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Item 7. Management’s Discussion and Analysis

2021-03-01 compared with 2020-03-02 · 950 added, 727 removed, 724 unchanged (70% of the section changed)

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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

Ambac Assurance and Subsidiaries

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

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

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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)

Other net assets 10

(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.

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Asset Management

Investment portfolios are subject to internal investment guidelines, as well as limits on types and quality of investments imposed by applicable insurance laws and regulations.

As part of its investment strategy, and in accordance with the aforementioned guidelines, Ambac Assurance and Ambac Assurance UK Limited ("Ambac UK"), purchase distressed Ambac-insured securities based on their relative risk/reward characteristics.

The investment portfolios of Ambac Assurance and Ambac UK also hold fixed income securities and various pooled investment funds.

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 income investments by asset category and pooled investment funds by investment type.

During the year ended December 31, 2019 , Ambac did not acquire a significant amount of distressed Ambac-insured securities.

At December 31, 2019 , Ambac owned $436 million of distressed

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Ambac-insured bonds, including $158 million of Puerto Rico bonds and excluding Ambac's holdings of secured notes issued by Ambac LSNI (the "Secured Notes") in connection with 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).

Subject to applicable internal and regulatory guidelines and other constraints, Ambac may opportunistically purchase and sell Ambac-insured securities and Secured Notes in the future.

In the event that Ambac Assurance sells any of the Secured Notes it owns, it must use the proceeds of such sale to redeem a like amount of Secured Notes at par in accordance with the terms of the Indenture and related security and collateral documents.

The price at which Ambac Assurance sells the Secured Notes may differ from the price at which it redeems the Secured Notes.

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

Ambac Assurance's Risk Management Group ("RMG") focuses on the analysis, implementation and execution of risk reduction, loss mitigation and loss recovery strategies.

Analysts evaluate the estimated timing and severity of projected policy claims as well as the potential impact of such strategies in order to target and prioritize policies, or portions thereof, for commutation, reinsurance, refinancing, restructuring or other risk reduction and loss mitigation outcomes.

For targeted policies, analysts will engage with bondholders, issuers and other economic stakeholders to negotiate, structure and execute such strategies.

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:

The COFINA Plan of Adjustment ("POA").

On February 12, 2019, the POA, including certain related commutation transactions, and subsequent distributions, became effective, resulting in a reduction of Ambac Assurance's insured net par exposure to COFINA by approximately 77% or $620 million.

Subsequent redemptions of obligations of the COFINA Class 2 Trust (as further described in the Financial Guarantees in Force section included in Part II, Item 7 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 ) brought COFINA net par outstanding down to $101 million as of December 31, 2019 ;

An Irish scheme of arrangement (the "Arrangement") on June 17, 2019, for the restructuring of Ballantyne Re plc ("Ballantyne").

This restructuring allowed for the commutation of $900 million of Ambac UK's net par outstanding.

See below under Financial Guarantees in Force for further details of the Arrangement;

Purchasing quota share reinsurance in September 2019 to sculpt the risk profile of the insured portfolio.

This included ceding certain public finance exposures totaling $1.2 billion of par exposure (principal and interest of $2.4 billion), which were comprised of lease and tax-backed revenue ($616 million par), general obligation ($374 million par), transportation ($240 million par) and higher education ($4 million par) exposures and included $509 million par of watch list and adversely classified credits;

Purchasing quota share reinsurance in December 2019 for $228 million of par exposure, including $153 million of watch list credits;

Completing work in January 2019, with an issuer to refinance two watch list asset-backed lease securitizations with net par outstanding of $95 million at December 31, 2018;

A commutation in February 2019, via a refunding, of an adversely classified public finance transaction with net par outstanding of $350 million at December 31, 2018;

Working with an issuer and noteholders to negotiate the removal of the guarantee from a tranche of notes on a Watch List credit in December 2019 with net par of $300 million outstanding at December 31, 2018;

Working closely with servicers and owners of Master Servicing Rights to exercise their clean-up call rights on several watch list and adversely classified RMBS transactions with total net par outstanding of $200 million at December 31, 2018;

The final paydown, refunding, or partial commutation of various watch list exposures and adversely classified exposures that were subject to risk remediation efforts with total net par outstanding at December 31, 2018 of $463 million.

The following table provides a comparison of total, adversely classified credits ("ACC") and watch list net par outstanding in the insured portfolio at December 31, 2019 and 2018 .

Basis of Presentation and Significant Accounting Policies t o the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K for a description of adversely classified and watch list credits.) Net par exposures within the U.S.

• 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;

• 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)

The overall reduction in total net par outstanding was significantly impacted by active de-risking initiatives at Ambac Assurance and Ambac UK, including the transactions noted above, as well as scheduled maturities, amortizations, refundings and calls.

The decrease in Watch List and ACC exposures is primarily due to active de-risking and paydowns or calls by issuers, mostly related to Puerto Rico, Ballantyne, international asset-backed, public finance, aircraft asset-backed and residential mortgage-backed securities.

Although our insured portfolio generally performed satisfactorily in 2019, we continue to experience stress in certain insured exposures, particularly within our approximately $1,123 million of exposure to Puerto Rico, consisting of several different issuing entities (all below investment grade).

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

During 2019, Ambac made partial paydowns of the Ambac Note (as defined in Note 1.

Background and Business Description t o the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K) by $178 million .

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

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As of December 31, 2019 net assets of AFG were $483 million .

($ in millions)

Cash and short-term investments

Other investments (1)

Other net assets (2)

Includes surplus notes (fair value of $63 ) issued by Ambac Assurance that are eliminated in consolidation.

Includes accruals for tolling payments from Ambac Assurance in accordance with the intercompany Tax Sharing Agreement of $28 .

As a result of positive taxable income at Ambac Assurance in 2017, AFG has accrued approximately $28 million in tax tolling payments.

In May 2018, AFG executed a waiver under the intercompany Tax Sharing Agreement pursuant to which Ambac Assurance was relieved of the requirement to make this payment by June 1, 2018.

AFG also agreed to continue to defer the tolling payment for the use of net operating losses in 2017 by Ambac Assurance until such time as OCI (as defined in Note 1.

Background and Business Description t o the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K) consents to the payment.

Ambac Assurance accrued $16 million of tolling payments for year ended December 31, 2018, which were paid to AFG in July of 2019.

As a result of filing it's 2018 tax return, Ambac Assurance accrued an additional $2 million of tolling payments during the year ended December 31, 2019, for 2018, which were paid to AFG in December 2019.

Pursuant to the Stipulation and Order, Ambac's tax positions are subject to review by the OCI, which may lead to the adoption of positions that reduce the amount of tolling payments otherwise available to AFG.

Financial Statement Impacts of Foreign Currency

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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.

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

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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:

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Net income (1)

Changes in other comprehensive income(loss):

Gain (losses) on foreign currency translation

Unrealized gains (losses) on non-functional currency available-for-sale securities

Total changes in other comprehensive income (loss)

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

A portion of Ambac UK's, and to a lesser extent Ambac Assurance'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).

(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 Form 10-K for further details on transaction gains and losses.

Future changes to currency rates, including as a result of a no deal Brexit, may adversely affect our financial results.

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.

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

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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.

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

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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, market conditions, industry trends and other information that is reasonable under the circumstances.

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.

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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 cash flows on public finance and structured finance transactions (including RMBS).

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.

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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.

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.

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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.

addition, many transactions have a combination of issuer/entity and collateral support.

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 result of the credit performance of our insured portfolio, including the number, size, bond types and quality of credits included in our loss reserves;

Loss reserve volatility will be a direct

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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;

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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.

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.

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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:

($ in millions) December 31

($ in millions) December 31 Gross Par

Outstanding (1)(2)

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Reserves (1)(3)(4)

RMBS $ 2,530 $ (1,446) $ 3,027 $ (1,392)

Domestic Public Finance 3,016 724 2,398 627

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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.

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Ambac has recorded gross estimated recoveries of $1,751 and $1,727 at December 31, 2020 and 2019, respectively.

Basis of Presentation and Significant Accounting Policies t o 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.

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.

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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.

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.

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.

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In estimating loss reserves, we also incorporate scenarios which represent the potential outcome of remediation strategies.

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Valuation of Certain Financial Instruments

The Fair Value Measurement Topic of the ASC requires financial instruments to be classified within a three-level fair value hierarchy.

The Fair Value Measurement Topic of the ASC requires financial instruments to be classified within a three-level fair

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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.

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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 loan receivables of consolidated VIEs incorporate estimates of Ambac's financial guarantee cash flows, including future premiums and losses.

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.

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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

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") and tax credit carry forwards.

More specifically, deferred tax assets represent a future tax benefit (or receivable) 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.

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.

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uncertainty regarding timing and magnitude of RMBS R&W litigation recoveries;

no new financial guarantee business and execution risk of any new business venture.

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.

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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.

Income Taxes t o 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.

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

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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 excludes exposure of the policy that insures the notes issued by Ambac LSNI as defined in Note 1.

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.

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Public Finance (1)(2)

$ 15,497 $ 17,653

Structured Finance 6,337 7,508

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Total net par outstanding

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$ 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 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.

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.

