 2,354 $ 241 The RMBS and student loan insured portfolios are expected to be adversely impacted by the previously mentioned forbearances and the overall state of the U.S. economy which contracted in 2020, and 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. Ambac reduced its exposure to stadiums by $540 million of net par in February 2021. Ambac insured exposure includes a number of international policies where the revenue of the issuer is demand dependent. Such transactions have been impacted by the reduction of revenue due to the COVID-19 pandemic. Ambac and its advisors are working closely with impacted issuers to review their plans and liquidity facilities in light of these events. In connection with these efforts. Ambac's NPO with respect to international demand dependent policies are as follows at December 31, 2020: ($ in millions) Market / Sector Total NPO Total Debt Service Due for Twelve Months Asset Securitizations $ 974 $ 86 Toll Roads / Bridges 768 62 Airports 215 7 Higher Education 178 10 Total $ 2,135 $ 165 At this time, there are significant uncertainties surrounding the ultimate number of claims and scope of damage resulting from this pandemic. Actual losses from these events may vary materially from Ambac's loss and loss expense reserves due to several factors, including the inherent uncertainties in making such determinations and the evolving nature of this pandemic. 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. U.S. Public Finance Insured Portfolio Ambac’s portfolio of U.S. public finance exposures is $15,497 million, representing 46% of Ambac’s net par outstanding as of December 31, 2020, and a 12% reduction from the amount outstanding at December 31, 2019. This reduction in exposure was due to additional reinsurance acquired, restructuring and related commutation transactions, scheduled paydowns, and early terminations (calls, refundings and pre-refundings). While Ambac’s U.S. public finance portfolio consists predominantly of municipal bonds such as general obligation, revenue, and lease and tax-backed obligations of state and local government entities, the portfolio also comprises 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 interests. See Note 7. Financial Guarantees in Force to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for exposures by bond type. Municipal bonds are generally supported directly or indirectly by the issuer’s taxing authority or by public sector fees and assessments which may or may not be specifically pledged. Risk factors in these transactions derive from the municipal issuer, including its fiscal management, politics, and economic position, as well as its ability and willingness to continue to pay its debt service. Municipal bankruptcies and similar proceedings, while still relatively uncommon, have occurred, exposing Ambac to the risk of liquidity claims and ultimate losses if issuers cannot successfully adjust their liabilities without impairing creditors. Not-for-profit transactions are generally supported by the not-for-profit entities’ net revenues and may also include specific pledges, liens and/or mortgages. The entity typically serves a well-defined market and promulgates a public purpose mission. These transactions may afford Ambac contractual protections such as financial covenants and control rights in the event of issuer breaches and defaults. Risk factors in these transactions derive from the creditworthiness of the issuer, including but not limited to, its financial condition, leverage, management, business mix, competitive position, industry and socioeconomic trends, government programs and other factors. Examples of | Ambac Financial Group, Inc. 36 2020 FORM 10-K | Table of Co ntents these types of transactions include not-for-profit hospitals, universities, associations and charities. Public/private transactions are generally structured to achieve their targeted public interest objective without direct support from the public sector. Some examples of this type of financing include affordable housing, private education, privatized military housing and student housing. Protections within these financings provided to Ambac usually include the strength of the financed asset’s essentiality and public purpose and may include financial covenants, collateral and control rights. Risk factors include financial underperformance, event risk and a shift in the asset’s mission or essentiality. One example of this type of financing is U.S. military housing. • Ambac insures approximately $5,575 million net par of privatized military housing debt. The debt was issued to finance the construction and/or renovation of housing units for military personnel and their families on domestic U.S. military bases. Debt service is not directly paid or guaranteed by the U.S. Government. Rather, the bonds are serviced from the cash flow generated in most cases by rental payments deposited by the military directly into lockbox accounts as part of each service personnel’s Basic Allowance for Housing (BAH). In a small number of cases rental payments also come from civilians, including retired service personnel, living on a particular base. Collateral for these transactions includes the BAH payments as well as an interest in the ground lease. Risk factors affecting these transactions include ongoing base essentiality, military deployments, the U.S. government’s commitment to fund the BAH, marketability/attractiveness of the on-base housing units versus off-base housing, construction completion, environmental remediation, utility and other operating costs and housing management. Ambac's exposure to privatized military housing debt is a growing concentration given the long-dated maturity profile of the exposure relative to faster run-off of other parts of Ambac's insured portfolio. As of December 31, 2020, privatized military housing represented approximately 16% of net par outstanding. Puerto Rico 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 $1,070 as of December 31, 2020. Each has its own credit risk profile attributable to, as applicable, discrete revenue sources, direct general obligation pledges and/or general obligation guarantees. COVID-19 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. The island does not appear to be insulated from the fiscal and economic impact COVID-19 has had on U.S. municipalities on the mainland. Net general fund revenue collected from July-November 2020 totaled $4.01 billion, down about $210 million from the $4.22 billion collected during the same period in 2019, according to the Puerto Rico Treasury Department's tax collection reports released in January 2021. Sales and use, corporate income and personal income tax collections have all been adversely impacted to varying degrees by the pandemic. It is unclear if this cumulative underperformance will continue, what this implies for the Commonwealth’s ability to pay debt service, and what 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. economy; • 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; • the receptivity, availability, pace and effectiveness of vaccinations for COVID-19; • changes to supplemental Medicaid funding relief and other federal transfer payments; and • 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 the Commonwealth Fiscal Plan, which purports to incorporate the impact of COVID-19 on the Commonwealth economy, and projects diminished growth, budget surplus, and debt capacity as compared to previous versions of the Commonwealth Fiscal Plan. 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. According to a letter sent January 19, 2021, from the Oversight Board's Executive Director, Natalie Jaresko, to Governor Pedro Pierluisi and legislative leaders, the Oversight Board is aiming to certify an updated Commonwealth Fiscal Plan reflecting new information regarding the Commonwealth’s macroeconomic environment and government revenues and expenditures, as well as the impact of expenses from the anticipated amended Commonwealth Plan of Adjustment. The letter also establishes the timeline for the annual fiscal plan revision process, which would conclude with the Oversight Board certification of the Commonwealth Fiscal Plan by April 23, 2021. No assurances can be given that Ambac's financial condition will not suffer a materially negative impact as an ultimate result of the Commonwealth Fiscal Plan, the Commonwealth Plan of Adjustment, or any future changes or revisions to the Commonwealth Fiscal Plan or future fiscal plans and/or plans of adjustment for Puerto Rico Highways and Transportation Authority ("PRHTA") or other Puerto Rico instrumentalities. Commonwealth Plan of Adjustment On February 9, 2020, the Oversight Board announced it reached an agreement in principle on a plan support agreement (the "Amended PSA") with certain creditors supporting the | Ambac Financial Group, Inc. 37 2020 FORM 10-K | Table of Co ntents restructuring of the Commonwealth's General Obligation ("GO") and Public Building Authority ("PBA") debt. 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, Employees Retirement System (ERS), and other issuers as well as more than $50 billion in pension liabilities. If confirmed, 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 disadvantages claims against the Commonwealth related to certain revenue bonds issued by Puerto Rico instrumentalities, including those insured by AAC, 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. In light of COVID-19 and its impact, and potential future impact, on the Commonwealth, the Oversight Board and the parties to the Amended PSA began negotiating revisions to the Amended PSA without terminating that agreement. Information released publicly regarding these negotiations indicated that proposals considered during the course of such negotiations implied recoveries related to certain revenue bonds insured by AAC below 3.9%. 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. On February 16, 2021, the Court entered an order granting the Oversight Board’s motion to extend the court’s deadline to file a Commonwealth Plan of Adjustment or comprehensive term sheet to March 8, 2021. The Oversight Board's motion disclosed that the Oversight Board reached an agreement in principle regarding the terms of a new plan support agreement (the “Second Amended PSA”) with certain holders of GO Bond Claims and/or CW Guarantee Bond Claims (each as defined in the Second Amended PSA) and holders of PBA Bond Claims (as defined in the Second Amended PSA). The motion also indicated that the requested extension of the deadline to March 8, 2021, will allow the Oversight Board to schedule and conduct additional mediation sessions with parties in interest to increase support for the forthcoming Commonwealth Plan of Adjustment. On February 22, 2021, the Oversight Board, as representative of the Commonwealth of Puerto Rico, PBA, and the Employee Retirement System of the Government of the Commonwealth of Puerto Rico publicly disclosed the Second Amended PSA. Assured Guaranty Corp. and Assured Guaranty Municipal Corp. ("Assured"), Syncora Guarantee Inc., and National Public Finance Guarantee Corporation ("National") have conditionally agreed to the Second Amended PSA. In addition, by a Joint Notice of Termination, dated February 22, 2021, the Amended PSA, dated as of February 9, 2020, was terminated and is of no further force or effect. On February 23, 2021, the Oversight Board announced that the Second Amended PSA had the support of 70% of all GO Bond and PBA Bond claims. In the Second Amended PSA, approximately $18.8 billion of the GO and GO-guaranteed liabilities will be reduced to approximately $7.4 billion, newly issued securities will be GO-only with no inclusion of the COFINA junior lien bonds contemplated within the February 2020 Amended POA, and creditors will accept part of their recovery consideration in the form of a contingent value instrument (“CVI”) that pays out if a portion of the island’s Sales and Use Tax outperforms the projections in the Oversight Board’s Certified Fiscal Plan. The Government of the Commonwealth of Puerto Rico and Ambac Assurance are not currently parties to the Second Amended PSA. Further, the Second Amended PSA provides that Assured and National may terminate their agreement to the Second Amended PSA on or prior to March 31, 2021; until that date, Assured and National are permitted to continue litigation against the Oversight Board with respect to certain revenue bond exposures. If Assured and National do not terminate their agreement by March 31, 2021, the Second Amended PSA requires that Assured and National take no further action with respect to such revenue bond-related litigation. Given that the Oversight Board has stated publicly that it is further amending the Amended POA, including to reflect the terms of the Second Amended PSA, it is not yet clear how the Commonwealth Plan of Adjustment will be modified or how the final adjustments will impact revenues available to the Puerto Rico instrumentalities addressed in the Commonwealth Plan of Adjustment or the recoveries on claims against the Commonwealth by creditors of those instrumentalities, including Ambac and Ambac-insured bondholders. If the Commonwealth Plan of Adjustment were confirmed in its current form, Ambac's financial condition would suffer a materially negative impact. Refer to Note 8. Financial Guarantee Insurance Contracts, in this Annual Report Form 10-K located in Part II for the possible increase in loss reserves under stress or other adverse conditions, including the impact of the Commonwealth Plan of Adjustment. There can be no assurance that losses may not exceed such estimates. Political Developments In 2020, President Donald J. Trump appointed Justin Peterson, Betty A. Rosa, John E. Nixon and Antonio L. Medina Comas as new members of the Oversight Board and reappointed Andrew G. Biggs, David Skeel and Arthur Gonzalez to new terms. The Puerto Rico gubernatorial election was held on November 3, 2020, to elect the governor of Puerto Rico, concurrently with the election of the Resident Commissioner, the Senate, the House of Representatives, and the mayors of the 78 municipalities. Pedro Pierluisi of Puerto Rico’s pro-statehood New Progressive Party was voted to become the territory’s next governor in 2021. In terms of the local legislature, there will be a “shared government”; the Governor and the Resident Commissioner from the PNP and Legislative leadership from the PDP. The new President of the Senate will be Senator Jose Luis Dalmau and the new Speaker of the House will be | Ambac Financial Group, Inc. 38 2020 FORM 10-K | Table of Co ntents Representative Rafael "Tatito" Hernández (former Chair of House Treasury Committee 2013-2016). It is unclear how the Oversight Board member changes and local election outcomes will impact the debt restructuring process, negotiations, timing and ultimate recoveries for Ambac. Ambac Title III Litigation Update AAC 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, AAC, together with other monoline insurers, filed motions which sought to lift the automatic stay and allow AAC and others to enforce their rights related to PRHTA, PRCCDA 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 PRCCDA motion relating to a particular account over which it is undisputed the monolines have a lien. AAC and the other movants have appealed the PRHTA and PRIFA decisions. Briefing concluded in late December with oral argument heard in February 2021. Ambac is unable to predict when and how the issues raised in these cases will be resolved. If AAC is unsuccessful in any of these proceedings, Ambac’s financial condition, including liquidity, loss reserves and capital resources may suffer a materially negative impact. On January 16, 2020, the Oversight Board filed four adversary proceeding complaints against AAC and other monoline insurers seeking to disallow their proofs of claim against the Commonwealth as they relate to PRHTA, PRCCDA, 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. On January 20, 2021, the District Court granted defendants’ request for deferral of the adjudication of the summary judgment motions until defendants have the opportunity to conduct certain discovery. Discovery is ongoing. AAC, along with other monoline insurers, filed a motion seeking appointment of trustees under Section 926 of the Bankruptcy Code to pursue certain avoidance actions on behalf of PRHTA 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 AAC and the other movants have appealed that denial. AAC 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 PRHTA lift-stay motion (as described above). Briefing on both motions concluded on October 27, 2020. On December 22, 2020, the First Circuit denied the motion to hold the appeal in abeyance, and referred the motion to dismiss to the panel determining the merits of the appeal. Movants’ opening brief before the First Circuit was filed on February 17, 2021. Refer to Note 17. Commitments and Contingencies to the Consolidated Financial Statements, included in Part II, Item 8 of this Form 10-K for further information about Ambac's litigation relating to Puerto Rico. Mediation The status, timing and subject of any past or future mediation discussion has not yet been publicly disclosed. The timeline for resolution of Puerto Rico’s debt restructuring process is uncertain. 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 the Puerto Rico Fiscal Agency and Finance Advisory Authority ("AAFAF") concerning the terms of a Commonwealth Plan of Adjustment and what, if any, modifications or amendments needed to be proposed. On February 10, 2021, the Oversight Board disclosed that mediation resulted in an agreement in principle with certain GO and PBA bondholders. The Second Amended PSA was publicly disclosed on February 23, 2021. No assurances can be given that further 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, PSA 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. Federal Aid 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. A new U.S. President, Puerto Rico governor, and Oversight Board makeup could all 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. Furthermore, a change in the federal government's approach to Puerto Rico's needs, including Social Security disability payments, Medicaid, and other health and nutritional assistance programs, is possible under the new administration. But while the previously allocated hurricane disaster relief funds, the more recent COVID-19 crisis related funds and potential new federal support are all expected to support economic recovery and growth 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. Summary Ambac has considered these developments and other factors in evaluating its Puerto Rico loss reserves. During the year ended December 31, 2020, Ambac had incurred losses associated with its Domestic Public Finance insured portfolio of $256 million, which was impacted by lower discount rates, the continued uncertainty and volatility of the situation in Puerto Rico, including the potential impact of the COVID-19 crisis on the Commonwealth and the developing potential impact of the COVID-19 crisis on other sectors in the Domestic Public Finance insured portfolio; and loss adjustment expenses related to the cost of defending our rights and pursuing recoveries. | Ambac Financial Group, Inc. 39 2020 FORM 10-K | Table of Co ntents While management believes its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance that Ambac may not incur additional losses in the future, particularly given the developing economic, political, and legal circumstances in Puerto Rico and the overall uncertain impact of the COVID-19 crisis on the Commonwealth and the Domestic Public Finance Insured Portfolio in general. Such additional losses may have a material adverse effect on Ambac’s results of operations and financial condition. The following table shows Ambac's insured exposure to each issuer segregated by whether such debt obligation is subject to the Priority Debt Provision or "clawback." Ambac has initiated litigation challenging the application of the "clawback" announced by Governor Padilla, Puerto Rico's former governor, on December 1, 2015. A description of Ambac's legal challenge is provided in Note 17. Commitments and Contingencies in the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K. ($ in millions) Range of Maturity Ambac Ratings (1) Net Par Outstanding (2) Net Par and Interest Outstanding (3)(8) Ever-to-Date Net Claims Paid (4) Exposures Subject to Priority Debt Provision (5) PR Highways and Transportation Authority (1968 Resolution - Highway Revenue) (6) 2021-2027 BIG $ 4 $ 10 $ 23 PR Highways and Transportation Authority (1998 Resolution - Senior Lien Transportation Revenue) (6) 2021-2042 BIG 395 639 144 PR Infrastructure Financing Authority (Special Tax Revenue) (7) 2023-2044 BIG 404 887 187 PR Convention Center District Authority (Hotel Occupancy Tax) 2021-2031 BIG 86 128 68 Total 889 1,664 422 Exposures Not Subject to Priority Debt Provision Commonwealth of Puerto Rico - General Obligation Bonds 2021-2023 BIG 18 19 49 PR Public Buildings Authority - Guaranteed by the Commonwealth of Puerto Rico 2021-2035 BIG 83 145 87 PR Sales Tax Financing Corporation - Senior Sales Tax Revenue (COFINA) 2047-2054 BIG 80 712 37 Total 181 876 173 Total Net Exposure to The Commonwealth of Puerto Rico and Related Entities $ 1,070 $ 2,540 $ 595 (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. BIG denotes credits deemed below investment grade. (2) Net Par 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. Accretion of the capital appreciation bonds would increase the related net par by $214 at December 31, 2020. (3) Net Par and Interest Outstanding ("P&I") represents the total insured future debt service remaining over the lifetime of the bonds. P&I for capital appreciation bonds does not represent the accreted amount as noted in footnote (2) but rather the amount due at respective maturity dates. (4) In addition to ever-to-date net claims paid, Ambac made net claim payments of $23 in January 2021. (5) Commonly known as "clawback," provision pursuant to Section 8 of Article VI of the Constitution of the Commonwealth of Puerto Rico. Under this provision, in the event Commonwealth available revenues and any surplus for any fiscal year are insufficient to meet the appropriations made for that year, interest on the public debt and amortization thereof shall first be paid and other disbursements, including debt service on the obligations subject to such provision as described above (to the extent payable from such revenues), shall thereafter be made in accordance with the order of priorities established by law. These exposures are also subject to Act No. 5-2017, as amended, also known as the Financial Emergency and Fiscal Responsibility Act of 2017, which declares an emergency period that has been subsequently re-extended until June 30, 2021, from its prior December 31, 2020, deadline. Pursuant to Act 5-2017, all executive orders issued under Act No. 21-2016 (as amended, known as the Puerto Rico Emergency Moratorium and Financial Rehabilitation Act), shall continue in full force and effect until amended, rescinded or superseded. (6) Certain Pledged Revenues for Highways and Transportation Revenue Bonds such as Toll Revenues and Investment Earnings are not subject to the Priority Debt Provision. (7) Payable from and secured by proceeds from a federal excise tax imposed on all items produced in Puerto Rico and sold on the mainland of the United States. Currently, rum is the only product from Puerto Rico subject to this federal excise tax. (8) Net Par and Interest Outstanding excludes the effects of a 10% current interest rate on $60 net par of PR Public Building Authority ("PBA") bonds with a maturity date of July 1, 2035, resulting from the absence of a remarketing. Should a remarketing not occur before the maturity of the bonds, the Net Par and Interest Outstanding for PBA exposure would increase by $39. U.S. Structured Finance Portfolio Ambac’s portfolio of U.S. structured finance exposures is $6,337 million, representing 19% of Ambac’s net par outstanding as of December 31, 2020, and a 16% reduction from the amount outstanding at December 31, 2019. This reduction in exposure was primarily related to residential mortgage-backed securities ("RMBS") policies, which continued to prepay as well as incur claims. | Ambac Financial Group, Inc. 40 2020 FORM 10-K | Table of Co ntents Current insured exposures include securitizations of mortgage loans, home equity loans and student loans as well as other asset-backed financings, in each case where the majority of the underlying collateral risk is situated in the United States. Additionally, Ambac’s structured finance insured portfolio includes secured and unsecured debt issued by investor-owned utilities and structured insurance transactions providing insurance on the notes of trusts established in connection with the reinsurance of defined blocks of life insurance that were used to fund regulatory reserves associated with level premium term life insurance policies (commonly referred to as Regulation XXX reserves). See Note 7. Financial Guarantees in Force to the Consolidated Financial Statements, included in Part II, Item 8 included in this Form 10-K, for exposures by bond type as of December 31, 2020. Structured finance securitization exposures generally entail three forms of risk: (i) asset risk, which relates to the amount and quality of the underlying assets; (ii) structural risk, which relates to the extent to which the transaction’s legal structure and credit support provide protection from loss; and (iii) servicer risk, which is the risk that poor performance at the servicer or manager level contributes to a decline in cash flow available to the transaction. AAC seeks to mitigate and manage these risks through its risk management practices. Ambac has exposure to the U.S. mortgage market primarily through direct financial guarantees of RMBS, including transactions that contain risks to first and second lien mortgages. Ambac's total net par exposure to RMBS at December 31, 2020, was approximately $3,635 million ($2,137 million, $1,399 million, $99 million are first lien, second lien and other respectively), a decrease of 18% during 2020. At December 31, 2020, 88% of RMBS net par exposure relates to securitizations issued during 2005 through 2007. International Finance Insured Portfolio Ambac’s portfolio of international finance insured exposures is $12,054 million, representing 36% of Ambac’s net par outstanding as of December 31, 2020, and a 6% reduction from the amount outstanding at December 31, 2019. This reduction in exposure was primarily the result of policy terminations, refinancings and scheduled maturities within stadiums and investor-owned utilities, partially offset by a weakening of the US dollar versus the British pound. Ambac’s international finance insured exposures include a wide array of obligations in the international markets, including infrastructure financings, asset-securitizations, utility obligations, whole business securitizations (e.g., securitizations of substantially all of the operating assets of a corporation) and sub-sovereign credits. Ambac has no insured exposure related to emerging markets. See Note 7. Financial Guarantees in Force to the Consolidated Financial Statements, included in Part II, Item 8 included in this Form 10-K, for exposures by bond type as of December 31, 2020. When underwriting transactions in the international markets, Ambac considered the specific risks related to the particular country and region that could impact the credit of the issuer. These risks include the legal and political environment, capital markets dynamics, foreign exchange issues and the degree of governmental support. Ambac continues to assess these risks through its ongoing risk management. Ambac UK, which is regulated in the United Kingdom (“UK”), had been AAC’s primary vehicle for directly issuing financial guarantee policies in the UK and the European Union with $11,186 million net par outstanding at December 31, 2020. The portfolio of insured exposures underwritten by Ambac UK is financially supported exclusively by the assets of Ambac UK and no capital support arrangements are in place with any other Ambac affiliate. European Union Exposures (“EU”) Ambac's international net par exposures are principally in the United Kingdom ($9,711 million); however, we also have exposures with credit risk based in various EU member states, including Austria, France, Germany and Italy ($1,797 million). Italy, with net par exposure of $803 million, in particular has experienced economic, fiscal and political strains since the 2008 global financial crisis such that the likelihood of default on an insured sub-sovereign obligation in that country is higher than when the policy was underwritten. Ambac does not guarantee any sovereign bonds of the above EU countries. Brexit: In January 2020 the UK Government and EU ratified the terms of a legal binding treaty ("Withdrawal Agreement") setting out the terms of a transition period to apply to the UK until December 31, 2020. The effect of the withdrawal agreement was to retain the rights and obligations between the UK and the EU from the date of the UK's exit from the EU on January 31, 2020, ("Exit Day") to the end of this transition period. Prior to December 31, 2020, Ambac UK either commuted any policies with EU based policyholders or transferred the benefits of those policies to UK policyholders. In addition, Ambac UK transferred the administration of its last remaining policy within its Italian Branch to the UK on December 1, 2020, and closed its Italian Branch on December 18, 2020. Therefore, while Ambac UK's net par exposures continue to contain credit risk based in EU member states, Ambac UK no longer services any insurance policies with EU based policyholders and its ability to continue to service its insurance portfolio is therefore not impacted by Brexit. Additional Insured Portfolio Information Average Life of Insured Portfolio Ambac underwrote and priced financial guarantees based on the assumption that the guarantees would remain in force until the maturity of the underlying bonds. Ambac estimates that the average life of its guarantees on par in force at December 31, 2020 is approximately 10 years. The average life is determined by applying a weighted average calculation, using the remaining years to expected maturity of each guaranteed bond, and weighting them on the basis of the remaining net par guaranteed. Except for RMBS policies, no assumptions are made for non-contractual reductions, refundings or terminations of insured issues. RMBS policies incorporate assumptions on expected prepayments over the remaining life of the insured obligation. | Ambac Financial Group, Inc. 41 2020 FORM 10-K | Table of Co ntents The following table depicts amortization of existing guaranteed net par outstanding: Net Par Outstanding Amortization (1) ($ in millions) Estimated Net Amortization 2021 $ 2,903 2022 2,768 2023 1,753 2024 2,037 2025 1,556 2021-2025 $ 11,017 2026-2030 7,141 2031-2035 6,595 2036-2040 5,687 After 2040 3,448 Total $ 33,888 (1) Depicts amortization of existing guaranteed portfolio, assuming no advance refundings, as of December 31, 2020. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay guaranteed obligations. Geographic Area The following table sets forth the geographic distribution of Ambac's existing guaranteed net par outstanding as of December 31, 2020: Geographic Area ($ in millions) Net Par Amount Outstanding % of Total Net Par Amount Outstanding Domestic: Mortgage and asset-backed (1) $ 3,646 10.8 % Colorado 2,362 7.0 % California 2,104 6.2 % New York 1,816 5.4 % New Jersey 1,290 3.8 % Texas 1,233 3.6 % Puerto Rico 1,070 3.2 % Pennsylvania 896 2.6 % Washington 799 2.4 % Florida 656 1.9 % Oregon 627 1.9 % Other domestic 5,335 15.7 % Total Domestic 21,834 64.4 % International: United Kingdom 9,711 28.7 % Italy 803 2.4 % Austria 707 2.1 % Australia 420 1.2 % France 277 0.8 % Other international (2) 136 0.4 % Total International Finance 12,054 35.6 % Total $ 33,888 100.0 % (1) Mortgage and asset-backed obligations includes guarantees with multiple locations of risk within the United States and is primarily comprised of residential mortgage and commercial asset-backed securitizations. (2) Other international may include components of U.S. exposure. Exposure Currency The table below shows the distribution by currency of Ambac's existing guaranteed net par outstanding as of December 31, 2020: Currency ($ in millions) Net Par Amount Outstanding in Base Currency Net Par Amount Outstanding in U.S. Dollars Percentage of Net Par Amount Outstanding U.S. Dollars $ 22,205 $ 22,205 65.5 % British Pounds £ 6,940 9,486 28.0 % Euros € 1,455 1,777 5.2 % Australian Dollars A$ 545 420 1.2 % Total $ 33,888 100.0 % Ratings Distribution The following charts provide a rating distribution of existing net par outstanding based upon internal Ambac credit ratings at December 31, 2020 and 2019 and a distribution by bond type of Ambac's below investment grade ("BIG") net par exposures at December 31, 2020 and 2019. BIG is defined as those exposures with an internal credit rating below BBB-: Note: AAA is less than 1% in both periods. | Ambac Financial Group, Inc. 42 2020 FORM 10-K | Table of Co ntents (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. BIG denotes credits deemed below investment grade. Summary of Below Investment Grade Exposure: Net Par Outstanding - December 31, Bond Type ($ in millions) 2020 2019 Public Finance: Lease and tax-backed (1) $ 1,194 $ 1,109 Stadium 540 — General obligation (1) 325 525 Housing (2) 308 311 Transportation 30 27 Other 38 42 Total Public Finance 2,435 2,014 Structured Finance: RMBS 2,800 3,362 Student loans 512 620 Other — 33 Total Structured Finance 3,312 4,015 International Finance: Other 1,574 1,455 Total International Finance 1,574 1,455 Total $ 7,321 $ 7,484 (1) Lease and tax-backed includes $969 and $1,014 of Puerto Rico net par at December 31, 2020 and 2019, respectively. General obligation includes $101 and $109 of Puerto Rico net par at December 31, 2020 and 2019, respectively. 