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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)

($ in millions) Risk Name Bond Type Ambac

Outstanding (2)

Mitchells & Butlers Finance plc-UK Pub Securitisation

UK-Asset Securitizations

Capital Hospitals plc (3)

UK-Infrastructure

Aspire Defence Finance plc

UK-Infrastructure

Anglian Water

New Jersey Transportation Trust Fund Authority - Transportation System

Lease and Tax-backed Revenue

National Grid Gas

Posillipo Finance II S.r.l

Italy-Sub-Sovereign

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 %

Ostregion Investmentgesellschaft NR 1 SA (3)

Austria-Infrastructure

RMPA Services plc

UK-Infrastructure

Mets Queens Baseball Stadium Project, NY, Lease Revenue

General Obligation

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

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(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.

A portion of this transaction is insured by an insurance policy issued by Ambac Assurance.

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

Net par related to the top ten exposures reduced $862 million from December 31, 2018 .

(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 decrease from 2018 was primarily related to the Ballantyne commutation, the COFINA Plan of Adjustment, and refundings, partially offset by the addition of RMPA Services plc and Mets Queens Baseball Stadium Project.

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 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.

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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;

• 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.

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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.

Public Finance Insured Portfolio

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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, the COFINA Plan of Adjustment, restructuring and related commutation transactions, commutations, exposure runoff, and early terminations (calls, refundings and pre-refundings).

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.

including financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public interests.

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.

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

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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.

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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 these types of transactions include not-for-profit hospitals, universities, associations and charities.

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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.

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As of December 31, 2020, privatized military housing represented approximately 16% of net par outstanding.

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 $1,123 million as of December 31, 2019.

Each has its own credit risk

profile attributable to, as applicable, discrete revenue sources, direct general obligation pledges and/or general obligation guarantees.

On May 9, 2019, the Oversight Board certified its own version of a new Commonwealth Fiscal Plan ("Revised Fiscal Plan"), which superseded the previous Commonwealth Fiscal Plan certified on October 23, 2018.

In the Commonwealth Revised Fiscal Plan, the annual Commonwealth budget surpluses are lower in the short term but larger in the long term because of a longer than previously expected roll-out of federal disaster spending.

The new surplus through fiscal 2024 is just under $14 billion, whereas the previous plan was almost $18 billion.

The plan projects a 30-year surplus of $19.7 billion, but $5.4 billion of that money may not be available to the Commonwealth because it is being generated by public corporations.

This compares to a 30-year surplus of just under $13 billion under the previous fiscal plan.

As was the case with prior fiscal plans for the Commonwealth of Puerto Rico, the Commonwealth Revised Fiscal Plan lacks a high degree of transparency regarding the underlying data, assumptions and rationales supporting those assumptions, making reconciliation and due diligence difficult.

As a result, it is difficult to assess the possible impact that Commonwealth Revised Fiscal Plan changes may have on creditor outcomes or Ambac's financial condition, including liquidity, loss reserves and capital resources.

On June 7, 2019, the Oversight Board certified its own version of the Fiscal Plan for the Puerto Rico Highways and Transportation Authority ("PRHTA").

Without considering PRHTA Fiscal Plan measures, the PRHTA’s total financial surplus over the six-year plan period is projected to be $31 million.

However, after taking into account the measures set forth in the PRHTA Fiscal Plan, the Oversight Board states that the cumulative surplus over that six-year period would grow to $493 million.

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

It is also unknown if and when other Puerto Rico instrumentalities, which have debt outstanding insured by Ambac Assurance, will be filed under Title III and what effect their fiscal plans and/or plans of adjustment may have on Ambac's financial position.

No assurances can be given that Ambac's financial condition will not suffer a materially negative impact as an ultimate result of the Commonwealth Revised Fiscal Plan, the Commonwealth Plan of Adjustment, or any future changes or revisions to Commonwealth fiscal plans or fiscal plans and/or plans of adjustment for PRHTA or other Puerto Rico instrumentalities.

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

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

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.

• 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;

• 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 September 27, 2019, the Oversight Board filed a disclosure statement and plan of adjustment (the "Initial POA") to restructure $35 billion of debt and other claims against the Commonwealth of Puerto Rico, PBA, and the Employee Retirement System ("ERS"), as well as more than $50 billion of pension liabilities.

(On the same day, PBA filed a petition for a Title III restructuring.)

On October 21, 2019, Puerto Rico's House of Representatives unanimously passed Concurrent Resolution 114 (which was subsequently passed by the Puerto Rico Senate on November 7,

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

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37 2020 FORM 10-K |

2019) which rejected the Initial POA due to its proposed 8.5% cut to the pensions of retired public workers.

The resolution states that the Puerto Rico legislature will not approve any legislation that may be required to implement the Initial POA and authorizes the Speaker of the House and the Senate President to take the actions they deem pertinent, as well as the use of the resources of the Legislative Assembly, to defend against those actions of the Oversight Board that are detrimental to the best interests of Puerto Ricans.

On February 28, 2020, the Oversight Board filed an amended disclosure statement and amended plan of adjustment (the “Amended POA”) to restructure $35 billion of debt and other claims against the Commonwealth of Puerto Rico, PBA, and ERS, as well as more than $50 billion in pension liabilities.

The Amended POA would reduce Commonwealth debt and other claims from $35 billion to less than $11 billion, a 70% cut.

The Amended POA would reduce the Commonwealth’s annual debt service by 56%.

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

The Amended POA, as is, disproportionately disadvantages claims related to the Commonwealth revenue bonds, including those insured by Ambac Assurance.

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

It is unknown if and how the Amended POA may be modified or what the final adjustments will be to the obligations of Commonwealth instrumentalities addressed in the Amended POA.

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

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 Form 10-K located in Part II.

Item 8 for the possible increase in loss reserves under stress or other adverse conditions, including the impact of the Amended POA.

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.

On November 27, 2019, the court-appointed mediation team (the "Mediation Team") filed an interim report and set of recommendations regarding the scheduling and sequencing of litigation matters.

In the report, the Mediation Team provided an update on the status of mediation stating the Oversight Board, "...the Government of Puerto Rico, and various creditor parties...have been and remain engaged in substantive, and delicately poised, negotiations facilitated by the Mediation Team regarding the terms of a possible amended Plan of Adjustment that would be acceptable to those creditors.

If successful, these negotiations could result in the filing of an amended Plan of Adjustment that differs from, and has materially more creditor support than, the current Plan [of Adjustment]."

On February 9, 2020, the Oversight Board announced it reached an agreement in principle ("Plan Support Agreement") with certain creditors supporting the restructuring of the Commonwealth's

General Obligation and PBA debt, and intended to file the Amended POA reflecting the terms of this agreement.

On February 10, 2020, following the Oversight Board's announcement regarding the Plan Support Agreement, the Mediation Team filed a report with the Title III court recommending a schedule for continuation of certain litigation matters and recommending that other litigation matters be stayed while the Oversight Board pursued confirmation of the Amended POA.

The court has not yet ruled on these recommendations.

The status, timing and subject of any subsequent or future mediation discussion has not yet been publicly disclosed.

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

The Commonwealth of Puerto Rico is projected to benefit from over $45 billion of federal disaster aid for infrastructure improvement initiatives or recovery efforts, as a result of the damage cause by hurricanes Irma and Maria as well as the earthquakes that began in late December 2019.

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

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

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

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

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

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

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

Consequently, it is anticipated that drawdown of funds will begin soon.

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

In addition to CDBG and several billion in additional federal Medicaid money for Puerto Rico that was recently approved, Puerto Rico is receiving additional federal assistance in the wake of the earthquakes that have occurred on parts of the island through FEMA.

In addition, it is possible that Congress will appropriate more federal funds to Puerto Rico.

The House of Representatives has passed legislation providing $4.7 billion (most of which is CDBG as well as highway funds) but the Senate has not taken that

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

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38 2020 FORM 10-K |

legislation up yet, and the White House has threatened to veto the legislation in its current form.

While these federal funds are 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.

COFINA Debt Restructuring

On January 16-17, 2019, hearings for the confirmation of the COFINA Plan of Adjustment (the "COFINA POA") and the Commonwealth 9019 motion (to approve the settlement of the Commonwealth-COFINA dispute) were held.

On February 4, 2019, the COFINA POA was confirmed and the Commonwealth 9019 motion was approved by Judge Laura Taylor Swain of the U.S.

District Court for the District of Puerto Rico.

On February 12, 2019, the COFINA POA went effective, concurrent with the completion of the commutation described above in the "Executive Summary" section of this Management Discussion and Analysis.

As a result, Ambac Assurance's insured COFINA bond exposure decreased by $620 million net par to approximately $185 million net par.

Subsequent redemptions of obligations of the COFINA Class 2 Trust brought COFINA net par outstanding down to $101 million as of December 31, 2019 .

Ambac Assurance's remaining policy obligation of $101 million net par is an asset of the COFINA Class 2 Trust, which holds a ratable distribution of cash and new COFINA bonds, which can be used to partially offset Ambac’s remaining insurance liability.

Several parties are presently appealing the confirmation of the POA and no assurances can be given regarding the results of such appeals.

At this time, it is unclear what impact the COFINA restructuring will have on the prospective recoveries of Ambac Assurance's other insured Puerto Rico instrumentalities.

Other Developments

On February 15, 2019, the United States Court of Appeals for the First Circuit issued an opinion in the consolidated appeals brought by certain parties who argued that the members of the Financial Oversight and Management Board for Puerto Rico (the "Oversight Board") were appointed in violation of the U.S.

Constitution’s Appointments Clause.

The First Circuit ruled that the Oversight Board members (other than the ex-officio Member) must be, and were not, appointed in compliance with the Appointments Clause.

The First Circuit declined to dismiss the Oversight Board’s Title III petitions, did not render ineffective any otherwise valid actions of the Oversight Board prior to the issuance of the ruling and stayed its ruling until the Supreme Court rendered a decision in the case.

On June 18, 2019, President Trump sent to the U.S.

Senate for confirmation the nominations of the seven members of the Oversight Board for the remainder of their term.

It is unclear if and when President Trump will send new nominations to the U.S.

Senate following the Oversight Board term expiration on August

The Supreme Court heard argument on October 15, 2019.

It is unclear how the Supreme Court will rule and how the ruling will impact the restructuring process, mediation discussions and relevant litigation with respect to Ambac-insured Puerto Rico exposures.

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

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

The Oversight Board has filed five adversary proceedings related to Ambac Assurance’s Puerto Rico exposures within the Title III cases.

Ambac Assurance has several active matters before the District Court within the Commonwealth’s Title III case, including motions seeking a determination that the automatic stay does not apply to certain actions Ambac Assurance contemplates taking with respect to the pledged revenues from PRIFA, PRHTA, and PRCCDA, or that any such stay should be lifted for cause.

Four litigations are COFINA-related cases that have been, or will soon be, dismissed by operation of the COFINA POA that was confirmed on February 4, 2019, and became effective on February 12, 2019.

Several parties are presently appealing the confirmation of the COFINA POA.

A fifth is another COFINA-related case that had been stayed pending resolution of an interpleader action related to COFINA funds, but which will be permitted to proceed by operation of the POA now that the interpleader action has been resolved.

A number of other Puerto Rico-related litigations predating the Title III cases are stayed under Title III of PROMESA and certain other matters within the Title III cases are stayed as well.

Ambac is unable to predict when and how the issues raised in these cases (other than those already dismissed by operation of the COFINA POA) will be resolved.

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

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 in this Form 10-K, for further information about Ambac's litigation relating to Puerto Rico.

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.

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.

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

President, Puerto Rico governor, 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.

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

During the year ended December 31, 2019 , Ambac had incurred losses associated with its Domestic Public Finance insured portfolio of $250 million , which was significantly impacted by the continued uncertainty and volatility of the situation in Puerto Rico.

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.

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

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.

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Table of Co ntents

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 Co nsolidated Financial Statements, included in Part II, Item 8 in this Form 10-K.

($ in millions)

Commitments and Contingencies in the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K.

($ in millions) Range of

Outstanding (2)

2 unchanged sentences

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 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.

17 unchanged sentences

(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 $42.

Should a remarketing not occur before the maturity of the bonds, the Net Par and Interest Outstanding for PBA exposure would increase by $39.

Structured Finance Portfolio

Ambac’s portfolio of U.S.

structured finance exposures is $7,508 million , representing 20% of Ambac’s net par outstanding as of December 31, 2019 , and a 25% reduction from the amount outstanding at December 31, 2018 .

This reduction in exposure was primarily related to residential mortgage-backed securities ("RMBS") policies, which continued to prepay;

claims presented on insured RMBS bonds;

commutations and clean-up calls of

certain RMBS transactions, with less than 10% of their original mortgage pool balances remaining and the commutation of $900 million of Ambac UK's exposure to Ballantyne Re Plc, as discussed further below.

Current insured exposures include securitizations of mortgage loans, home equity loans, student loans, leases, operating assets, collateralized loan obligations (“CLO”), and 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

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.

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unsecured debt issued by investor-owned utilities.

It also includes structured insurance transactions, including transactions providing insurance on the notes of trusts that were established in connection with the reinsurance of defined blocks of life insurance and that were used to fund regulatory reserves associated with level premium term life insurance policies (commonly referred to as Regulation XXX reserves).

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).

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.

3 unchanged sentences

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.

Ambac Assurance seeks to mitigate and manage these risks through its risk management practices.

Securitized securities are usually designed to help protect the investors and, therefore, the guarantor from the bankruptcy or insolvency of the entity that originated the underlying assets as well as from the bankruptcy or insolvency of the servicer of those assets.

The servicer of the assets is typically responsible for collecting cash payments on the underlying assets and forwarding such payments, net of servicing fees, to a trustee for the benefit of the issuer.

One potential issue is whether the sale of the assets by the originator to the issuer would be upheld in the event of the bankruptcy or insolvency of the originator and whether the servicer of the assets may be permitted or stayed from remitting to investors cash collections held by it or received by it after the servicer or the originator becomes subject to bankruptcy or insolvency proceedings.

Another potential issue is whether the originator sold ineligible assets to the securitization transaction that subsequently deteriorated, and, if so, whether the originator has the willingness or financial wherewithal to meet its contractual obligations to repurchase those assets out of the transaction.

Structural protection in a transaction, such as control rights that are typically held by the senior note holders, or guarantor in insured transactions, will determine the extent to which underlying asset performance can be influenced upon non-performance to improve the revenues available to cover debt service.

AAC seeks to mitigate and manage these risks through its risk management practices.

Ambac has exposure to the U.S.

2 unchanged sentences

At December 31, 2020, 88% of RMBS net par exposure relates to securitizations issued during 2005 through 2007.

Ballantyne Re Plc

Following entry into a lock-up agreement with Ballantyne Re plc ("Ballantyne"), Assured Guaranty Europe plc and Assured Guaranty Corp., certain Ballantyne Class A Noteholders, Security Life of Denver Insurance Company ("SLD") and Swiss Re Life

and Health America Inc.

("SRLHA") Ballantyne commenced, under Irish law, a restructuring transaction ("Restructuring") in respect of its obligations under its Class A-1 Notes, Class A-2a Notes, Class A-2b Notes, Class A-3a Notes, Class A-3b Notes, Class A-3c Notes and Class A-3d Notes (together, the "Scheme Notes") (the "Restructuring").

The Class A-2a Notes, the Class A-3a Notes, the Class A-3b Notes, the Class A-3c Notes and the Class A-3d Notes had a guarantee from Ambac UK (the "Ambac UK Guaranteed Notes").

The Restructuring was commenced by Ballantyne on April 25, 2019 and was implemented through an Irish scheme of arrangement (the "Arrangement") under Part 9 of the Irish Companies Act 2014 which required the consent of the requisite majorities of the relevant Class A Noteholders at each Arrangement meeting.

The Arrangement was approved on June 17, 2019, and the Restructuring was implemented on the terms proposed.

The key features of the Restructuring were as follows:

the novation of the indemnity reinsurance agreement between Ballantyne and SLD dated November 19, 2008, (as amended) to SRLHA (the "Novation");

the disbursement of the assets from Ballantyne's reinsurance trust account to effectuate the Novation and make payment to the holders of Scheme Notes in full and final satisfaction of their claims against Ballantyne;

the commutation of the obligations of Ambac UK in respect of the Ambac UK Guaranteed Notes.

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

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 within asset-backed securities 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 credit.

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 has no insured exposure related to emerging markets.

1 unchanged sentence

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.

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 Ambac Assurance’s primary vehicle for directly issuing financial guarantee policies in the UK and the European Union

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with $11,862 million net par outstanding in those markets at December 31, 2019 .

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.

Other European Union Exposures (“EU”)

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 other EU member states, including Austria, France, Germany and Italy ($1,756 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.

In March 2017 the UK government gave the European Union (“EU”) formal notification of its intention to leave the EU (“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 is 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.

The UK and EU are currently negotiating a free trade agreement which is expected to come into force at the end of the transition period.

It is currently unclear what regulations may apply to the activities in the EEA of passporting insurers as part of this free trade agreement.

They may lose their legal authorization to serve clients who benefit from policies issued by a UK incorporated insurer under freedom of services and freedom of establishment passporting rights (and thereby maybe unable to legally collect premiums or pay claims) and if they have branches in EEA Member States they may be legally obliged to close them down and no longer be legally represented in those jurisdictions.

However on February 19, 2019, the European Insurance and Occupational Pensions Authority (“EIOPA”) made a series of recommendations to EU insurance regulators in light of Brexit.

These recommendations include the recommendation that regulatory authorities apply legal frameworks that facilitate the orderly run off (without time limit) of branch operations and of insurance policies issued in EEA member states by UK insurers prior to Exit Day that terminate after this date.

The recommendations will require to be incorporated into EEA member states legal and regulatory frameworks in an appropriate manner to bring them into effect.

If introduced as expected, these measures will retain Ambac UK's right to collect premium and pay claims on policies issued under EU passporting rights.

As of December 31, 2019 Ambac UK's insured portfolio included 4 financial guarantee obligations with a gross par outstanding of

$1,407 million issued under EU passporting rules.

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

5 unchanged sentences

RMBS policies incorporate assumptions on expected prepayments over the remaining life of the insured obligation.

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Table of Co ntents

The following table depicts amortization of existing guaranteed net par outstanding:

2 unchanged sentences

Estimated Net

2021-2025 $ 11,017

2026-2030 7,141

2031-2035 6,595

2036-2040 5,687

After 2040 3,448

(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.