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) Includes $308 and $311 of military housing net par at December 31, 2020 and 2019, respectively. 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. Ceded Reinsurance AAC has reinsurance in place pursuant to surplus share treaties and facultative agreements. As a primary financial guarantor, AAC is required to honor its obligations to its policyholders whether or not its reinsurers perform their obligations under these reinsurance agreements. For exposures reinsured, AAC generally withholds a ceding commission to defray its underwriting and operating expenses. To minimize its exposure to losses from reinsurers, AAC (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by AAC in the event of rating agency downgrades of a reinsurer (among other events and circumstances). AAC held letters of credit and collateral amounting to $117 million from its reinsurers at December 31, 2020. As of December 31, 2020, the aggregate amount of insured par ceded by AAC to reinsurers under reinsurance agreements was $5,182 million, with the largest reinsurer accounting for $2,398 million or 6.1% of gross par outstanding at December 31, 2020. The following table shows the distribution, by bond type, of AAC’s ceded guaranteed portfolio at December 31, 2020: Bond Type ($ in millions) Ceded Par Amount Outstanding % of Gross Par Ceded Public Finance: General obligation $ 1,327 36 % Lease and tax-backed revenue 1,156 22 % Housing revenue 934 14 % Transportation revenue 586 43 % Utility revenue 243 27 % Higher education 167 18 % Other 99 10 % Total Public Finance 4,512 23 % Structured Finance: Investor-owned utilities 224 12 % Student loan 219 26 % Structured insurance 115 27 % Mortgage-backed and home equity 40 1 % Asset-backed and other 21 12 % Total Structured Finance 619 9 % Total Domestic 5,131 19 % International Finance: Investor-owned and public utilities 26 1 % Transportation 25 2 % Asset-backed — — % Total International Finance 51 — % Total $ 5,182 13 % RESULTS OF OPERATIONS The following discussion should be read along with the financial statements included in this Form 10-K, as well as Part II, "Item 7, Management's Discussion and Analysis's of Financial Condition and Results of Operations" of our Form 10-K for the year ended December 31, 2019, which provides additional information on comparisons of years 2019 and 2018. Net loss attributable to common stockholders for the year ended December 31, 2020, was $437 million compared to a net loss attributable to common stockholders of $216 for the year ended December 31, 2019. The increase in loss was primarily driven by: (i) higher loss and loss expenses, (ii) receipt of $142 million | Ambac Financial Group, Inc. 43 2020 FORM 10-K | Table of Co ntents arising from the settlement between the SEC and Citigroup which was recognized as a gain in Other income for the year ended December 31, 2019, (iii) lower net investment income, (iv) lower net realized investment gains, and (v) lower income on variable interest entities, partially offset by (a) lower insurance intangible amortization and (b) lower interest and operating expenses. A summary of our financial results is shown below: ($ in millions) Year Ended December 31, 2020 2019 2018 Revenues: Net premiums earned $ 54 $ 66 $ 111 Net investment income 122 227 273 Net realized investment gains (losses) 22 81 108 Net gains (losses) on derivative contracts (50) (50) 7 Other income (expense) (1) 3 134 8 Income (loss) on variable interest entities 5 38 3 Expenses: Losses and loss expenses (benefit) 225 13 (224) Insurance intangible amortization 57 295 107 Operating expenses 92 103 112 Interest expense 222 269 242 Provision for income taxes (3) 32 5 Net income (loss) (437) (216) 267 Less: loss on exchange of auction market preferred shares (2) — — 82 Net income (loss) attributable to common stockholders $ (437) $ (216) $ 186 (1) 2019 includes proceeds received in connection with an SEC action against Citigroup Global Markets Inc. in the amount of $142 million. (2) In connection with the AMPS Exchange, the difference between the fair value of consideration provided to AMPS holders and the carrying amount of the AMPS has been reflected as a reduction to Net income attributable to common stockholders in 2018 for approximately $82. Refer to Note 1. Background and Business Description for a discussion of the AMPS Exchange. 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 2020 contributed 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 maturity securities (recorded through other comprehensive income) and the majority of other investments (recorded through net investment income). During the last three quarters of 2020, credit spreads largely 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 COVID-19, refer to “Part I, Item 1A-Risk Factors” in this Form 10-K. 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 years ended December 31, 2020, 2019 and 2018. The most significant transactions were: Puerto Rico COFINA Plan of Adjustment ("POA"). On February 12, 2019, the POA, including certain related commutation transactions, and subsequent distributions, became effective, resulting in a significant reduction of AAC's insured net par exposure to COFINA. Pursuant to the COFINA POA, approximately 75% of holders of AAC-insured senior COFINA bonds (including Ambac) elected to commute their insurance policy. Under this restructuring, Ambac-insured COFINA bonds that were not commuted were deposited, along with new uninsured COFINA bonds, into a newly formed trust called the COFINA Class 2 Trust ("COFINA Trust"), a VIE that Ambac determined must be consolidated. Sales of assets from the COFINA Trust may be made from time to time with proceeds used to redeem the trust's debt. Ballantyne Re plc ("Ballantyne") Restructuring. On April 25, 2019, Ballantyne commenced, under Irish law, a restructuring transaction ("Restructuring") in respect of its obligations, including obligations that were guaranteed by Ambac UK. The arrangement was approved on June 17, 2019. 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 for 2020 and 2019. Net Premiums Earned . Net premiums earned for the year ended December 31, 2020, decreased by $12 million or 18% as compared to net premiums earned for the year ended December 31, 2019. We present accelerated premiums, which result from calls and other accelerations of insured obligations separate from normal net premiums earned. When an insured bond has been retired, any remaining unearned premium revenue ("UPR") is recognized at that time to the extent the financial guarantee contract is legally extinguished, causing accelerated premium revenue. 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. | Ambac Financial Group, Inc. 44 2020 FORM 10-K | Table of Co ntents Normal net premiums earned are impacted by the following: • The runoff of the insured portfolio, including through transaction terminations, calls and scheduled maturities, which reduce normal net premiums earned. • New ceded reinsurance which reduces normal net premiums earned over the remaining period of the related ceded policies. • Changes to the allowance for credit losses on the premium receivable asset. 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 strengthening or weakening of the U.S. dollar relative to the British Pound since Ambac's wholly-owned UK subsidiary, Ambac UK, operates in the United Kingdom and the British Pound is its functional currency. • Pre-refundings of insured securities, primarily Public Finance transactions. Since the maturity date of pre-refunded securities is shortened (to a specified call date from its previous legal maturity), normal net premiums earned will increase over the remaining period of the related policy. 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: ($ in millions) Year Ended December 31, 2020 2019 2018 Public finance $ 21 $ 27 $ 37 Structured finance 8 10 17 International finance 13 19 23 Total net normal premiums earned $ 42 $ 56 $ 77 Total net accelerated earnings $ 12 $ 10 $ 35 Total net premiums earned $ 54 $ 66 $ 111 Net Investment Income. Net investment income primarily consists of interest and net discount accretion on fixed maturity securities classified as available-for-sale, and net gains (losses) on pooled investment funds which include changes in fair value of the funds' net assets. Fixed maturity securities include investments in Ambac-insured securities that are made opportunistically based on their risk/reward and asset-liability management characteristics. 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 been affected by restructuring transactions involving Puerto Rico COFINA and Ballantyne bonds. 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 Consolidated Balance Sheets. For further information about investment funds held, refer to Note 11. Investments to the Consolidated Financial Statements, included in this Annual Report on Form 10-K. Net investment income from Ambac-insured securities, available-for-sale and short-term securities other than Ambac-insured and Other investments is summarized in the table below: ($ in millions) Year Ended December 31, 2020 2019 2018 Securities available-for-sale: Ambac-insured (including Secured Notes) $ 62 $ 121 $ 220 Securities available-for-sale and short-term other than Ambac-insured 41 75 51 Other investments (includes trading securities) 19 32 2 Net investment income $ 122 $ 227 $ 273 Net investment income decreased $106 million for the year ended December 31, 2020 compared to 2019. As described further below, the variances were primarily driven by 2020 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. • Investment income from Ambac-insured securities decreased $59 million in 2020, compared to 2019. The decrease was due primarily to the effects of the 2019 de-risking of Ballantyne and lower income on Secured Notes issued by Ambac LSNI, LLC. The Ballantyne restructuring in June 2019 resulted in accelerated discount accretion into income and settled the Ballantyne bonds held in the investment portfolio. Income on the Secured Notes declined from 2019 due to quarterly early redemptions and the impact of lower rates, as the coupon rate is indexed to LIBOR subject to a 1.0% LIBOR floor. Additionally, income on Ambac insured-RMBS declined compared to 2019 primarily as a result of declining interest rates over both 2020 and 2019. • Net investment income from available-for-sales securities other than Ambac-insured securities decreased $34 million in 2020, compared to the prior year. The decrease resulted from the favorable impact of high yielding uninsured COFINA bonds received under the POA on 2019 income, as well as the impact of a smaller asset base and lower average yields in 2020. All of the uninsured COFINA bonds received under the POA were sold from Ambac's non-VIE investment portfolio by December 31, 2019, with reinvestment in lower yielding fixed maturities or allocated to pooled funds included in Other investments. Additional re-allocation of the portfolio in 2020 toward pooled funds and Ambac-insured bonds from investment grade corporate bonds, commercial mortgage backed securities and certain CLOs resulted in a lower asset base and average yield in this portion of the portfolio. The use of cash for early debt redemptions and operating cash needs also contributed to the smaller asset base, while steadily declining reinvestment rates on short-term holdings adversely | Ambac Financial Group, Inc. 45 2020 FORM 10-K | Table of Co ntents impacted the average yield of available-for-sale securities other than Ambac-insured in 2020 compared to 2019. • Other investments income decreased $13 million in 2020, compared to the prior year. The decrease resulted from the financial market impact of the COVID-19 pandemic and repositioning of pooled fund investments in 2020, compared to strong portfolio returns in 2019. Other investments income for 2020 included lower returns on equity, high-yield and loan funds, partially offset by higher income from hedge fund investments. Higher income on hedge funds was driven primarily by net gains on investments funded mostly following the initial broad market decline of the first quarter. Decreased holdings of equity, high yield and loan funds in the first half of 2020 resulted in recognition of only modest net gains on such holdings for the full year, compared to above average performance in these asset types in 2019. Net Realized Investment Gains . The following table provides a breakdown of net realized gains, for the periods presented: ($ in millions) Year Ended December 31, 2020 2019 2018 Net gains on securities sold or called $ 26 $ 59 $ 105 Foreign exchange gains (losses) (4) 22 7 Credit impairment — — — Intent / requirement to sell impairments — — (3) Total net realized gains $ 22 $ 81 $ 108 Net realized gains on securities sold or called during the year ended December 31, 2020, are primarily from sales in connection with routine portfolio management. Net realized gain on securities sold or called for the year ended December 31, 2019, included $50 million of net gains related to the impact of the COFINA POA, 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 year ended December 31, 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. Credit impairments are recorded in earnings only to the extent management does not intend to sell, and it is not more likely than not that the Company will be required to sell the securities, before recovery of their amortized cost. When credit impairments are recorded, any non-credit related impairment amounts on the securities are recorded in other comprehensive income. Net Gains (Losses) on Derivative Contracts. Net gains (losses) on derivative contracts includes result from the Company's interest rate derivatives portfolio and its runoff credit derivative portfolio. The interest rate derivatives portfolio is positioned to benefit from rising rates as a partial economic hedge against interest rate exposure in the financial guarantee and investment portfolios. As forward rates and interest rate exposures elsewhere in the company have declined over the course of 2019 and 2020, the economic hedge position has been adjusted. Net gain (loss) on interest rate derivatives generally reflect mark-to-market gains (losses) in the portfolio caused by increases (declines) in forward interest rates during the periods, the carrying cost of the portfolio, and the impact of counterparty credit adjustments as discussed below. Results from credit derivatives were not significant to the periods presented. • Net losses on interest rate derivatives for the year ended December 31, 2020, were $50 million, compared to $51 million for the year ended December 31, 2019. The net loss for the year ended December 31, 2020, reflects significant declines in forward interest rates, triggered by the COVID-19 pandemic, and losses from the application of counterparty credit adjustment, described further below. The net losses for the year ended December 31, 2019, reflect the impact of declines in forward interest rates, partially offset by negative net carrying costs driven by an inverted yield curve. Although interest rates declined more in 2020 than in 2019, their impact on derivative losses was lower due to the relative positioning of the portfolio in each period. • 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 losses within Net gains (losses) on derivative contracts of $(6) million and $(2) million for the years ended December 31, 2020 and 2019, respectively. The loss for the year ended December 31, 2020, was driven by wider credit spreads reflecting the credit rating downgrade of a derivative counterparty by Ambac during the first quarter, simultaneous with an increase in the underlying asset values 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) included various fees, primarily consent and waiver fees, as well as foreign exchange gains (losses) unrelated to investments or loss reserves. Other income also included proceeds received by AAC 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. 