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37 2019 FORM 10-K |

Geographic Area

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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 %

2 unchanged sentences

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)

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.

3 unchanged sentences

($ in millions)

Dollars $ 22,205 $ 22,205 65.5 %

British Pounds £ 6,940 9,486 28.0 %

Australian Dollars

Euros € 1,455 1,777 5.2 %

Australian Dollars A$ 545 420 1.2 %

Total $ 33,888 100.0 %

Ratings Distribution

The following tables provide a rating distribution of existing net par outstanding based upon internal Ambac credit ratings at December 31, 2019 and 2018 and a distribution by bond type of

Ambac's below investment grade ("BIG") net par exposures at December 31, 2019 and 2018 .

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-:

AAA is less than 1% in both periods.

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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.

2 unchanged sentences

BIG denotes credits deemed below investment grade.

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Summary of Below Investment Grade Exposure:

3 unchanged sentences

Lease and tax-backed (1)

$ 1,194 $ 1,109

Stadium 540 —

General obligation (1)

2 unchanged sentences

Structured Finance:

Structured Insurance

RMBS 2,800 3,362

Student loans 512 620

1 unchanged sentence

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.

2 unchanged sentences

(2) Includes $308 and $311 of military housing net par at December 31, 2020 and 2019, respectively.

The decrease in below investment grade exposures is primarily due to (i) the commutation or restructuring of certain structured insurance, lease and tax-backed and transportation transactions (including the Ballantyne and COFINA commutations), (ii) paydowns or calls by issuers, mostly related to residential mortgage-backed and other asset-backed securities, and (iii) a termination of an international aircraft asset-backed transaction.

This decrease is offset by the addition of an Italian sub-sovereign exposure.

Despite the decrease in below investment grade exposures, such 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 and therefore Ambac is subject to the risk that its insured portfolio will increasingly become concentrated in higher risk below investment grade exposures.

This risk may result in greater volatility in our results from operations and have adverse effects on our financial condition.

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

Ambac Assurance has reinsurance in place pursuant to surplus share treaties and facultative agreements.

As a primary financial guarantor, Ambac Assurance is required to honor its obligations to its policyholders whether or not its reinsurers perform their obligations under these reinsurance agreements.

For exposures reinsured, Ambac Assurance generally withholds a ceding

commission to defray its underwriting and operating expenses.

To minimize its exposure to losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers;

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 Ambac Assurance in the event of rating agency downgrades of a reinsurer (among other events and circumstances).

Ambac Assurance held letters of credit and collateral amounting to $124 million from its reinsurers at December 31, 2019 .

As of December 31, 2019 , the aggregate amount of insured par ceded by Ambac Assurance to reinsurers under reinsurance agreements was $5,890 million , with the largest reinsurer accounting for $2,746 million or 6.3% of gross par outstanding at December 31, 2019 .

The following table shows the distribution, by bond type, of Ambac Assurance’s ceded guaranteed portfolio at December 31, 2019 :

Bond Type ($ in millions)

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

Public Finance:

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Higher education 167 18 %

Other 99 10 %

Total Public Finance 4,512 23 %

1 unchanged sentence

Investor-owned utilities 224 12 %

Student loan 219 26 %

Structured insurance 115 27 %

Asset-backed and other

Mortgage-backed and home equity 40 1 %

Asset-backed and other 21 12 %

Total Structured Finance 619 9 %

3 unchanged sentences

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.

Certain amounts in the tables that follow may not add due to rounding.

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

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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

Net premiums earned $ 54 $ 66 $ 111

Net investment income 122 227 273

Net other-than-temporary impairment losses

Net realized investment gains (losses) 22 81 108

8 unchanged sentences

Net income (loss) (437) (216) 267

exchange of auction market preferred shares (1)

loss on exchange of auction market preferred shares (2)

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.

1 unchanged sentence

Background and Business Description for a discussion of the AMPS Exchange.

2019 includes proceeds received in connection with an SEC action against Citigroup Global Markets Inc.

in the amount of $142 million.

2018 and 2017 include net realized gains on extinguishment of debt.

During 2018 and 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, loss reserves and debt of the Company, had a significant impact on the comparability of the results of operation for the years ended December 31,2019 and 2018.

The most significant transactions, which are more fully discussed in the "Financial Guarantees in Force" section of this Form 10-K were:

Rehabilitation Exit Transactions.

On February 12, 2018, Ambac Assurance executed the Rehabilitation Exit Transactions under which Deferred Amounts (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) and a substantial portion of Ambac Assurance senior surplus notes were settled at a discount, with holders (other than Ambac) receiving in exchange, a consideration package of cash and debt securities.

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 Ambac Assurance's insured net par exposure to COFINA.

Pursuant to the COFINA POA, approximately 75% of holders of Ambac Assurance-insured senior COFINA bonds (including Ambac) elected to commute their insurance policy.

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.

3 unchanged sentences

The following paragraphs describe the consolidated results of operations of Ambac for 2020 and 2019.

Some tables may not add due to rounding.

Net Premiums Earned .

Net premiums earned primarily represent the amortization into income of insurance premiums.

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.

2 unchanged sentences

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

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Table of Co ntents

Normal net premiums earned are impacted by the following:

The runoff of the insured portfolio occurring through transaction terminations, calls and scheduled maturities, which reduce normal net premiums earned.

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.

New ceded reinsurance of insurance risk which reduces normal net premiums earned over the remaining period of the related policies.

Changes to allowance for uncollectible premiums on premium receivable asset.

• 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.

Normal net premiums earned and accelerated premiums are reconciled to total net premiums earned in the table below, including a breakdown of net premiums earned by market:

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40 2019 FORM 10-K |

• Pre-refundings of insured securities, primarily Public Finance transactions.

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)

4 unchanged sentences

Total net normal premiums earned $ 42 $ 56 $ 77

Public Finance

Structured Finance

International Finance

Total net accelerated earnings $ 12 $ 10 $ 35

1 unchanged sentence

Net Investment Income.

Net investment income primarily consists of interest and net discount accretion on fixed income securities classified as available-for-sale, including investments in Ambac-insured securities.

Investments in Ambac-insured securities are made opportunistically based on their risk/reward 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 primarily been driven by restructuring transactions involving RMBS, Puerto Rico and Ballantyne bonds.

Also, included in net investment income are net gains and (losses) on pooled investment funds and certain other investments that are either classified as trading securities with changes in fair value recognized in earnings or are reported under the equity method.

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

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

For further information about investment funds held, refer to Note 11.

Investments to the Consolidated Financial Statements, included in this Annual Report.

Net investment income from Ambac-insured securities, available for sale and short-term securities other than Ambac-insured and Other investments is summarized the table below:

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)

6 unchanged sentences

Net investment income decreased $106 million for the year ended December 31, 2020 compared to 2019.

The $99 million decrease in net investment income from Ambac-insured securities for 2019 compared to 2018 is due primarily to the reduced amount of Ambac-insured RMBS and COFINA bonds held following their restructuring transactions in February of 2018 and 2019, respectively.

The impact of lower insured RMBS and COFINA bond holdings was partially offset by increased income from accelerated accretion on Ballantyne bonds in connection with the

Ballantyne restructuring in June 2019.

Net investment income from Secured Notes was slightly lower in 2019 than 2018 as a result of early redemptions and AFG's divestiture of its holdings completed in early 2019.

Net investment income from available-for-sale securities other than Ambac-insured increased $24 million in 2019, reflecting the effects of uninsured COFINA bonds received under the POA;

higher allocations towards other non-insured bonds including investment grade corporates, CMBS and CLOs;

and higher interest rates on short-term positions.

Net investment income from Other investments increased $30 million from 2018, due to strong equity and credit market performance, including gains on investments in high-yield and an asset-backed focused hedge fund by Ambac Assurance as well as gains on investments in high yield funds held by Ambac UK.

Additionally, 2018 included losses on hedge fund, equity and insurance linked-security fund investments of Ambac UK.

Net Other-Than-Temporary Impairment Losses.

Net other-than-temporary impairment losses recorded in earnings include only credit related impairment amounts on securities 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 before recovery of the amortized cost basis.

Non-credit related impairment amounts are recorded in other comprehensive income (loss).

Alternatively, non-credit related impairment is reported through earnings as part of net other-than-temporary impairment losses 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 less any current period credit impairment.

Net other-than-temporary impairments for the year ended December 31, 2019 related to management's intent to sell securities.

Net other-than-temporary impairments for the year ended December 31, 2018 related to credit losses on certain securities and to management’s intent to sell securities.

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

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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 .

2 unchanged sentences

Year Ended December 31,

2020 2019 2018

Net gains on securities sold or called

$ 26 $ 59 $ 105

Foreign exchange gains (losses)

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, 2019 included $50 million of net gains arising directly or indirectly from the COFINA restructuring, including sales of Ambac-insured COFINA bonds and sales of new uninsured COFINA bonds received in the restructuring.

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.

Net gains during the year ended December 31, 2018 were primarily from sales of Ambac-insured RMBS.

Additionally, 2018 gains included a $27 million recovery from a class-action settlement

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relating to certain RMBS securities previously 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 results from the Company's interest rate derivatives portfolio and its legacy credit derivative positions as presented in the following table:

($ in millions)

Year Ended December 31,

Net gains (losses) on interest rate derivatives

Net gains (losses) on credit derivatives

Total net gains (losses)

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.

Results in 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 net liability position of the portfolio, and the impact of counterparty credit adjustments as discussed below.

Net losses on interest rate derivatives for the year ended December 31, 2019 were $51 million , compared to the net gain of $7 million for the year ended December 31, 2018 .

The net loss for the year ended December 31, 2019, reflects declines in forward interest rates, partially offset by negative net carrying costs driven by the partially inverted yield curve in place for most of the year.

Net gains for 2018 were primarily the result of rising forward interest rates offset by carrying costs.

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 gain (loss) on interest rate derivatives of $(2) million in both 2019 and 2018.

The net gain/(loss) from change in fair value of credit derivatives for the year ended December 31, 2019 was a gain of $2 million , as compared to the loss of $(1) million for the year ended December 31, 2018.

Changes in fair value of credit derivatives are driven by price changes on the underlying reference obligations of remaining legacy positions plus continued accretion of fees.

Net Realized Gains (Losses) on Extinguishment of Debt .

Net realized gains on extinguishment of debt was $0 million for the year ended December 31, 2019 , compared to gains of $3 million for the year ended December 31, 2018 .

The gains for the year ended December 31, 2018 related to surplus notes received by Ambac Assurance in settlement of Deferred Amounts held in its investment portfolio in connection with the Rehabilitation Exit Transactions.

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.

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) present value of projected cash flows from (to) the VIEs which are attributable to Ambac’s insurance subsidiaries in the form of financial guarantee insurance premiums, fees and losses.

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

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

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

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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.

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.

Income on variable interest entities for the year ended December 31, 2019 , was driven by the impact of a VIE created in connection with the restructuring of Puerto Rico COFINA debt.

Under the restructuring, Ambac-insured COFINA bonds that were not commuted were deposited into a newly formed trust called the COFINA Class 2 Trust ("COFINA Trust"), which Ambac has determined must be consolidated.

Refer to Part II, Item 7, “Management's Discussion and Analysis — Financial Guarantees in Force" in this report on Form 10-K for further discussion of the COFINA Debt Restructuring.

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 used for early redemptions of debt, partially offset by net interest expense and fees.

Income for t he 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 related to higher financial guarantee insurance premiums.

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.

Income on variable interest entities for the year ended December 31, 2018 , included gains of $2 million on deconsolidation of VIEs as a result of financial guarantee policy terminations and discount accretion on remaining VIE net assets.

Refer to Note 4.

Variable Interest Entities to the Consolidated Financial Statements included in this Form 10-K for further information on the accounting for VIEs.

Other income (expense) .

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

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

in the amount of $142 million.

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42 2019 FORM 10-K |

the year ended December 31, 2018 , other income (expense) included foreign exchange gains and amortization of fee income.

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.

Losses and loss expenses for the year ended December 31, 2018, included interest on Deferred Amounts pursuant to the Segregated Account Rehabilitation Plan (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) that were discharged on February 12, 2018.

Ambac records as a component of its loss reserve estimate subrogation recoveries related to securitized loans in RMBS transactions with respect to which Ambac Assurance is pursuing claims for breaches of representations and warranties described herein.

Ambac does not estimate an RMBS R&W subrogation recovery where its sole claim is for fraudulent inducement.

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 RMBS R&W subrogation recoveries, net of reinsurance, of $1,702 million and $1,744 million at December 31, 2019 and 2018 , respectively.

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 Form 10-K for more information regarding the estimation process for RMBS R&W subrogation recoveries.

Losses and loss expenses (benefit) for the year ended December 31, 2019 and 2018 were $13 million and $(224) million , respectively.

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:

1 unchanged sentence

Year Ended December 31,

2020 2019 2018

$ (76) $ (93) $ (8)

Domestic Public Finance 256 250 37

3 unchanged sentences

Discount on Rehabilitation Exit Transaction — — (288)

$ 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.

Lo sses and loss expenses for 2019 were driven by the following:

Higher projected losses in domestic public finance driven mostly by lower dis count rates and additions to Puerto Rico loss reserves, partially offset by;

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;

• 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 .

Lo sses and loss expenses for 2018 were driven by the following:

Discount achieved pursuant to the Rehabilitation Exit Transactions, partially offset by interest on Deferred Amounts through the Rehabilitation Exit Transactions effective date;

Higher projected losses in domestic public finance largely driven by Military Housing loss expenses incurred and adverse development on a certain general obligation and transportation risks;

Favorable RMBS credit development, which was more than offset by a decrease in RMBS R&W subrogation recoveries and loss expenses incurred;

$15 million of foreign exchange losses related to Ambac UK loss reserves denominated in currencies other than its functional currency of British Pounds, resulting in incurred losses (gains) when the British Pound depreciates (appreciates).

Insurance Intangible Amortization .

Insurance intangible amortization was $57 million and $295 million for the years ended December 31, 2020 and 2019, respectively.

The increase in intangible amortization for the year ended December 31, 2019, compared to 2018, is primarily due to accelerated amortization as a result of the Ballantyne commutation that occurred in 2019.

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.

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Table of Co ntents

Operating Expenses.

Operating expenses consist of gross operating expenses plus reinsurance commissions.

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

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

4 unchanged sentences

The decrease was primarily due to the following:

Lower non-compensation costs primarily due to reduced advisory costs of $15 million, of which $5 million relates to

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43 2019 FORM 10-K |

services provided for the benefit of OCI;

partially offset by increased premises costs of $3 million, primarily due to the extinguishment of lease reducing Junior Surplus Notes which previously reduced rent expense.

Higher compensation costs related to higher incentive compensation driven by (i) improvements in performance metrics, mostly related to Ambac UK incentive compensation and (ii) higher severance and post employment costs related to staff right-sizing.

With the conclusion of the Segregated Account rehabilitation, the duties of the Wisconsin Insurance Commissioner as rehabilitator of the Segregated Account have been discharged.

Legal and consulting services provided for the benefit of OCI amounted to $2 million and $7 million for the years ended December 31, 2019 and 2018 , respectively.

Subsequent to the Segregated Account's exit from rehabilitation, advisory services for the benefit of OCI continue, but at a reduced level.

• 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 primarily includes accrued interest on the Ambac Note, Tier 2 Notes and surplus notes issued by Ambac Assurance.

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.

2 unchanged sentences

Year Ended December 31,

2020 2019 2018

Surplus notes (1)

$ 85 $ 99 $ 80

Ambac note 107 143 139

Tier 2 notes 28 26 22

Total interest expense $ 222 $ 269 $ 242

(1) Includes junior surplus notes.

The increase in interest expense for the year ended December 31, 2019 , compared to 2018 primarily reflects the higher average balance of surplus notes outstanding in 2019 and compounding of interest on surplus notes.

Although the amount of surplus notes outstanding decreased in connection with the Rehabilitation Exit Transactions, the amount outstanding increased in the third quarter of 2018 due to surplus notes issued by Ambac Assurance 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 ) and resales of notes by Ambac to the market.

Increased interest expense on the floating rate Ambac note was driven by higher reset rates in 2019 and the impact of the notes being outstanding for the full year, partially offset by optional redemptions and full amortization of deferred debt issuance costs through interest expense in 2018.

Interest expense increased on the Tier 2 notes due primarily to interest compounding.

The increase in interest expense also reflects the impact of applying the level yield method on surplus notes and Tier 2 notes as the discount to the face value of the long-term debt accretes over time.

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 in 2018.

Ambac Assurance has not requested to pay interest on any junior surplus notes since their issuance.

Ambac Assurance may not receive approval from OCI to make payments as and when scheduled, including the payment of the surplus notes on their scheduled maturity date of June 7, 2020.

If the OCI does not approve the making of any payment of principal of or interest on surplus notes on the scheduled payment date or scheduled maturity date thereof, the scheduled payment date or scheduled maturity date, as the case may be, shall be extended until OCI grants approval to make the payment.

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.

3 unchanged sentences

Provision for Income Taxes .

The provision for income taxes for the year ended December 31, 2019 and 2018 , was $32 million and $5 million , respectively.

The income tax for the year ended December 31, 2019 and 2018 , includes provisions for income tax due in respect of Ambac UK of $36 million and $5 million , respectively.

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 $1,250 million at AFG and $2,285 million at Ambac Assurance.

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 dependent on its cash, investments, and net receivables, totaling $483 million as of December 31, 2019 , and expense sharing and other arrangements with Ambac Assurance.

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

AFG has accrued $28 million of tolling payments based on NOLs used by Ambac Assurance in 2017.

In May 2018, AFG executed a waiver under the intercompany tax sharing agreement pursuant to which Ambac Assurance was relieved of the requirement to make this payment by June 1, 2018.

AFG also agreed to defer the tolling payment for the use of net operating losses by Ambac Assurance in 2017 until such time as OCI consents to the payment.

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

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48 2020 FORM 10-K |

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

AFG has not accrued any receivable related to this payment as of December 31, 2019.

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

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

It is highly unlikely that Ambac Assurance will be able to make dividend payments to AFG for the foreseeable future and therefore cash and investments and payments under the intercompany cost

allocation agreement will be AFG’s principal source of liquidity in the near term.

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

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

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, 2019 , excluding variable interest entities consolidated as a result of Ambac Assurance’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 Ambac Assurance’s surplus notes, the Ambac Note, Tier 2 Notes and Ambac UK debt, and payments due under operating leases.