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 | Ambac Financial Group, Inc. 46 2020 FORM 10-K | Table of Co ntents 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. 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 $5 million and $38 million for the years ended December 31, 2020 and 2019, respectively. Results for the year ended December 31, 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 impacted by COVID-19. Results for the year ended December 31, 2019, were driven by the impact of the creation and subsequent activities of the COFINA Trust. Income from COFINA Trust for the the year ended December 31, 2019, was $26 million, including $15 million from consolidation and $13 million from realized investment gains on sales of assets from the trust, partially offset by net interest expense and fees. Income for the year ended December 31, 2019, also included a gain on the fair value of net assets of a VIE arising from an increase in projected cash flows on the VIE's assets due to higher financial guarantee insurance premiums. Results for 2019 also included a loss of $2 million from deconsolidation of a VIE. Refer to Note 4. Variable Interest Entities to the Consolidated Financial Statements included in this Annual Report on Form 10-K for further information on the accounting for VIEs. Losses and Loss Expenses (Benefit). Losses and loss expenses are based upon estimates of the aggregate losses inherent in the non-derivative financial guarantee portfolio for insurance policies issued to beneficiaries, including unconsolidated VIEs. Ambac records as a component of its loss reserve estimate subrogation recoveries related to securitized loans in RMBS transactions with respect to which AAC is pursuing claims for breaches of representations and warranties. Ambac does not include potential recoveries attributed solely to fraudulent inducement claims in our litigations in our estimate of subrogation recoveries. 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 warranty ("R&W") subrogation recoveries, net of reinsurance, of $1,725 million and $1,702 million at December 31, 2020 and 2019, respectively. The increase in these recoveries was primarily driven by lower discount rates used to discount estimated cash flows. Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K for more information regarding the estimation process for R&W subrogation recoveries. The following table provides details, by bond type, for losses and loss expenses (benefit) incurred for the periods presented: ($ in millions) Year Ended December 31, 2020 2019 2018 RMBS (1) $ (76) $ (93) $ (8) Domestic Public Finance 256 250 37 Student Loans 24 (17) (4) Ambac UK and Other Credits 21 (127) 19 Interest on Deferred Amounts — — 21 Discount on Rehabilitation Exit Transaction — — (288) Totals (2) $ 225 $ 13 $ (224) (1) The loss and loss expense (benefit) associated with changes in estimated representation and warranties for the year ended December 31, 2020, 2019 and 2018 was ($23), $42 and $62, respectively. (2) Includes loss expenses incurred of $103, $78 and $92 for the year ended December 31, 2020, 2019 and 2018, respectively. Losses and loss expenses for 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; and • An increase in student loan losses as a result of lower discount rates and the impact from COVID-19; partially offset by • Improved RMBS losses 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 for 2019 were driven by the following: • Higher projected losses in domestic public finance driven mostly by lower discount rates and additions to Puerto Rico loss reserves, partially offset by; • Favorable development within Ambac UK and Other Credits primarily due to the Ballantyne commutation; • Favorable RMBS development as a result of credit improvement, the impact on excess spread from declines in interest rates and a trustee settlement related to Lehman sponsored transactions, partially offset by RMBS R&W litigation loss expenses incurred and a reduction to estimated RMBS R&W subrogation recoveries . Insurance Intangible Amortization . Insurance intangible amortization was $57 million and $295 million for the years ended December 31, 2020 and 2019, respectively. The decrease in intangible amortization for the year ended December 31, 2020, compared to 2019, is primarily due to accelerated amortization as a result of the Ballantyne commutation that occurred in 2019. | Ambac Financial Group, Inc. 47 2020 FORM 10-K | Table of Co ntents Operating Expenses. Operating expenses consist of gross operating expenses plus reinsurance commissions. The following table provides a summary of operating expenses for the periods presented: ($ in millions) Year Ended December 31, 2020 2019 2018 Compensation $ 51 $ 58 $ 55 Non-compensation 41 44 56 Gross operating expenses 92 103 111 Reinsurance commissions, net — — 1 Total operating expenses $ 92 $ 103 $ 112 Gross operating expenses for the year ended December 31, 2020 are $92 million, a decrease of $10 million from gross operating expenses for the year ended December 31, 2019. The decrease was primarily due to the following: • Lower compensation costs primarily due to: (i) lower salaries and severance resulting from continued right sizing of staffing levels partially offset by hiring in connection with the launch of Everspan Group and (ii) lower incentive compensation costs primarily related to the Ballantyne restructuring incentive compensation recognized in 2019 • Lower non-compensation costs primarily due to: (i) a UK Value Added Tax (VAT) refund recognized in 2020, (ii) lower premises costs as a result of relocating Ambac's corporate headquarters, and (iii) lower subscription and data access costs associated with runoff of the financial guarantee portfolio partially offset by: (i) increased legal fees and (ii) incremental costs arising due to the COVID-19 pandemic. Legal and consulting services provided for the benefit of OCI were flat at $2 million during the years ended December 31, 2020 and 2019. Interest Expense. Interest expense includes accrued interest on the Ambac Note, Tier 2 Notes, surplus notes and other debt obligations. Additionally, interest expense includes discount accretion when the debt instrument carrying value is at a discount to par. The following table provides details by type of obligation for the periods presented: ($ in millions) Year Ended December 31, 2020 2019 2018 Surplus notes (1) $ 85 $ 99 $ 80 Ambac note 107 143 139 Tier 2 notes 28 26 22 Other 1 — 1 Total interest expense $ 222 $ 269 $ 242 (1) Includes junior surplus notes. The decrease in interest expense for the year ended December 31, 2020, compared to 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. Since the issuance of the surplus notes in 2010, OCI has declined to approve regular payments of interest on surplus notes, although the OCI has permitted exceptional payments in connection with (a) increasing the percentage of deferred policy payments of the Segregated Account of Ambac Assurance from 25% to 45% in 2014 and (b) a one-time payment of approximately six months of interest on the surplus notes (other than junior surplus notes) outstanding immediately after consummation of the Rehabilitation Exit Transactions (as defined in Part II, Item 8, Note 1 Background and Business Description to the Consolidated Financial Statements included in this Form 10-K) in 2018. In April 2020, OCI declined the request of Ambac Assurance to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on the scheduled maturity date of June 7, 2020. As a result, the scheduled payment date for interest, and the scheduled maturity date for payment of principal of the surplus notes, shall be extended until OCI grants approval to make the payment. Interest will accrue, compounded on each anniversary of the original scheduled payment date or scheduled maturity date, on any unpaid principal or interest through the actual date of payment, at 5.1% per annum. Holders of surplus notes will have no rights to enforce the payment of the principal of, or interest on, surplus notes in the absence of OCI approval to pay such amount. 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 interest payment date. Total accrued and unpaid interest for surplus notes and junior surplus notes outstanding to third parties were $344 million and $172 million, respectively, at December 31, 2020. Provision for Income Taxes . The provision for income taxes for the year ended December 31, 2020 and 2019, was a benefit of $3 million and an expense of $32 million, respectively. Income taxes for the year ended December 31, 2020 and 2019, includes provisions for income tax due in respect of Ambac UK of $(3) million and $36 million, respectively. At December 31, 2020, the Company had approximately $3,639 million of U.S. Federal net ordinary operating loss carryforwards, including approximately $1,457 million at AFG and $2,182 million at AAC. LIQUIDITY AND CAPITAL RESOURCES Ambac Financial Group, Inc. ("AFG") Liquidity. AFG’s liquidity is primarily dependent on its cash, investments (excluding equity investment in subsidiaries), and net receivables totaling $366 million as of December 31, 2020. AFG also receives partial expense reimbursements under the terms of an expense sharing agreement with AAC, and is expected to receive distributions beginning in 2021 from its 80% ownership stake in Xchange. • During 2020, AFG established Everspan Indemnity Insurance Company with an initial capital contribution of $15 million. Additionally, AFG purchased Everspan Insurance Company from AAC for approximately $14 | Ambac Financial Group, Inc. 48 2020 FORM 10-K | Table of Co ntents million and repositioned it as a subsidiary of Everspan Indemnity Insurance Company, forming the Everspan Group. In order to obtain an A- Financial Strength Rating from A.M. Best, AFG contributed an additional $82 million to Everspan Indemnity Insurance Company in February 2021. • In December 2020, AFG further amended its existing amended and restated tax sharing agreement among AFG, AAC and certain affiliates (the "Third TSA Amendment"), in connection with which AAC paid to AFG approximately $28 million of accrued payments based on net operating loss carry-forwards (“NOLs”) used by AAC ("tolling payments") in 2017. Under the Third TSA Amendment, AAC and AFG agreed to eliminate AAC's requirement to make future tolling payments based on its utilization of NOLs for any taxable year beginning on or after January 1, 2019 in exchange for a reallocation of $210 million of NOL's from AAC to AFG. • Under an inter-company cost allocation agreement, AFG is reimbursed by AAC 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 for 2019 expenses, which was paid in March 2020. AFG's investments include securities directly and indirectly issued and/or insured by AAC, some of which are eliminated in consolidation. Securities issued or insured by AAC are generally less liquid than investment grade and other traded investments. It is highly unlikely that AAC 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 distributions from Xchange 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 this Annual Report on Form 10-K, and Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in this Annual Report on Form 10-K, 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; the making of investments, which may include securities issued or insured by AAC and other less liquid investments; and capital expenditures to acquire and/or capitalize new businesses. Contingencies could cause material liquidity strains. The following table includes aggregated information about contractual obligations for AFG and its subsidiaries at December 31, 2020, excluding variable interest entities consolidated as a result of AAC’s and Ambac UK's financial guarantee contracts. These obligations include payments due under specified contractual obligations, aggregated by type of contractual obligation, including claim payments, principal and interest payments under AAC’s surplus notes, the Ambac Note, Tier 2 Notes and Ambac UK debt, and payments due under operating leases. The table and commentary below reflect scheduled payments and maturities based on the original payment terms specified in the underlying agreements and contracts, or expected required payment dates if earlier. Payments Due by Period ($ in millions) Total Less Than 1 Year 1 - 3 Years 3 - 5 Years More Than 5 Years Surplus note obligations (1) $ 3,884 $ 894 $ — $ — $ 2,990 Ambac note obligations (2) 1,849 98 1,751 — — Tier 2 note obligations (3) 5,394 — — — 5,394 Ambac UK debt obligations (4) 41 — — — 41 Operating lease obligations (5) 45 5 10 10 19 Purchase obligations (6) 11 7 4 — — Postretirement benefits (7) 5 — 1 1 3 Loss and loss expenses (8) 2,395 94 140 167 1,993 Income taxes — — — — — Total $ 13,624 $ 1,098 $ 1,906 $ 178 $ 10,440 (1) Amounts due on surplus notes (excluding junior surplus notes) include principal on their scheduled maturity date and interest on scheduled payment dates, including payment of previously deferred interest totaling $320 million on the next anniversary of the original scheduled payment date of June 7, 2021. Also includes all principal and interest on junior surplus notes on the date all future and existing senior indebtedness of Ambac Assurance policy and other priority claims against Ambac Assurance have been paid in full (included in the more than 5 years column). Surplus note principal and interest payments require the approval of OCI. Since the issuance of the surplus notes in 2010, OCI has declined to approve regular payments of interest on surplus notes, although the OCI has permitted exceptional payments in connection with (a) increasing the percentage of deferred policy payments of the Segregated Account of Ambac Assurance from 25% to 45% in 2014 and (b) a one-time payment of approximately six months of interest on the surplus notes (other than junior surplus notes) outstanding immediately after consummation of the Rehabilitation Exit Transactions in 2018. In April 2020, OCI declined the request of Ambac Assurance to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on the scheduled maturity date of June 7, 2020. As a result, the scheduled payment date for interest, and the scheduled maturity date for payment of principal of the surplus notes, shall be extended until OCI grants approval to make the payment. Interest will accrue, compounded on each anniversary of the original scheduled payment date or scheduled maturity date, on any unpaid principal or interest through the actual date of payment, at 5.1% per annum. Holders of surplus notes will have no rights to | Ambac Financial Group, Inc. 49 2020 FORM 10-K | Table of Co ntents enforce the payment of the principal of, or interest on, surplus notes in the absence of OCI approval to pay such amount. (2) Includes principal on Ambac Note as of December 31, 2020 to be paid on its legal maturity date of February 12, 2023, and scheduled interest payments. Interest amounts on this variable rate debt are projected at a rate of 6.00% which is based on the index rate in effect at the balance sheet date. These notes are subject to mandatory redemption provisions that could significantly accelerate the timing of required payments, as described further in Note 13. Long-term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. (3) Includes principal and compounded paid-in-kind interest on Tier 2 notes to be paid on their legal maturity date of February 12, 2055. These notes are subject to mandatory redemption provisions that could significantly accelerate the timing of required payments, as described further in Note 13. Long-term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. (4) Includes principal on the zero coupon note payable on its legal maturity date of May 2, 2036. (5) Amount represents future lease payments on lease agreements existing as of December 31, 2020. Includes fixed costs, such as base rent, and estimated variable costs, such as real estate taxes and electricity. (6) Purchase obligations represent future expenditures for contractually scheduled fixed terms and amounts due for