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)

Less Than 1 Year

More Than 5 Years

($ 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)

Operating lease obligations (5)

45 5 10 10 19

Purchase obligations (6)

1 unchanged sentence

Loss and loss expenses (8)

Amounts 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 $279 million on the next scheduled payment date of June 7, 2020.

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).

All payments of principal and interest 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 annually from 2011 through 2019, although the OCI has permitted exceptional payments in connection with (a) increasing the percentage of deferred policy payments of the Segregated Account 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 Rehabilitation Exit Transactions in 2018.

Ambac Assurance may not receive approval from OCI to make payments as and when scheduled, including the payment of the surplus notes on their scheduled maturity date of June 7, 2020.

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.

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

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.

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.

Holders of surplus notes will have no rights to

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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.

8 unchanged sentences

Includes fixed costs, such as base rent, and estimated variable costs, such as real estate taxes and electricity.

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45 2019 FORM 10-K |

(6) Purchase obligations represent future expenditures for contractually scheduled fixed terms and amounts due for various technology-related maintenance agreements and other outside services.

Amount represents future payments relating to Ambac Assurance's postretirement medical reimbursements to current retirees over the next 10 years.

(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.

4 unchanged sentences

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.

Ambac Assurance Liquidity .

Ambac Assurance’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 Ambac Assurance’s liquidity are gross installment premiums on insurance policies;

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;

2 unchanged sentences

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

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

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

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 Ambac Assurance.

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.

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.

Ambac Assurance's intercompany loans are with Ambac Financial Services ("AFS").

AFS uses interest rate derivatives (primarily interest rate swaps and US Treasury futures) as an economic hedge against the effects of rising interest rates elsewhere in the Company, including on Ambac Assurance’s financial guarantee exposures.

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.

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

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.

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

Ambac Assurance 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 Ambac Assurance 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 date that all accumulated and unpaid dividends have been paid on the AMPS.

Ambac Assurance has not paid dividends on the AMPS since 2010.

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

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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 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, 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 and meet our other obligations would be reduced materially.

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.

4 unchanged sentences

Year Ended December 31,

2020 2019 2018

Cash provided by (used in):

5 unchanged sentences

Operating activities

The following represents the significant operating cash activities during the years ended December 31, 2019 and 2018 :

During the year ended December 31, 2019 , Ambac Assurance received $142 million in connection with an SEC settlement with Citigroup Global Markets Inc.

During the year ended December 31, 2019 , Ambac made interest payments on the Ambac Note of $143 million .

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the year ended December 31, 2018 , Ambac made interest payments on long-term debt of $143 million , including $11 million on surplus notes made in connection with the Rehabilitation Exit Transactions, $130 million on the Ambac Note and $2 million on the secured borrowing which was fully repaid in June 2018;

Cash outflow in 2018 from the Rehabilitation Exit Transactions to third parties was $1,354 million of which $1,162 million is included in operating activities and $191 million is included in financing activities as it related to payments for surplus note principal;

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)

2020 2019 2018

Net losses paid (1)

Net subrogation received

$ 159 $ 416 $ 344

Net subrogation

(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.

During the year ended December 31, 2019 and 2018 tax payments, primarily at Ambac UK, amounted to $21 million and $35 million , respectively.

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

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, 2019 , included paydowns of Ambac Note of $178 million , 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 the issuance of Ambac UK debt in connection with the Ballantyne restructuring.

Financing activities for the year ended December 31, 2018 , included proceeds from the issuance of Tier 2 notes of $240 million , paydowns of Ambac Note of $214 million , repayments of the Secured Borrowing of $74 million , payments for the extinguishment of surplus notes of $191 million (in connection with the Rehabilitation Exit Transactions) and paydowns of VIE debt obligations of $349 million .

Principal and interest due on the debt issued in connection with the Rehabilitation Exit Transactions as well as future payments on the remaining surplus notes will impact Ambac's future cash flows.

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 contracts, AFS is required to post collateral or margin to its counterparties and futures commission merchants to cover unrealized losses.

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.

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.

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Treasury obligations with market values equal to or in excess of market values of the swaps and futures contracts.

AFS may look to re-establish hedge positions that are terminated early, resulting in additional collateral or margin obligations.

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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 $121 million (cash and securities), including independent amounts, under these contracts at December 31, 2019 .

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

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 $1,269 million from December 31, 2018 to $13,320 million at December 31, 2019 , primarily due to lower VIE assets from the deconsolidation of a VIE during 2019 (causing a reduction in assets of $1,233 million ) partially offset by the consolidation of another VIE (causing an increase in assets of $167 million ) and increases from currency changes (strengthening of the British Pound).

Other significant changes during 2019 were lower premium receivables and intangible assets from the continued runoff of the financial guarantee insurance portfolio, particularly the Ballantyne commutation, and lower invested assets due to claim payments and debt redemptions.

Total liabilities decreased by approximately $1,172 million from December 31, 2018 to $11,783 million as of December 31, 2019 , primarily due to changes in VIEs consolidated as a result of financial guarantees provided by Ambac, as noted above.

The net impact of these VIE changes to liabilities was a net decrease of $1,028 million .

Other significant changes during 2019 were (i) lower unearned premiums from the runoff of the insured portfolio, (ii) lower loss reserves (from claim and commutation payments, including commutation payments on Ballantyne, and the elimination of loss reserves from the COFINA VIE consolidated), and (iii) lower long-term debt due to partial paydowns on the Ambac Note (net of of debt issued by Ambac UK of $12 million in connection with the Ballantyne commutation).

Such declines are partially offset by an increases in accrued interest payable on long-term debt and increases in interest rate derivative obligations as a result of reductions in forward interest rates.

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 driven by the net loss for 2019 partially offset by translation gains related to

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Ambac's foreign subsidiaries and unrealized gains on investment securities.

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

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

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

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

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

The Board of Directors of Ambac Assurance approves any changes to Ambac Assurance's investment policy.

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

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

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

Ambac UK’s investment policy sets forth minimum credit rating requirements and concentration limits, among other restrictions.

The Board of Directors of Ambac UK approves any changes or exceptions to Ambac UK’s investment policy.

Ambac Financial Group, Inc.'s investment portfolio's primary objective is to preserve capital and liquidity for strategic uses while maximizing income.

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 Form 10-K located in Part II.

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)

Fixed income securities

Fixed maturity securities $ 2,317 $ 2,577

Short-term 492 653

Other investments 595 478

Fixed income securities pledged as collateral

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 income securities portfolio, including securities covered by guarantees issued by Ambac Assurance and Ambac UK and other financial guarantors ("insured securities").

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 10-K located in Part II.

Item 8 for information about insured securities by guarantor and fixed income and equity interests by asset class.

The following table provides additional details of the composition of the fair value of other asset-backed securities at December 31, 2019 and 2018 by classification:

($ in millions)

Other asset-backed securities

Military Housing

Structured Insurance

Student Loans

Total other asset-backed securities

Includes investments guaranteed by Ambac Assurance and Ambac UK.

Refer to Note 10.

Investments in this 10-K located in Part II.

Item 8 for further details of Ambac-insured securities held in the investment portfolio.

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.

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The following tables provide the ratings (1) distribution of the fixed income investment portfolio based on fair value at December 31, 2019 and 2018 .

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.

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(2) Below investment grade and not rated bonds insured by Ambac represented 41% and 33% of the 2020 and 2019 combined investment portfolios, respectively.

The decrease in the percentage of below investment grade and increase in the percentage of AAA-rated holdings since December 31, 2018 , was driven by the COFINA restructuring where below investment grade Ambac-insured bonds were exchanged for new COFINA non-rated bonds and cash, with a majority of the new non-rated bonds being sold prior to December 31, 2019 .

Cash proceeds from the restructuring and bond sales throughout the year were invested in, amongst other things, AAA-rated short-term investments, commercial mortgage-backed securities and collateralized debt obligations at December 31, 2019 .

Premium Receivables.

Ambac either received premium upfront at time of issuance of the insurance policy or in installments over the policy term.

For installment premium transactions, a premium

receivable asset is established equal to the (i) present value of future contractual premiums due or (ii) if the underlying insured obligation is a homogenous pool of assets which are contractually prepayable, the present value of premiums to be collected over the expected life of the transaction.

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 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 the impact of currency exchange rates, partially offset by accretion of premium receivable discount.

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:

(Amounts in millions)

Premium Receivable in Payment Currency

Premium Receivable in U.S.

Premium Receivable in Payment Currency Premium Receivable in U.S.

Dollars $ 234 $ 234

British Pounds £ 86 117

Euros € 16 19

Reinsurance Recoverable on Paid and Unpaid Losses .

Ambac Assurance has reinsurance in place pursuant to surplus share treaty and facultative agreements.

To minimize its exposure to losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers;

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 Ambac Assurance in the event of rating agency downgrades of a reinsurer (among other events and circumstances).

Ambac Assurance benefited from letters of credit and collateral amounting to approximately $124 million from its reinsurers at December 31, 2019 .

Collateral is based on reinsurance contracts, but generally includes reinsurers share of loss and loss expense reserves and statutory unearned premiums and contingency reserves, amongst other considerations.

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 insured exposures.

Insurance Intangible Asset .

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

The net intangible asset at December 31, 2019 and 2018 was $427 million and $719 million , respectively.

The decrease was primarily driven by amortization expense of $295 million .

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.

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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:

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Present Value of Expected

Net Cash Flows

Net Cash Flows Unearned

Revenue Gross Loss

($ in millions)

Balance Sheet Line Item

Recoveries (1)

Balance Sheet Line Item Claims and

Expenses Recoveries (1)

December 31, 2020:

1 unchanged sentence

Subrogation recoverable 100 (2,256) — (2,156)

Totals $ 2,160 $ (2,485) $ (72) $ (397)

December 31, 2019:

1 unchanged sentence

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.

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

Please refer to the "Critical Accounting Policies and Estimates" and “Results of Operations” sections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations in addition to Note 2.

Basis of Presentation and Significant Accounting Policies and Note 7.

Financial Guarantee Insurance Contracts , respectively of the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K for further information on loss and loss expenses.

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 bond types.

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%.

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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

Net Cash Flows Unearned

Revenue Gross Loss

Expense Reserves (1)(3)

($ in millions)

($ in millions) Gross Par

Outstanding (1)(2)

Expenses Recoveries

December 31, 2020:

RMBS $ 2,530 $ 669 $ (2,102) $ (13) $ (1,446)

Domestic Public Finance 3,016 1,112 (349) (39) 724

2 unchanged sentences

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

2 unchanged sentences

Loss expenses — 73 — — 73

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

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

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(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.

8 unchanged sentences

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 following descriptions of "RMBS Variability," "Public Finance Variability," "Student Loan Variability," and "Other Credits, including Ambac UK, Variability," for further discussion of the risks relating to future losses and recoveries that could result in more highly stressed outcomes.

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

the initiation of rehabilitation proceedings against Ambac Assurance;

decreased likelihood of Ambac Assurance delivering value to AFG, through dividends or otherwise;

and a significant drop in the value of securities issued or insured by AFG or Ambac Assurance.

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 direct financial guarantees of RMBS, including transactions collateralized by first and second liens.

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

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.

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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 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), timing of receipt of any such recoveries, 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.

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:

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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.

1 unchanged sentence

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

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 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 purpose facilities and interests.

The decline in public finance gross loss reserves at December 31, 2019 , as compared to December 31, 2018 , was primarily related to the Puerto Rico COFINA debt restructuring, payments of claims and commutations, substantially offset by increases in other Puerto Rico loss reserves.

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:

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($ in millions)

Outstanding (1)

Reserves Gross Par

Outstanding (1)

1 unchanged sentence

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.

1 unchanged sentence

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

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

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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, Ambac Assurance 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 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.

The amounts were confirmed as part of the COFINA Plan of Adjustment on February 4, 2019.

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 the Tax Cuts and Jobs Act that was signed into law on December 22, 2017, which could reduce certain municipal investors' appetite for tax-exempt municipal bonds and over the longer term could potentially put additional pressure on issuers in states with high state and local taxes.

These factors could deprive issuers access to funding at a level necessary to avoid defaulting on their obligations.

In addition, a more recent judicial decision in connection with the PRHTA Title III proceedings could cause the loss reserves on our public finance credits to be underestimated.

On March 26, 2019, the U.S.

Court of Appeals for the First Circuit, affirming a decision by the U.S.

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 complainants 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 dismissal of the complaint, holding that it could not compel the issuer to make such payments.

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 significant 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.

In the wake of the decision, rating agencies have already taken ratings actions on, or announced their intention to review ratings given to, bonds issued across the country highlighting the potential contagion effect of the various Puerto Rico proceedings under PROMESA.

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.

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Our exposures to the Commonwealth of Puerto Rico are under stress arising from the Commonwealth’s poor financial condition, uncertain willingness and ability to pay, weak economy, loss of capital markets access, weakened infrastructure and severe damage caused by hurricanes Irma and Maria in 2017 as well as the earthquakes that began in late December 2019.

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

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 and details on the legal, economic and fiscal developments that have impacted or may impact Ambac Assurance’s insured Puerto Rico bonds.

Material additional losses caused by the above-described factors would have a material adverse effect on our results of operations and financial condition.

For public finance credits, including Puerto Rico as well as other issuers, for which we have an estimate of expected loss at December 31, 2019 , the possible increase in loss reserves could be approximately $1,000 million .

Among other things, this estimate includes the possibility that the current Plan Support Agreement (as discussed above in the Financial Guarantees in Force section of this Management Discussion and Analysis) were to become effective.

However, there can be no assurance that losses may not exceed such amount.

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.

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.

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.

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.

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Additionally, an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately $20 million.

However, there can be no assurance that losses may not exceed such amounts.

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.

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Other Credits, including Ambac UK, Variability

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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.

However, there can be no assurance that losses may not exceed such amount.

The highest stress case losses at December 31, 2019 , are $120 million lower

than the December 31, 2018 , estimate primarily as a result of the Ballantyne commutation.

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 Ambac Assurance, the Ambac Note and Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions, and Ambac UK debt issued in connection with the Ballantyne commutation.

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)

($ 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, 2018 is primarily due to optional redemptions of the Ambac Note by $178 million , partially offset by increase in the Tier 2 notes balance due to paid-in-kind interest and discount accretion, together with issuance of Ambac UK debt.

Increase in Surplus notes was due to the accretion on the carrying value of the notes.

SPECIAL PURPOSE AND VARIABLE INTEREST ENTITIES

Please refer to Note 2.

Basis of Presentation and Significant Accounting Policies and Note 3.

Variable Interest Entities to the Consolidated Financial Statements, included in Part II, Item 8 in this Form 10-K, for information regarding special purpose and variable interest entities.

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

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We do not expect these accounting standards to have a consequential impact on Ambac's financial statements.

VIE Related Party Guidance

In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810) - Targeted Improvements to Related Party Guidance for Variable Interest Entities.

To determine whether a decision-making fee is a variable interest, under the new guidance a reporting entity must consider indirect interests held through related parties under common control on a proportional basis rather than as a direct interest in its entirety (as currently required in GAAP).

These amendments create alignment between determining whether a decision making fee is a variable interest and determining whether a reporting entity within a related party group is the primary beneficiary of a VIE.

ASU 2018-17 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted.

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.

Cloud Computing Arrangement Service Contracts

In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other— Internal-Use Software (Subtopic 350-40) - Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.

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new guidance requires a customer in a cloud computing arrangement that is a service contract to capitalize certain implementation costs as if the arrangement was an internal-use software project.

The internal-use software guidance requires the capitalization of certain costs incurred only during the application development stage.

That guidance also requires entities to expense costs during the preliminary project and post-implementation stages as they are incurred.

ASU 2018-15 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted.

The ASU may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption.

Ambac will adopt this ASU on January 1, 2020 to prospective costs.

Defined Benefit and Other Postretirement Plans Disclosures

In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20) - Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans .

The ASU modifies various disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans.

Relevant disclosures that will be removed are:

i) amounts in accumulated other comprehensive income expected to be recognized as net periodic benefit cost over the next fiscal year and ii) the effects of a one percentage point change in assumed health care cost trend rates on the (a) aggregate of the service and interest cost components of the net periodic pension cost and (b) benefit obligation for postretirement healthcare benefits.

Relevant disclosures that will be added are an explanation of the reasons for significant gains and losses related to changes in the benefit obligations for the period.

ASU 2018-14 is effective for fiscal years ending after December 15, 2020, with early adoption permitted.

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 December 31, 2020.

Fair Value Measurement Disclosures

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement .

The ASU modifies various disclosure requirements on fair value measurements.

Relevant disclosures that will be removed, modified and added are as follows:

1) Amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, 2) Policy for timing of transfers between levels, and 3) Valuation processes for Level 3 fair value measurements.

Modifications :

1) For investments in certain entities that calculate net asset value, disclosures are only required for the timing of liquidation of an investee's assets and the date when restrictions from redemption might lapse, only if the investee has communicated the timing to the reporting entity or publicly announced it and 2) Clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date and not possible future changes.

1) Changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and 2) Range and weighted average of

significant unobservable inputs used to develop Level 3 fair value measurements.

Alternatively, an entity may disclose other quantitative information (such as the median or arithmetic average) if it determines that it is a more reasonable and rational method to reflect the distribution of unobservable inputs used.

ASU 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted.

Disclosure amendments related to changes in unrealized gains and losses included in other comprehensive income (loss) for Level 3 instruments, the range and weighted average of significant unobservable inputs, and the narrative description of measurement uncertainty should be applied prospectively only for the most recent interim or annual period presented.

All other disclosure amendments should be applied retrospectively to all periods presented.

Ambac will adopt this ASU on January 1, 2021.

Measurement of Credit Losses on Financial Instruments

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments, subsequently amended by ASU 2018-19 , Codification Improvements to Topic 326, Financial Instruments - Credit Losses;

ASU 2019-04 , Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments ;

ASU 2019-05, Financial Instruments—Credit Losses (Topic 326):

Targeted Transition Relief ;

and ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses (collectively "the ASU").

The ASU significantly affects how reporting entities will measure credit losses for financial assets that are not accounted for at fair value through net income, which include loans, debt securities, premium receivables, reinsurance recoverables, net investments in leases and certain off-balance sheet credit exposures.