various technology-related maintenance agreements and other outside services. (7) Amount represents future payments relating to AAC's postretirement medical reimbursements to current retirees over the next 10 years. (8) The timing of expected claim payments is based on deal specific cash flows, excluding expected recoveries. These deal specific cash flows are based on the expected cash flows of the underlying transactions. The timing of expected claim payments for credits with reserves that were established using our statistical loss reserve method is determined based on the weighted average expected life of the exposure. Refer to the Loss Reserves section in Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further discussion of our statistical loss reserve method. The timing of these payments may vary significantly from the amounts shown above, especially for credits that are based on our statistical loss reserve method. AAC Liquidity . AAC’s liquidity is dependent on the balance of liquid investments and, over time, the net impact of sources and uses of funds. The principal sources of AAC’s liquidity are gross installment premiums on insurance policies; principal and interest payments from investments; sales of investments; 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 AAC’s liquidity. The principal uses of AAC’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 outstanding debt, additional loans to affiliates, and purchases of securities and other investments that may not be immediately converted into cash. In December 2020, AAC paid to AFG $28 million of tolling payments, which as described above it will no longer be required to make for future tax years. • The COVID-19 pandemic had a negative impact on Ambac's liquidity resources as a consequence of the initial severe reaction of the capital markets and potential for prolonged low reinvestment rates on invested assets; derivative losses, which required either timely settlement or additional collateral posting; and higher credit risk within the insured portfolio, as further described below. Nevertheless, Ambac has not yet experienced incremental demands on its liquidity, from higher claims, other than the aforementioned impact of derivatives. • Claim payments may increase during and in the aftermath of the global recession and COVID-19 pandemic as issuers, particularly those with revenues that were interrupted by the effects of the pandemic, including social distancing, other restrictions on activities and the increase in unemployment, may not have sufficient cash inflows to pay debt service on Ambac-insured debt. Refer to "Financial Guarantees in Force" in this Management's Discussion and Analysis for further discussion of the potential impact of the COVID-19 pandemic on claim payments. • Interest and principal payments on surplus notes are subject to the approval of OCI, which has full discretion over payments regardless of the liquidity position of AAC. 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. See Note 13. Long-term Debt to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K 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 AAC's request to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on June 7, 2020. AAC's intercompany loans are with its wholly owned subsidiary, Ambac Financial Services ("AFS"). AFS uses interest rate derivatives (primarily interest rate swaps and US Treasury futures) as a partial hedge against the effects of rising interest rates elsewhere in the Company, including on AAC’s financial guarantee exposures. AFS's derivatives include, interest rate swaps previously provided to asset-backed issuers and other entities in connection with their financings. AAC 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. AAC 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. AAC is limited in its ability to pay dividends pursuant to the terms of its Auction Market Preferred Shares (“AMPS”), which state that dividends may not be paid on the common stock of AAC unless all accrued and unpaid dividends on the AMPS for the then current dividend period have been paid, provided that dividends on the common stock may be made at all times for the purpose of, and only in such amounts as are necessary for enabling AFG (i) to service its indebtedness for borrowed money as such payments become due or (ii) to pay its operating expenses. If dividends are paid on the common stock for such purposes, dividends on the AMPS become cumulative until the | Ambac Financial Group, Inc. 50 2020 FORM 10-K | Table of Co ntents date that all accumulated and unpaid dividends have been paid on the AMPS. AAC has not paid dividends on the AMPS since 2010. AAC is also subject to additional restrictions on the payment of dividends pursuant to certain contractual and regulatory restrictions. Refer to Part I, Item 1, “Insurance Regulatory Matters - Dividend Restrictions, Including Contractual Restrictions” in this Annual Report on Form 10-K, and Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in this Annual Report on Form 10-K, for more information on dividend payment restrictions. Our ability to realize RMBS representation and warranty ("R&W") subrogation recoveries is subject to significant uncertainty, including risks inherent in litigation, collectability of such amounts from counterparties (and/or their respective parents and affiliates), timing of receipt of any such recoveries, including uncertainty due to delays in court proceedings as a result of the COVID-19 pandemic, intervention by the OCI, which could impede our ability to take actions required to realize such recoveries, 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. See Part I, Item 1A. Risk Factors in this Annual Report on Form 10-K for more information about risks relating to our RMBS R&W subrogation recoveries. Cash Flow Statement Discussion . The following table summarizes the net cash flows for the periods presented. ($ in million) Year Ended December 31, 2020 2019 2018 Cash provided by (used in): Operating activities $ (175) $ (311) $ (1,543) Investing activities 432 1,000 1,588 Financing activities (303) (691) (585) Effect of foreign exchange on cash and cash equivalents — — — Net cash flow $ (46) $ (2) $ (541) Operating activities The following represents the significant cash operating activities during the years ended December 31, 2020 and 2019: • Debt service on the Ambac Note was $107 million and $143 million for the years ended December 31, 2020 and 2019, respectively. • In September 2019, AAC received $142 million in connection with an SEC settlement with Citigroup Global Markets Inc. • Cash used related to interest rate derivatives was $20 million and $75 million for the years ended December 31, 2020 and 2019, respectively. • Cash used for operating expenses were $76 million and $82 million for the years ended December 31, 2020 and 2019, respectively. • Cash provided by the investment portfolio was $104 million and $144 million for the years ended December 31, 2020 and 2019, respectively. • Net loss and loss expenses paid, including commutation payments are detailed below: ($ in million) Year Ended December 31, 2020 2019 2018 Net losses paid (1) $ 159 $ 416 $ 344 Net subrogation received (2) (118) (168) (140) Net loss expenses paid 108 70 117 Net cash flow $ 149 $ 318 $ 321 (1) Net losses paid include commutation payments of $13, $214 and $87 for the years ended December 31, 2020, 2019 and 2018, respectively. (2) For the year ended December 31, 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 receipts and premium collections. Investing Activities During 2020, AAC and Ambac UK continued to diversify their investment portfolio from fixed maturity to other assets, primarily hedge funds (increase in fair value of $11 million). Additionally, AFG purchased 80% of Xchange for $74 million in 2020, net of cash acquired. Financing Activities Financing activities for the year ended December 31, 2020, include paydowns of the Ambac Note of $121 million and paydowns/maturities of VIE debt obligations of $178 million. Financing activities for the year ended December 31, 2019, include paydowns of the Ambac Note of $178 million and paydowns of VIE debt obligations of $542 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. Collateral 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. Under these hedge agreements, AFS is required to post collateral or margin to its counterparties and futures commission merchants to cover unrealized losses. 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. 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. Treasury obligations with market values equal to or in excess of market values of the swaps and futures contracts. AFS | Ambac Financial Group, Inc. 51 2020 FORM 10-K | Table of Co ntents may look to re-establish hedge positions that are terminated early, resulting in additional collateral or margin obligations. The amount of additional collateral or margin posted on derivatives contracts will depend on several variables including the degree to which counterparties exercise their termination rights (or agreements terminate automatically) and the terms on which hedges can be replaced. All collateral and margin obligations are currently met. Collateral and margin posted by AFS totaled a net amount of $141 million (cash and securities collateral of $1 million and $140 million, respectively), including independent amounts, under these contracts at December 31, 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 $100 million from December 31, 2019 to $13,220 million at December 31, 2020, primarily due to payment of loss and loss adjustment expenses, interest and operating expenses, and partial redemptions of long-term debt. These were partially offset by higher VIE assets caused by the impact of currency changes (strengthening of pound sterling). Other significant changes during 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 from the continued runoff of the financial guarantee insurance portfolio. Total liabilities increased by approximately $290 million from December 31, 2019, to $12,074 million as of December 31, 2020, primarily due to higher loss reserves and higher consolidated VIE liabilities resulting from currency changes (as notes above), partially offset by lower unearned premiums from the continued runoff of the financial guarantee insurance portfolio. As of December 31, 2020, total stockholders’ equity was $1,140 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 year ended December 31, 2020, of $437 million and translation gains on the consolidation of AFG's foreign subsidiaries.of $23 million. Investment Portfolio . Ambac's investment portfolio is managed under established guidelines designed to meet the investment objectives of AAC, Everspan Group, Ambac UK and AFG. Refer to "Description of the Business — Investments and Investment Policy" in this Annual Report on Form 10-K located in Part I. Item 1, for further description of Ambac's investment policies and applicable regulations. Refer to Note 11. Investments in this Annual Report on Form 10-K located in Part II. Item 8 for information about Ambac's consolidated investment portfolio. Ambac's investment polices and objectives do not apply to the assets of VIEs consolidated as a result of financial guarantees written by its insurance subsidiaries. In the second quarter of 2020, Ambac monetized a material portion of its investments in certain assets classes; including corporate securities rated below the 'A' rated category, all directly owned CMBS (other than Military Housing bonds), and approximately 50% of all CLOs (all rated investment grade) and acquired additional distressed Ambac-insured securities. In the third quarter of 2020, Ambac began acquiring corporate securities rated below 'A' again. These actions resulted in changes to the credit rating distribution of available-for-sale investments from December 31, 2019, to December 31, 2020, illustrated in the charts below. The following table summarizes the composition of Ambac’s investment portfolio, excluding VIE investments, at carrying value at December 31, 2020 and 2019: ($ in millions) December 31, 2020 2019 Fixed maturity securities $ 2,317 $ 2,577 Short-term 492 653 Other investments 595 478 Securities pledged as collateral 140 85 Total investments (1) $ 3,544 $ 3,792 (1) Includes investments denominated in non-US dollar currencies with a fair value of £317 ($434) and €39 ($48) as of December 31, 2020 and £257 ($341) and €2 ($2) as of December 31, 2019. Ambac invests in various asset classes in its fixed maturity securities portfolio. Other investments include diversified equity interests in pooled funds. Refer to Note 11. Investments in this Annual Report on Form 10-K located in Part II. Item 8 for information about fixed maturity securities and pooled funds by asset class. | Ambac Financial Group, Inc. 52 2020 FORM 10-K | Table of Co ntents The following charts provide the ratings (1) distribution of the fixed maturity investment portfolio based on fair value at December 31, 2020 and 2019. (1) Ratings are based on the lower of Moody’s or S&P ratings. If ratings are unavailable from Moody's or S&P, Fitch ratings are used. If guaranteed, rating represents the higher of the underlying or guarantor’s financial strength rating. (2) Below investment grade and not rated bonds insured by Ambac represented 41% and 33% of the 2020 and 2019 combined investment portfolios, respectively. Premium Receivables. Ambac's premium receivables decreased to $370 million at December 31, 2020, from $416 million at December 31, 2019. As further discussed in Note 8. Financial Guarantee Insurance Contracts, in this Annual Report Form 10-K located in Part II. Item 8, the decrease is due to premium receipts, adjustments for changes in expected and contractual cash flows 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: Currency (Amounts in millions) Premium Receivable in Payment Currency Premium Receivable in U.S. dollars U.S. Dollars $ 234 $ 234 British Pounds £ 86 117 Euros € 16 19 Total $ 370 Reinsurance Recoverable on Paid and Unpaid Losses . AAC has reinsurance in place pursuant to surplus share treaty and facultative agreements. To minimize its exposure to losses from reinsurers, AAC (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties under certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by AAC in the event of rating agency downgrades of a reinsurer (among other events and circumstances). AAC benefited from letters of credit and collateral amounting to approximately $117 million from its reinsurers at December 31, 2020. As of December 31, 2020 and 2019, reinsurance recoverable on paid and unpaid losses were $33 million and $26 million, respectively. The increase was primarily a result of adverse development in public finance and student loan insured exposures. Intangible Assets . Intangible assets includes (i) an insurance intangible asset that was established at the Fresh Start Reporting Date, representing the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities of $373 million and (ii) intangible assets of $38 million established as part of the acquisition of Xchange on December 31, 2020. Refer to Note 3. Business Combination for further information relating to this acquisition. As of December 31, 2020 and 2019 the net insurance intangible asset was $409 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). Derivative Assets and Liabilities. The interest rate derivative portfolio is positioned to benefit from rising rates as a partial hedge against interest rate exposure in the financial guarantee and investment portfolios. Derivative assets and liabilities on the balance sheet primarily reflect the portion of the portfolio that is not subject to daily cash variation margin payments. Derivative assets increased from $75 million at December 31, 2019, to $93 million as of December 31, 2020. Derivative liabilities increased from $90 million at December 31, 2019, to $114 million as of December 31, 2020. The increases resulted primarily from lower interest rates during the year ended December 31, 2020. The interest driven increase in derivative assets was partially offset by higher counterparty credit adjustments. | Ambac Financial Group, Inc. 53 2020 FORM 10-K | Table of Co ntents Loss and Loss Expense Reserves and Subrogation Recoverable . Loss and loss expense reserves are based upon estimates of the ultimate aggregate losses inherent in the non-derivative portfolio for insurance policies issued to beneficiaries, including unconsolidated VIEs. 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 Significant Accounting Policies and Note 8. Financial Guarantee Insurance Contracts, respectively, of the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report on Form 10-K, for further information on loss and loss expenses. The loss and loss expense reserves net of subrogation recoverables and before reinsurance as of December 31, 2020 and 2019 were $(397) million and $(482) million, respectively. Loss and loss expense reserves are included in the Consolidated Balance Sheets as follows: Present Value of Expected Net Cash Flows Unearned Premium Revenue Gross Loss and Loss Expense Reserves ($ in millions) Balance Sheet Line Item Claims and Loss Expenses Recoveries (1) December 31, 2020: Loss and loss expense reserves $ 2,060 $ (229) $ (72) $ 1,759 Subrogation recoverable 100 (2,256) — (2,156) Totals $ 2,160 $ (2,485) $ (72) $ (397) December 31, 2019: Loss and loss expense reserves $ 1,835 $ (233) $ (54) $ 1,548 Subrogation recoverable 131 (2,160) — (2,029) Totals $ 1,966 $ (2,394) $ (54) $ (482) (1) Present value of future recoveries include R&W subrogation recoveries of $1,751 and $1,727 at December 31, 2020 and 2019, respectively. Ambac has exposure to various bond types issued in the debt capital markets. Our experience has shown that, for the majority of bond types, we have not experienced significant claims. The bond types that have experienced significant claims, including through commutations, are residential mortgage-backed securities (“RMBS”), student loan securities and public finance securities. These bond types represent 94% of our ever-to-date insurance claims recorded with RMBS comprising 75%. | Ambac Financial Group, Inc. 54 2020 FORM 10-K | Table of Co ntents The table below indicates gross par outstanding and the components of gross loss and loss expense reserves related to policies in Ambac’s gross loss and loss expense reserves at December 31, 2020 and 2019: Present Value of Expected Net Cash Flows Unearned Premium Revenue Gross Loss and Loss Expense Reserves (1)(3) ($ in millions) Gross Par Outstanding (1)(2) Claims and Loss Expenses Recoveries December 31, 2020: RMBS $ 2,530 $ 669 $ (2,102) $ (13) $ (1,446) Domestic Public Finance 3,016 1,112 (349) (39) 724 Student Loans 415 271 (34) (3) 234 Ambac UK and Other Credits 1,612 40 — (17) 23 Loss expenses — 68 — — 68 Totals $ 7,573 $ 2,160 $ (2,485) $ (72) $ (397) December 31, 2019: RMBS $ 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 — 73 — — 73 Totals $ 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 $739 and $33 respectively, at December 31, 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. (2) 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. (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. Variability of Expected Losses and Recoveries Ambac’s management believes that the estimated future loss component of loss reserves (present value of expected net cash flows) are adequate to cover future claims presented, but there can be no assurance that the ultimate liability will not be higher than such estimates. It is possible that our estimated future losses for insurance policies discussed above could be understated or that our estimated future recoveries could be overstated. 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 December 31, 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. In arriving at such view, management makes considerable judgments about the possibility of various future events. Although we do not believe it is possible to have stressed outcomes in all cases, it is possible that we could have stress case outcomes in some or even many cases. 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 this Annual Report on From 10-K for further discussion of the risks relating to future losses and recoveries that could result in more highly stressed outcomes 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 Ambac, including (without limitation) impairing the ability of AAC to honor its financial obligations; the initiation of rehabilitation proceedings against AAC; decreased likelihood of AAC delivering value to AFG, through dividends or otherwise; and a significant drop in the value of securities issued or insured by AFG or AAC. RMBS Variability Ambac has exposure to the U.S. mortgage market primarily through 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, 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. | Ambac Financial Group, Inc. 55 2020 FORM 10-K | Table of Co ntents We established a representation and warranty subrogation recovery as further discussed in Note 8. Financial Guarantee Insurance Contracts to the Consolidated Financial Statements included in this Annual Report on Form 10-K. Our ability to realize RMBS representation and warranty recoveries is subject to significant uncertainty, including risks inherent in litigation, collectability of such amounts from counterparties (and/or their respective parents and affiliates), delays in realizing such recoveries, including delays in getting to trial due to court closures caused by COVID-19 or other events, intervention by the OCI, which could impede our ability to take actions required to realize such recoveries, 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 $1,725 million, net of reinsurance, as of December 31, 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. 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 December 31, 2020, could be approximately $15 million. Combined with the absence of any R&W subrogation recoveries, a possible increase in loss reserves for RMBS could be approximately $1,740 million. A loss of this magnitude may render AAC insolvent. Additionally, loss payments are sensitive to changes in interest rates, increasing as interest rates rise. For example an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately $30 million. There can be no assurance that losses may not exceed such amounts. Additionally, the RMBS portfolio is sensitive to the COVID-19 related forbearances and delinquencies caused by the related general economic downturn. Due to the uncertainties related to the economic effects of the COVID-19 pandemic and other risks associated with RMBS, there can be no assurance that losses may not exceed our stress case estimates. Public Finance Variability Ambac’s U.S. public finance portfolio consists predominantly of municipal bonds such as general and revenue obligations and lease and tax-backed obligations of state and local government entities; however, the portfolio also includes a wide array of non-municipal types of bonds, including financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public purpose facilities and interests. The increase in public finance gross loss reserves at December 31, 2020, as compared to December 31, 2019, was primarily related to declines in discount rates, changes in assumptions on certain credits, particularly Puerto Rico and adverse impact on loss reserves from the global and issuer-specific economic impact of the COVID-19 pandemic. Total public finance gross loss reserves and related gross par outstanding on Ambac insured obligations by bond type were as follows: ($ in millions) Issuer Type December 31, 2020 2019 Gross Par Outstanding (1) Gross Loss Reserves Gross Par Outstanding (1) Gross Loss Reserves Lease and tax-backed $ 1,366 $ 693 $ 1,075 $ 561 General obligation 589 (37) 681 (16) Housing 453 27 457 29 Transportation revenue 220 30 88 42 Other 388 11 97 11 Total $ 3,016 $ 724 $ 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. It is possible our loss reserves for public finance credits may be under-estimated if issuers are faced with prolonged exposure to adverse political, judicial, economic, fiscal or socioeconomic events or trends. 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 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. Our experience with the city of Detroit in 2013 in its bankruptcy proceeding was not favorable and renders future outcomes with other public finance issuers even more difficult to predict and may increase the risk that we may suffer losses that could be sizable. 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. 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 | Ambac Financial Group, Inc. 56 2020 FORM 10-K | Table of Co ntents significant exposure, such as Chicago's school district, the State of New Jersey and many others. Less severe treatment of pension obligations in bankruptcy may lead to worse outcomes for traditional debt creditors. Variability of outcomes applies to even what is generally considered more secure municipal financings, such as dedicated sales tax revenue bonds that capture sales tax revenues for debt service ahead of any amounts being deposited into the general fund of an issuer. In the case of the Puerto Rico COFINA sales tax bonds that were part of the Commonwealth of Puerto Rico's Title III proceedings, AAC and other creditors agreed to settle at a recovery rate equal to about 93% of pre-petition amounts owed on the Ambac insured senior COFINA bonds. In the COFINA case, the senior bonds still received a reduction or "haircut" despite the existence of junior COFINA bonds, which received a recovery rate equal to about 56% of pre-petition amounts owed. 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. 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. Another potentially adverse development that could cause the loss reserves on our public finance credits to be underestimated is deterioration in the municipal bond market, resulting from reduced or limited access to alternative forms of credit (such as bank loans) or other exogenous factors, such as changes in tax law that could reduce certain municipal investors' appetite for tax-exempt municipal bonds or put pressure on issuers in states with high state and local taxes. These factors, as well as more recent volatility in the municipal markets as a result of the COVID-19 related economic downturn and the building budgetary pressures at the state and local level related to the cost of fighting the virus, could deprive issuers access to funding at a level necessary to avoid defaulting on their obligations. In addition, a judicial decision in connection with the PRHTA Title III proceedings could cause the loss reserves on our public finance credits to be underestimated. On January 13, 2020, the U.S. Supreme Court denied a petition for certiorari arising out of an appeal of the March 26, 2019, ruling by the U.S. Court of Appeals for the First Circuit. In the ruling, the First Circuit affirmed the decision by the U.S. District Court overseeing the PROMESA Title III proceedings for the PRHTA, found that under Sections 928(a) and 922(d) of the U.S. Bankruptcy Code, municipal issuers of revenue bonds secured by special revenues are permitted, but not required, to apply special revenues to pay debt service on such revenue bonds during the pendency of bankruptcy proceedings for such municipal issuers. The First Circuit's decision challenges what had been a commonly understood notion in the municipal finance marketplace that municipal revenues bondholders secured by special revenues (as defined in Chapter 9 of the U.S. Bankruptcy Code) would continue to receive payment during a bankruptcy of the municipal issuer. 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. 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 AAC, 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. See Note 17. Commitments and Contingencies to the Consolidated Financial Statements in Part II, Item 8 and "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 this Annual Report on Form 10-K for further updates relating to Puerto Rico. 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 December 31, 2020, the possible increase in loss reserves could be approximately $1,200 million. and there can be no assurance that losses may not exceed our stress case estimates. A loss of this magnitude may render AAC insolvent. Among other things, this estimate includes the possibility that the Commonwealth Plan of Adjustment (as discussed above in the Financial Guarantees in Force section of this Management Discussion and Analysis) were to become effective. Student Loan Variability Changes to assumptions that could make our reserves under-estimated include, but are not limited to, increases in interest rates, default rates and loss severities on the collateral due to economic or other factors, including the COVID-19 related economic downturn. 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 December 31, 2020, the possible increase in loss reserves could be approximately $25 million. Additionally, an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately $20 million. Additionally, the student loan portfolio is sensitive to COVID-19 related payment moratoriums and delinquencies caused by the general economic downturn. Due to such factors, there can be no assurance that losses may not exceed our stress case estimates. | Ambac Financial Group, Inc. 57 2020 FORM 10-K | Table of Co ntents Other Credits, including Ambac UK, Variability 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 $400 million greater than the loss reserves at December 31, 2020. Additionally, our loss reserves may be under estimated as a result of the ultimate scope, duration and magnitude of the effects of COVID-19. There can be no assurance that losses may not exceed our stress case estimates. Long-term Debt. Long-term debt consists of senior and junior surplus notes issued by AAC, the Ambac Note and Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions, and Ambac UK debt issued in connection with the 2019 Ballantyne commutation. The carrying value of each of these as of December 31, 2020 and 2019 is below: ($ in millions) December 31, 2020 December 31, 2019 Surplus notes $ 778 $ 769 Ambac note 1,641 1,763 Tier 2 notes 306 278 Ambac UK debt 14 13 Total Long-term Debt $ 2,739 $ 2,822 The decrease in long-term debt from December 31, 2019 is primarily due to optional redemptions of the Ambac Note of $121 million, partially offset by accretion on the carrying value of the surplus notes, Tier 2 Notes and Ambac UK debt. Redeemable Noncontrolling Interest . The increase during 2020 was the result of the acquisition of Xchange on December 31, 2020. Refer to Note 3. Business Combination for further information relating to this acquisition. ACCOUNTING STANDARDS The following accounting standards have been issued but have not yet been adopted. We do not expect these accounting 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. Simplifying Income Tax Accounting In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes . The FASB issued this ASU as part of its initiative to reduce complexity in accounting standards. The ASU removes certain exceptions in the guidance related to investments, intra-period allocations and interim period allocations. It further adds new guidance related to the allocation of consolidated income taxes and evaluating a step-up in the tax basis of goodwill. The ASU is effective for fiscal years beginning after December 15, 2020, with early adoption permitted. The modified disclosures must be applied on a retrospective basis for all periods presented. Ambac will adopt this ASU on January 1, 2021. Please refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements, included in Part II, Item 8 in this Annual Report Form 10-K for the year ended December 31, 2020, for a discussion of the impact of other recent accounting pronouncements on Ambac’s financial condition and results of operations. AAC STATUTORY BASIS FINANCIAL RESULTS AAC statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by the OCI. OCI recognizes only statutory accounting practices prescribed or permitted by the State of Wisconsin (“SAP”) for determining and reporting the financial condition and results of operations of an insurance company for determining its solvency under Wisconsin Insurance Law. The National Association of Insurance Commissioners (“NAIC”) Accounting Practices and Procedures manual (“NAIC SAP”) has been adopted as a component of prescribed practices by the State of Wisconsin. Additionally, the OCI has prescribed additional practices and has permitted accounting practices for AAC. For further information, see Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Annual Report Form 10-K. AAC’s statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were $865 million and $1,413 million at December 31, 2020, respectively, as compared to $1,088 million and $1,618 million at December 31, 2019, respectively. As of December 31, 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 $544 million that is not recorded under statutory basis accounting principles), preferred stock and all other liabilities (including insurance claims and debt issued by AAC) are obligations that have claims on the resources of AAC that are senior to AFG's equity and therefore impact AFG's ability to realize residual value or receive dividends from AAC. The significant drivers to the net decrease in policyholder surplus were statutory net losses of $213 million for the year ended December 31, 2020, (excluding dividends from | Ambac Financial Group, Inc. 58 2020 FORM 10-K | Table of Co ntents subsidiaries) and contributions to contingency reserves of $18 million. AAC’s statutory surplus is sensitive to multiple factors, including: (i) loss reserve development, (ii) approval by OCI of payments on surplus notes, (iii) on-going interest costs associated with the Ambac Note and Tier 2 Notes, including changes to the interest rates as the Ambac Note is a floating rate obligation, (iv) deterioration in the financial position of AAC subsidiaries that have their obligations guaranteed by AAC, (v) first time payment defaults of insured obligations, which increase statutory loss reserves, (vi) commutations of insurance policies or credit derivative contracts at amounts that differ from the amount of liabilities recorded, (vii) reinsurance contract terminations at amounts that differ from net assets recorded, (viii) changes to the fair value of pooled fund and other investments carried at fair value, (ix) settlements of representation and warranty breach claims at amounts that differ from amounts recorded, including failures to collect such amounts, (x) realized gains and losses, including losses arising from other than temporary impairments of investment securities, and (xi) future changes to prescribed SAP practices by the OCI. The significant differences between GAAP and SAP are that under SAP: • Loss reserves are only established for losses on guaranteed obligations that have experienced a payment default in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default, less estimated recoveries under subrogation rights (5.1% as prescribed by OCI). Under GAAP, in addition to the establishment of loss reserves for defaulted obligations, loss reserves are established (net of GAAP basis unearned premium revenue) for obligations that have experienced credit deterioration, but have not yet defaulted using a weighted-average risk-free discount rate, currently at 1.1%. • Mandatory contingency reserves are required based upon the type of obligation insured, whereas GAAP does not require such a reserve. Releases of the contingency reserves are generally subject to OCI approval and relate to a determination that the held reserves are deemed excessive. • Investment grade fixed maturity investments are stated at amortized cost and certain below investment grade fixed maturity investments are reported at the lower of amortized cost or fair value. Under GAAP, all fixed maturity investments are reported at fair value. • Wholly owned subsidiaries are not consolidated; rather, the equity basis of accounting is utilized and the carrying values of these investments are subject to admissibility tests. • Variable interest entities ("VIE") are not required to be assessed for consolidation. Under GAAP, a reporting entity that has both the following characteristics is required to consolidate the VIE: a) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and b) the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. AAC generally has the obligation to absorb losses of VIEs that could potentially be significant to the VIE as the result of its guarantee of insured obligations issued by VIEs. For certain VIEs AAC has the power to direct the most significant activities of the VIE and accordingly consolidates the related VIEs under GAAP. • All payments of principal and interest on the surplus notes are subject to the approval of the OCI. Unpaid interest due on the surplus notes is expensed when the approval for payment of interest has been granted by the OCI. Under GAAP, interest on surplus notes is accrued regardless of OCI approval. • Upfront premiums written are earned on a basis proportionate to the remaining scheduled debt service to the original total principal and interest insured. Installment premiums are reflected in income pro-rata over the period covered by the premium payment. Under GAAP, premium revenues for both upfront and installment premiums are earned over the life of the financial guarantee contract in proportion to the insured principal amount outstanding at each reporting date. • Insurance intangibles that arose as a result of the implementation of Fresh Start reporting is not a concept within SAP. This insurance intangible asset is amortized as an expense on a level yield basis over the life of the related insurance risks. 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 £412 million at December 31, 2020, as compared to £387 million at December 31, 2019. At December 31, 2020, the carrying value of cash and investments was £481 million, a 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 investment income, partially offset by loss expenses, foreign exchange losses within Ambac UK's investment portfolio and operating expense and tax payments. The significant differences between U.S. GAAP and UK GAAP are that under UK GAAP: • Loss reserves are only established for losses on guaranteed obligations when, in the judgment of management, a monetary default in the timely payment of debt service is likely to occur, which would result in Ambac UK incurring a loss. A loss provision is established in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default, less estimated recoveries under subrogation rights. The discount rate is equal to the lower of the rate of return on invested assets for either the current year or the period covering the current year plus the four previous years. Under U.S. GAAP, loss reserves are established (net of U.S. GAAP basis unearned premium revenue) for obligations that have experienced credit deterioration, but have not yet defaulted using a weighted-average risk-free discount rate. • Investments in fixed maturity securities are stated at amortized cost, subject to an other-than-temporary | Ambac Financial Group, Inc. 59 2020 FORM 10-K | Table of Co ntents impairment evaluation. Under U.S. GAAP, all bonds are reported at fair value and are evaluated for credit impairments under CECL, • Purchases of Ambac UK insured securities are bifurcated into an intrinsic and an Ambac UK claim based value. The intrinsic value is recorded as an investment whereas the Ambac UK claim based value is recorded as a claim payment with an accompanying reduction in Ambac UK loss reserves. Under U.S. GAAP, investments in Ambac UK insured securities are reported as investments and do not reduce loss reserves. • VIEs are not required to be assessed for consolidation. Under U.S. GAAP, as noted under AAC Statutory Basis Financial Results above, VIE's with certain characteristics are required to be consolidated. For several VIEs Ambac UK has the power to direct the most significant activities of the VIE and accordingly consolidates the related VIEs under U.S. GAAP. • Upfront premiums written are earned on a basis proportionate to the remaining scheduled debt service to the total principal and interest insured. Installment premiums are reflected in income pro-rata over the period covered by the premium payment. Under U.S. GAAP, premium revenues for both upfront and installment premiums are earned over the life of the financial guarantee contract in proportion to the insured principal amount outstanding at each reporting date. • Insurance intangibles that arose as a result of the implementation of Fresh Start reporting is not a concept within UK GAAP. Under U.S. GAAP, this insurance intangible asset is amortized as an expense on a level yield basis over the life of the related insurance risks. 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. The calculation of capital resources, regulatory capital requirements and regulatory capital deficits under Solvency II at December 31, 2020, will be published on Ambac's website during March 2021. Final annual Solvency II data and Ambac UK's annual Solvency and Financial Condition Report will be published on Ambac's website during April 2021. Available capital resources under Solvency II were a surplus of £196 million at December 31, 2020, of which £188 million are eligible to meet solvency capital requirements. This is an increase from December 31, 2019, when available capital resources were a surplus of £184 million of which £178 million were eligible to meet solvency capital requirements. Eligible capital resources at December 31, 2020 and December 31, 2019, are in comparison to regulatory capital requirements of £256 million and £208 million, respectively. Therefore, Ambac UK was deficient in terms of compliance with applicable regulatory capital requirements by £72 million and £30 million at December 31, 2020 and December 31, 2019, respectively. The deficit increased as at December 31, 2020, due to the combined impact of (i) the reduction in long term interest rates, which resulted in an increase in technical provision liabilities and hence a reduction in eligible own funds and (ii) an increase in capital requirements for non-life risk due to parameter changes within the solvency capital requirement calculation. 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. NON-GAAP FINANCIAL MEASURES In addition to reporting the Company’s quarterly financial results in accordance with GAAP, the Company currently reports two non-GAAP financial measures: Adjusted Earnings and Adjusted Book Value. The most directly comparable GAAP measures are net income attributable to common stockholders for Adjusted Earnings and Total Ambac Financial Group, Inc. stockholders’ equity for Adjusted Book Value. A non-GAAP financial measure is a numerical measure of financial performance or financial position that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying drivers of our business. Adjusted Earnings and Adjusted Book Value are not substitutes for the Company’s GAAP reporting, should not be viewed in isolation and may differ from similar reporting provided by other companies, which may define non-GAAP measures differently. Ambac has a significant U.S. 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; which is subject to change. The following paragraphs define each non-GAAP financial measure and describe why it is useful. A reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure is also presented below. Adjusted Earnings (Loss). Adjusted Earnings (Loss) is defined as net income (loss) attributable to common stockholders, as reported under GAAP, adjusted on an after-tax basis for the following: • 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. 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. These adjustments allow for all financial guarantee contracts to be accounted for consistent with the Financial Services – Insurance Topic of ASC, whether or not they are subject to derivative accounting rules. • Insurance intangible amortization: Elimination of the amortization of the financial guarantee insurance intangible asset that arose as a result of the Ambac's emergence from bankruptcy and 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. | Ambac Financial Group, Inc. 60 2020 FORM 10-K | Table of Co ntents • Foreign exchange (gains) losses: Elimination of the foreign exchange gains (losses) on the re-measurement of assets, liabilities and transactions in non-functional currencies. 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 business results without the impact of fluctuations in foreign currency exchange rates and facilitates period-to-period comparisons of Ambac's operating performance. The following table reconciles net income attributable to common stockholders to the non-GAAP measure, Adjusted Earnings on a total dollar amount and per diluted share basis, for all periods presented: 2020 2019 2018 ($ in millions, except per share data) Year Ended December 31, $ Amount Per Diluted Share $ Amount Per Diluted Share $ Amount Per Diluted Share Net income (loss) attributable to common stockholders $ (437) $ (9.47) $ (216) $ (4.69) $ 186 $ 3.99 Adjustments: Non-credit impairment fair value (gain) loss on credit derivatives — — (1) (0.03) 1 0.02 Insurance intangible amortization 57 1.23 295 6.43 107 2.30 Foreign exchange (gains) losses 3 0.06 (12) (0.26) 7 0.15 Adjusted Earnings (Loss) $ (378) $ (8.19) $ 66 $ 1.44 $ 301 $ 6.47 Adjusted Book Value. Adjusted Book Value is defined as Total Ambac Financial Group, Inc. stockholders’ equity as reported under GAAP, adjusted for after-tax impact of the following: • Non-credit impairment fair value losses on credit derivatives: Elimination of the non-credit impairment fair value loss on credit derivatives, which is the amount in excess of the present value of the expected estimated economic credit loss. GAAP fair values are affected by, and in part fluctuate with, changes in market factors such as interest rates, credit spreads, including Ambac’s CVA that are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee contracts to be accounted for within Adjusted Book Value consistent with the provisions of the Financial Services—Insurance Topic of the ASC, whether or not they are subject to derivative accounting rules. • Insurance intangible asset: Elimination 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 within Adjusted Book Value consistent with the provisions of the Financial Services—Insurance Topic of the ASC. • Net unearned premiums and fees in excess of expected losses: Addition of the value of the unearned premium revenue ("UPR") on financial guarantee contracts, in excess of expected losses, net of reinsurance. This non-GAAP adjustment presents the economics of UPR and expected losses for financial guarantee contracts on a consistent basis. In accordance with GAAP, stockholders’ equity reflects a reduction for expected losses only to the extent they exceed UPR. However, when expected losses are less than UPR for a financial guarantee contract, neither expected losses nor UPR have an impact on stockholders’ equity. This non-GAAP adjustment adds UPR in excess of expected losses, net of reinsurance, to stockholders’ equity for financial guarantee contracts where expected losses are less than UPR. • Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income: Elimination of the unrealized gains and losses on the Company’s investments that are recorded as a component of accumulated other comprehensive income (“AOCI”). The AOCI component of the fair value adjustment on the investment portfolio may differ from realized gains and losses ultimately recognized by the Company based on the Company’s investment strategy. This adjustment only allows for such gains and losses in Adjusted Book Value when realized. | Ambac Financial Group, Inc. 61 2020 FORM 10-K | Table of Co ntents 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: 2020 2019 ($ in millions, except per share data) December 31, $ Amount Per Share $ Amount Per Share Total Ambac Financial Group, Inc. stockholders’ equity $ 1,080 $ 23.57 $ 1,477 $ 32.41 Adjustments: Non-credit impairment fair value losses on credit derivatives — 0.01 — 0.01 Insurance intangible asset (373) (8.14) (427) (9.37) Net unearned premiums and fees in excess of expected losses 378 8.24 414 9.09 Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income (Loss) (166) (3.63) (151) (3.31) Adjusted Book Value $ 919 $ 20.05 $ 1,313 $ 28.83 The decrease in Adjusted Book Value was primarily attributable to the Adjusted Loss for the year ended December 31, 2020, excluding earned premium previously included in Adjusted Book Value, partially offset by foreign exchange translation gains. 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. Net unearned premiums and fees in excess of expected losses will affect Adjusted Book Value for (i) changes to future premium assumptions (e.g. expected term, interest rates, foreign currency rates, time passage) and (ii) changes to expected losses for policies which do not exceed their related unearned premiums and (iii) new reinsurance transactions. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments, as a result of changes in market rates and prices, such as interest rates (inclusive of credit spreads), foreign currency exchange rates and other relevant market rate or price changes. Market risk is, in part, a function of the markets in which the underlying assets are traded. The Company’s market risk sensitive financial instruments are primarily entered into for purposes other than trading. As discussed further below, the Company’s primary market risk exposures include those from changes in interest rates, foreign currency exchange rates and equity values of limited partnership and other alternative investments. • The primary market risks for fixed maturity investment securities are interest rate risk and exchange rate risk. Ambac’s fixed maturity investment portfolio includes securities denominated both in U.S. dollars and foreign currencies, which are sensitive to changes in interest rates and foreign currency exchange rates. Our fixed maturity investments are classified as available for sale, with the effect of market movements recognized immediately through Other comprehensive income, or through Net income when securities are sold or when an impairment charge is recorded. • Ambac also invests in limited partnerships and other alternative investments, primarily consisting of diversified pooled investment funds, which are reported as Other investments. These funds are subject to equity value changes driven primarily by changes to their respective net asset value (“NAV”). Ambac’s share of the changes of the equity value of the funds is reported through Net income. For additional information about Ambac’s investments, see Note 11. Investments to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. • The interest rate derivatives portfolio is managed as a partial hedge against the effects of rising interest rates elsewhere in the Company, including on Ambac's financial guarantee exposures. Changes in fair value of interest rate derivatives are recognized immediately through Net income. For additional information about Ambac’s interest rate derivatives, see Note 12. Derivative Instruments to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. • Although our long-term debt obligations are reported at amortized cost and not adjusted for fair value changes, changes in interest rates could have a material impact on their fair value, though with no direct impact on our consolidated financial statements. For additional information about Ambac’s debt obligations, see Note 13. Long-Term Debt to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K. Fixed maturity investment securities that are distressed Ambac-insured bonds have market risk characteristics that behave inversely to those associated with future financial guarantee claim payments. Accordingly, such securities are excluded from the market risk sensitivity measures below. Financial instruments of VIEs that are consolidated as a result of Ambac financial guarantees are also excluded from Ambac's measures of market risk. Ambac’s exposure to such consolidated VIEs is generally limited to financial guarantees outstanding on the VIEs’ liabilities or assets. See Note 4. Variable Interest Entities to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information about VIEs consolidated as a result of Ambac’s financial guarantees. Ambac utilizes various systems, models and sensitivity scenarios to monitor and manage market risk. These models include estimates, made by management, which utilize current and historical market information. This market information is considered in management’s judgments about adverse sensitivity | Ambac Financial Group, Inc. 62 2020 FORM 10-K | Table of Co ntents scenarios that are reasonably possible to occur in the near-term. The impact of these scenarios do not consider the possible simultaneous movement in other market rates or prices, actions of management or other factors that could lessen or worsen actual results. For these reasons, the valuation results from these models could differ materially from amounts actually realized in the market. The Company’s market risk exposures have changed over the course of 2020 primarily as a result of re-positioning of our investment and derivative portfolios. Prior year-end quantitative market risk sensitivity disclosures below have been updated to conform with the current presentation. Market Risk Sensitivities Interest Rate Risk Financial instruments for which fair value may be affected by changes in interest rates consist primarily of fixed maturity investment securities, long-term debt and interest rate derivatives. Increases to interest rates would result in declines in the fair value of our fixed maturity investment portfolio. Interest rate increases would also have a negative economic impact on expected future claim payments within the financial guarantee portfolio, primarily related to RMBS and student loan policies. Conversely, interest rate increases would generally result in fair value gains on interest rate derivatives and lower the fair value of our debt obligations. Ambac performs scenario testing to measure the potential for losses in volatile markets. These scenario tests include parallel and non-parallel shifts in the benchmark interest rate curve. We also monitor our interest rates exposure through periodic reviews of projected cash flows and durations of our asset and liability positions. The following table summarizes the estimated change in fair value of our fixed maturity investment portfolio of a hypothetical immediate increase in interest rates of 100 basis points across the yield curve as of December 31, 2020 and 2019: ($ in millions) December 31, 2020 2019 Fair value of fixed maturity investment (1) $ 2,329 $ 2,343 Pre-tax impact of 100 basis point increase in interest rates Decrease in dollars $ (69) $ (65) As a percent of fair value 3 % 3 % (1) Excludes investments in distressed Ambac-insured securities and securities held by VIEs consolidated as a result of Ambac’s financial guarantees The following table presents the impact on the fair value of our long-term debt obligations and interest rate derivatives of a hypothetical immediate decrease in interest rates of 100 basis points across the yield curve as of December 31, 2020 and 2019: ($ in millions) December 31, 2020 2019 Fair value of long-term debt including accrued interest (1) $ (3,071) $ (3,274) Pre-tax impact of 100 basis point decrease in interest rates Increase in dollars $ (58) $ (33) As a percent of fair value 2 % 1 % Fair value of interest rate derivative net assets (liabilities) (1) $ (21) $ (15) Pre-tax impact of 100 basis point decrease in interest rates Pre-tax loss from change in fair value in dollars $ (8) $ (36) (1) Excludes long-term debt and derivative instruments of VIEs consolidated as a result of Ambac’s financial guarantees Foreign Currency Risk Ambac has fixed maturity investments and investments in pooled funds denominated in currencies other than the U.S. dollar, primarily British pounds sterling and euros. These financial instruments are primarily invested assets of Ambac UK and are held in consideration of non-U.S. dollar exposure in the financial guarantee insurance portfolio and operations of Ambac UK. The adverse fair value impact of a stronger U.S. dollar relative to other currencies on investment holdings would be directionally offset by the economic benefits to non-U.S. dollar financial guarantees and other risk exposures. The following table summarizes the estimated decrease in fair value of these financial instruments assuming immediate 20% strengthening of the U.S. dollar relative to the foreign currencies as of December 31, 2020 and 2019: ($ in millions) December 31, 2020 2019 Fair value of investments denominated in currencies other than the U.S. dollar (1) $ 453 $ 343 Pre-tax impact of 20% strengthening of the U.S. dollar $ (91) $ (69) (1) Excludes investments in distressed Ambac-insured securities and securities held by VIEs consolidated as a result of Ambac’s financial guarantees | Ambac Financial Group, Inc. 63 2020 FORM 10-K | Table of Co ntents Equity Sensitivity Ambac’s investment portfolio includes equity and partnership interests in pooled funds with diverse asset holdings and strategies. The table below summarizes the decrease in fair value of Ambac’s pooled fund investments that would occur assuming an immediate and uniform 10% decline in NAV of the funds. The selection of a 10% fair value stress is made only as an illustration of the hypothetical impact of adverse market movements on Ambac’s investments with equity value sensitivity. Actual market shocks could have materially different aggregate results and would likely not have a uniform impact on all funds given the diversity of the funds’ holdings and strategies. ($ in millions) December 31, 2020 2019 Fair value of investments in pooled funds $ 544 $ 432 Pre-tax impact of 10% decline in NAV of the funds $ (54) $ (43) | Ambac Financial Group, Inc. 64 2020 FORM 10-K | Table of Co ntents Item 8. Financial Statements and Supplementary Data AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Reports of Independent Registered Public Accounting Firm 66 Consolidated Financial Statements Consolidated Balance Sheets 69 Consolidated Statements of Stockholders’ Equity 71 Consolidated Statements of Total Comprehensive Income (Loss) 70 Consolidated Statements of Cash Flows 72 Notes to Consolidated Financial Statements Note 1. Background and Business Description 73 Note 10. Fair Value Measurements 108 Note 2. Basis of Presentation and Significant Accounting Policies 76 Note 11. Investments 116 Note 3. Business Combination 89 Note 12. Derivative Instruments 121 Note 4. Variable Interest Entities 90 Note 13. Long-term Debt 123 Note 5. Comprehensive Income 94 Note 14. Income Taxes 126 Note 6. Net Income Per Share 95 Note 15. Employment Benefit Plans 127 Note 7. Financial Guarantees in Force 96 Note 16. Leases 130 Note 8. Financial Guarantee Insurance Contracts 96 Note 17. Commitments and Contingencies 131 Note 9. Insurance Regulatory Restrictions 104 Note 18. Quarterly Information (Unaudited) 141 | Ambac Financial Group, Inc. 65 2020 FORM 10-K | Table of Co ntents Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors Ambac Financial Group, Inc.: Opinion on Internal Control Over Financial Reporting We have audited Ambac Financial Group, Inc. and subsidiaries' (the Company) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of total comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules I, II and IV (collectively, the consolidated financial statements), and our report dated March 1, 2021 expressed an unqualified opinion on those consolidated financial statements. Basis for Opinion The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting . Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Definition and Limitations of Internal Control Over Financial Reporting A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ KPMG LLP New York, New York March 1, 2021 | Ambac Financial Group, Inc. 66 2020 FORM 10-K | Table of Co ntents Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors Ambac Financial Group, Inc.: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Ambac Financial Group, Inc. and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of total comprehensive income (loss), stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes and financial statement schedules I, II and IV (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 1, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. Estimate of loss and loss expense reserves and subrogation recoverable As described in Notes 2 and 8 to the consolidated financial statements, the Company estimates loss and loss expense reserves and subrogation recoverable (loss reserves) on a policy-by-policy basis based upon the present value of expected net claim cash outflows or expected net recovery cash inflows, discounted at risk-free rates. Expected net claim cash outflows represent the present value of expected claim cash outflows, less the present value of expected recovery cash inflows. For such policies, a loss and loss expense reserves liability is recorded for the present value of expected net claim cash outflows in excess of the related unearned premium revenue. Expected net recovery cash inflows represent the present value of expected recovery cash inflows, less the present value of expected claim cash outflows. For such policies, a subrogation recoverable asset is recorded. As of December 31, 2020, the Company recorded loss and loss expense reserves of $1,759 million and subrogation recoverable of $2,156 million. We identified the evaluation of loss reserves as a critical audit matter. The evaluation encompassed the assessment of the loss reserve methodologies, including those methods used to estimate the following assumptions: (1) credit worthiness of the issuer of the insured security, (2) the likelihood of possible outcomes regarding the probability of default by the issuer of the insured security, (3) the expected loss severity for each insurance policy, (4) the probability of remediation, settlement and restructuring outcomes, and (5) the probability of successful litigation or related settlement outcomes, as well as the percentage of the breach rates of representations and warranties underlying certain insured residential mortgage backed securities. The evaluation of the methods and the impact of these assumptions required specialized skills and subjective and complex auditor judgment due to a high level of estimation uncertainty. The following are the primary procedures we performed to address this critical audit matter. With the involvement of professionals with specialized industry knowledge and experience, when necessary, we evaluated the design and tested the operating effectiveness of certain internal controls related to the Company's estimation of loss reserves. This included controls related to the determination of the sources of data and assumptions and the analysis of the loss reserves and historical trends. We inquired of internal and external | Ambac Financial Group, Inc. 67 2020 FORM 10-K | Table of Co ntents legal counsel and read letters received directly from the Company’s internal and external legal counsel regarding the status of litigation underlying certain insurance policies. We involved credit risk professionals with specialized skills and knowledge, who assisted in assessing the individual issuer ratings and credit classifications for certain policies by evaluating the financial performance of the issuer of the insured security and underlying collateral. We involved forensics professionals with specialized skills and knowledge, who assisted in inspecting underwriting documentation for certain mortgage loans underlying insured residential mortgage backed securities, which were examined by the Company’s consultants engaged to determine breach rates of representations and warranties. We also involved valuation professionals with specialized skills and knowledge, who assisted in: • evaluating the methods used to estimate loss reserves for compliance with U.S. generally accepted accounting principles • evaluating, for certain policies, the sources of data and assumptions used in the calculation of loss reserves by comparing to internal experience and related historical and industry trends • developing, for certain policies, an independent estimate of the loss reserves and comparing it to the recorded estimate. /s/ KPMG LLP We have served as the Company’s auditor since 1985. New York, New York March 1, 2021 | Ambac Financial Group, Inc. 68 2020 FORM 10-K | Table of Co ntents AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES Consolidated Balance Sheets (Dollars in millions, except share data) December 31, 2020 2019 Assets: Investments: Fixed maturity securities, at fair value (amortized cost of $ 2,175 and $ 2,450 ) $ 2,317 $ 2,577 Fixed maturity securities pledged as collateral, at fair value (amortized cost of $ 15 and $ 0 ) 15 — Short-term investments, at fair value (amortized cost of $ 492 and $ 653 ) 492 653 Short-term investments pledged as collateral, at fair value (amortized cost of $ 125 and $ 85 ) 125 85 Other investments (includes $ 544 and $ 432 at fair value) 595 478 Total investments (net of allowance for credit losses of $ 0 at December 31, 2020) 3,544 3,792 Cash and cash equivalents 20 24 Restricted cash 13 55 Premium receivables (net of allowance for credit losses of $ 17 at December 31, 2020) 370 416 Reinsurance recoverable on paid and unpaid losses (net of allowance for credit losses of $ 0 at December 31, 2020) 33 26 Deferred ceded premium 70 82 Subrogation recoverable 2,156 2,029 Derivative assets 93 75 Current taxes — 11 Intangible assets 409 427 Other assets 114 95 Variable interest entity assets: Fixed maturity securities, at fair value 3,354 3,121 Restricted cash 2 2