The ASU does not apply to recoveries of previously paid losses on financial guarantee insurance contracts accounted for under ASC 944 nor does it apply to equity method investments accounted for under ASC 323.

For financial assets measured at amortized cost, the ASU replaces the "incurred loss" model, which generally delayed recognition of the full amount of credit losses until the loss was probable of occurring, with an "expected loss" model, which reflects an entity's current estimate of all expected lifetime credit losses.

Expected lifetime credit losses for amortized cost assets will be recorded as a valuation allowance, with subsequent increases or decreases in the allowance reflected in net income each period.

For available-for-sale debt securities, credit losses under the ASU will be measured similarly to current GAAP.

However, under the ASU, credit losses for available-for-sale debt securities will be recorded as a valuation allowance (similar to the amortized cost assets approach described above), rather than as a direct write-down of the security as is required under current GAAP.

As a result, improvements to estimated credit losses for available-for-sale debt securities will be recognized immediately in net income rather than as interest income over time.

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For both amortized cost assets and available-for-sale debt securities, our implementation process included updates to our allowance documentation, reporting processes and related internal controls.

Given the more significant changes to the amortized cost asset credit model, the implementation process further included identifying the inventory of assets impacted by this standard;

design and selection of a credit loss model;

and identification of new data requirements and data sources for model implementation.

Depending on the asset type, either a discounted cash flow or probability of default/loss given default model will be used for estimating the effect of lifetime losses and will incorporate any necessary qualitative adjustments for model limitations.

The ASU is effective for SEC filers that are not eligible to be smaller reporting companies for interim and annual periods beginning after December 15, 2019.

Ambac will adopt this ASU effective January 1, 2020, using a modified retrospective approach.

While we do not expect the ASU to have a consequential impact on Ambac's financial statements, we continue to assess all the effects of adoption.

We currently believe the most significant effect will be increased disclosure requirements.

AMBAC ASSURANCE STATUTORY BASIS FINANCIAL RESULTS

Ambac Assurance and Everspan's statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by the OCI.

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.

OCI has prescribed or permitted additional accounting practices for Ambac Assurance and Everspan which are described in Note 8.

Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in this Form 10-K.

As a result of these prescribed and permitted practices, Ambac Assurance’s policyholder surplus at December 31, 2019 and 2018 was less than NAIC SAP by $12 million and less than $42 million , respectively.

Ambac Assurance’s statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were $1,088 million and $1,618 million at December 31, 2019 , respectively, as compared to $1,152 million and $1,648 million at December 31, 2018 , respectively.

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 $472 million that is not recorded under statutory basis accounting principles) and preferred stock issued by Ambac Assurance are obligations that have claims on the resources of Ambac Assurance that are senior to AFG's equity and therefore impact AFG's ability to realize residual value or receive dividends from Ambac Assurance.

The drivers to the net decrease in policyholder surplus were:

Statutory net loss of $225 million for the year ended December 31, 2019, primarily due to loss and loss expenses from net adverse development on the insured portfolio, operating expenses and impairment charges on loans to subsidiaries, partially offset by net investment gains and premiums earned;

Contributions to contingency reserves of $35 million;

partially offset by

Surplus benefits for (i) Ambac Assurance's receipt in September 2019, in connection with an SEC action against Citibank Global Markets Inc., of $142 million, (ii) the recognition of a previous deferred gain from the 2015 sale of Ballantyne bonds to Ambac UK of $28 million and (iii) an increase of $17 million in the fair value of investment securities that are recorded at the lower of amortized cost or fair value.

As further discussed in "Financial Guarantees in Force" above in the Management Discussion and Analysis section of this Form 10-K, pursuant to the COFINA Plan of Adjustment that was effective on February 12.

2019, Ambac Assurance commuted a significant portion of its COFINA insured exposure.

The commutation transactions resulted in a reduction of Ambac Assurance's insured exposure to COFINA by approximately 75% and an incurred loss of $37 million in 2019, which was offset by accelerated earned premiums of $31 million on the insured exposures being commuted.

Ambac Assurance’s statutory surplus is sensitive to multiple factors, including:

(i) loss reserve development, (ii) approval by OCI of principal or interest payments on existing surplus notes, (iii) approval by OCI of principal or interest payments on existing junior surplus notes, (iv) deterioration in the financial position of Ambac Assurance subsidiaries that have their obligations guaranteed by Ambac Assurance, (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 investments carried at fair value, (ix) settlements or resolutions 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.

Under SAP, these amounts will be recorded as a liability once approval for payment has been granted by 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,

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

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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 2.1%.

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 income investments are stated at amortized cost and certain below investment grade fixed income investments are reported at the lower of amortized cost or fair value.

Under GAAP, all fixed income investments are reported at fair value.

• 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;

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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.

Ambac Assurance 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 Ambac Assurance has the power to direct the most significant activities of the VIE and accordingly consolidates the related VIEs under GAAP.

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.

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Installment premiums are reflected in income pro-rata over the period covered by the premium payment.

When an insurance policy has been legally defeased, the related portion of unearned premium revenue is accelerated and recognized as premiums earned.

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.

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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.

The increase in Ambac UK’s shareholders’ funds was primarily due to the loss and loss expenses benefit in the period following the restructuring and commutation of Ballantyne coupled with the receipt of premiums and return on investments.

At December 31, 2019 , the carrying value of cash and investments was £470 million , a decrease from £498 million at December 31, 2018 .

The decrease in cash and investments is due to the impact of the restructuring and commutation of Ballantyne as noted above, tax payments and operating expenses partially offset by continued receipt of premiums and net investment income in the period.

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 a re that under UK GAAP:

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 (currently using a discount rate of 5.23%) of the anticipated defaulted debt service payments over the expected period of default, less estimated recoveries under subrogation rights.

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.

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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 income securities are stated at amortized cost, subject to an other-than-temporary impairment evaluation.

GAAP, all bonds are reported at fair value, also subject to an other-than-temporary impairment evaluation.

• Investments in fixed maturity securities are stated at amortized cost, subject to an other-than-temporary

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impairment evaluation.

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.

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GAAP, investments in Ambac UK insured securities are reported as investments and do not reduce loss reserves.

Variable interest entities (“VIE”) are not required to be assessed for consolidation.

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

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56 2019 FORM 10-K |

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.

Ambac 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 Ambac UK has the power to direct the most significant activities of the VIE and accordingly consolidates the related VIEs under U.S.

• VIEs are not required to be assessed for consolidation.

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.

• Upfront premiums written are earned on a basis proportionate to the remaining scheduled debt service to the total principal and interest insured.

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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, 2019 , will be be published on Ambac's website during March.

Final annual Solvency II data and Ambac UK's annual Solvency and Financial Condition Report will be published on Ambac's website on April 22, 2019.

Available capital resources under Solvency II were a surplus of £187.5 million at December 31, 2019 , (based on the quarterly Solvency II filing made on February 11, 2019, which may be subject to update in the final annual Solvency II filing noted above) an improvement from a surplus of £94.9 million at December 31, 2018 .

Of these available capital resources the value eligible to meet solvency capital requirements at December 31, 2019 , was £178 million in comparison to £90 million as at December 31, 2018 .

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.

Ambac UK is therefore deficient in terms of compliance with applicable regulatory capital requirements by £30 million and £267 million at December 31, 2019 and December 31, 2018 , respectively.

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.

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.

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 reports two 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.

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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.

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.

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• Insurance intangible amortization:

Elimination of the amortization of the financial guarantee insurance intangible asset that arose as a result of the implementation of Fresh Start reporting.

These adjustments ensure that all financial guarantee contracts are accounted for consistent with the provisions of the Financial Services – Insurance Topic of the ASC.

Foreign exchange (gains) losses:

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.

Fair value (gain) loss on interest rate derivative from Ambac CVA:

Elimination of the gains (losses) relating to Ambac’s CVA on interest rate derivative contracts.

Similar to credit derivatives, fair values include the market’s perception of

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.

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60 2020 FORM 10-K |

Ambac’s credit risk and this adjustment only allows for such gain or loss when realized.

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,

Per Diluted Share

$ 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

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

Fair value (gain) loss on interest rate derivatives from Ambac CVA

3 0.06 (12) (0.26) 7 0.15

Adjusted Earnings (Loss)

$ (378) $ (8.19) $ 66 $ 1.44 $ 301 $ 6.47

Adjusted Book Value.

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This adjustment ensures that all financial guarantee contracts are accounted for within Adjusted Book Value consistent with the provisions of the Financial Services—Insurance Topic of the ASC.

Ambac CVA on interest rate derivative liabilities:

Elimination of the gain relating to Ambac’s CVA on interest rate derivative contracts.

Similar to credit derivatives, fair values include the market’s perception of Ambac’s credit risk and this adjustment only allows for such gain when realized.

• 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.

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.

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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 total dollar amount and per share basis, for all periods presented:

($ in millions, except per share data) December 31,

stockholders’ equity to the non-GAAP measure Adjusted Book Value on a dollar amount and per share basis, for all periods presented:

($ in millions, except per share data) December 31, $ Amount Per Share $ Amount Per Share

Total Ambac Financial Group, Inc.

4 unchanged sentences

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.

The Adjusted Book Value increase from December 31, 2018 to December 31, 2019 was primarily driven by Adjusted earnings.

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.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis