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Item 2. Management’s Discussion and Analysis

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 
 Following this summary is a discussion addressing the consolidated results of operations and financial condition of Ambac Financial Group, Inc. (“AFG”) for the periods indicated. References to “Ambac,” the “Company,” “we,” “our,” and “us” are to AFG and its subsidiaries, as the context requires. This discussion should be read in conjunction with Ambac’s Annual Report on Form 10-K for the year ended December 31, 2020, the Cautionary Statement Pursuant To The Private Securities Litigation Reform Act Of 1995 below and Risk Factors set forth in Part II, Item 1A of this Form 10-Q and in Ambac’s Annual Report on Form 10-K for the year ended December 31, 2020. 
 This Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contains certain financial measures, in particular the presentation of Adjusted Earnings and Adjusted Book Value, which are not presented in accordance with U.S. generally accepted accounting principles (“GAAP”). We are presenting these non-GAAP financial 

 
 measures because they provide greater transparency and enhanced visibility into the underlying drivers of our business. We do not intend for these non-GAAP financial measures to be a substitute for any GAAP financial measure and they may differ from similar reporting provided by other companies. Readers of this Form 10-Q should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. Adjusted Earnings and Adjusted Book Value are non-GAAP financial measures that adjust for the impact of certain non-recurring or non-economic GAAP accounting requirements and include the addition of certain items that the Company has or expects to realize in the future, but that are not reported under GAAP. We provide reconciliations to the most directly comparable GAAP measures; Adjusted Earnings to Net income attributable to common stockholders and Adjusted Book Value to Total Ambac Financial Group, Inc. stockholders’ equity. 
 
 CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 
 Management has included in Parts I and II of this Quarterly Report on Form 10-Q, including this MD&A, statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as “estimate,” “project,” “plan,” “believe,” “anticipate,” “intend,” “planned,” “potential” and similar expressions, or future or conditional verbs such as “will,” “should,” “would,” “could,” and “may,” or the negative of those expressions or verbs, identify forward-looking statements. We caution readers that these statements are not guarantees of future performance. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, which may by their nature be inherently uncertain and some of which may be outside our control. These statements may relate to plans and objectives with respect to the future, among other things which may change. We are alerting you to the possibility that our actual results may differ, possibly materially, from the expected objectives or anticipated results that may be suggested, expressed or implied by these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of the 2020 Annual Report on Form 10-K and in Part II, Item 1A of this quarterly Report on Form 10-Q. 
 Any or all of management’s forward-looking statements here or in other publications may turn out to be incorrect and are based on management’s current belief or opinions. AFG’s and its subsidiaries’ (“Ambac”) actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among events, risks, uncertainties or factors that could cause actual results to differ materially are: (1) the highly speculative nature of AFG’s common stock and volatility in the price of AFG’s common stock; (2) Ambac's inability to realize the expected recoveries, including RMBS litigation recoveries, included in its financial statements which would have a materially adverse effect on AAC’s financial condition and may lead to regulatory intervention; (3) failure to recover claims paid on Puerto Rico exposures or realization of losses in amounts higher than expected; (4) increases to loss and loss expense reserves; (5) inadequacy of reserves established for losses and loss expenses and 

 | Ambac Financial Group, Inc. 46 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 possibility that changes in loss reserves may result in further volatility of earnings or financial results; (6) uncertainty concerning the Company’s ability to achieve value for holders of its securities, whether from AAC and its subsidiaries or from transactions or opportunities apart from AAC and its subsidiaries, including new business initiatives relating to the specialty property and casualty program insurance business, the managing general agency/underwriting business, or related businesses; (7) potential of rehabilitation proceedings against AAC; (8) increased fiscal stress experienced by issuers of public finance obligations or an increased incidence of Chapter 9 filings or other restructuring proceedings by public finance issuers, including an increased risk of loss on revenue bonds of distressed public finance issuers due to judicial decisions adverse to revenue bond holders; (9) our inability to mitigate or remediate losses, commute or reduce insured exposures or achieve recoveries or investment objectives, or the failure of any transaction intended to accomplish one or more of these objectives to deliver anticipated results; (10) insufficiency or unavailability of collateral to pay secured obligations; (11) credit risk throughout Ambac’s business, including but not limited to credit risk related to residential mortgage-backed securities, student loan and other asset securitizations, public finance obligations and exposures to reinsurers; (12) the impact of catastrophic environmental or natural events, including catastrophic public health events like the COVID-19 pandemic, on significant portions of our insured and investment portfolios; (13) credit risks related to large single risks, risk concentrations and correlated risks; (14) the risk that Ambac’s risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss; (15) risks associated with adverse selection as Ambac’s insured portfolio runs off; (16) Ambac’s substantial indebtedness could adversely affect its financial condition and operating flexibility; (17) Ambac may not be able to obtain financing or raise capital on acceptable terms or at all due to its substantial indebtedness and financial condition; (18) Ambac may not be able to generate the significant amount of cash needed to service its debt and financial obligations, and may not be able to refinance its indebtedness; (19) restrictive covenants in agreements and instruments may impair Ambac’s ability to pursue or achieve its business strategies; (20) adverse effects on operating results or the Company’s financial position resulting from measures taken to reduce risks in its insured portfolio; (21) disagreements or disputes with Ambac's insurance regulators; (22) default by one or more of Ambac's portfolio investments, insured issuers or counterparties; (23) loss of control rights in transactions for which we provide insurance due to a finding that Ambac has defaulted; (24) adverse tax consequences or other costs resulting from the characterization of the AAC’s surplus notes or other obligations as equity; (25) risks attendant to the change in composition of securities in the Ambac’s investment portfolio; (26) adverse impacts from changes in prevailing interest rates; (27) our results of operation may be adversely affected by events or circumstances that result in the impairment of our intangible assets and/or goodwill that was recorded in connection with Ambac’s acquisition of 80% of the membership interests of Xchange; (28) risks associated with the expected discontinuance of the London Inter-Bank Offered Rate; (29) factors that may negatively influence the amount of installment premiums paid to the Ambac; (30) market risks impacting assets in the Ambac’s investment portfolio or the value of our assets posted as collateral in respect of interest rate swap transactions; (31) risks relating to determinations of amounts of impairments taken on investments; (32) the risk of litigation and regulatory inquiries or investigations, 

 
 and the risk of adverse outcomes in connection therewith, which could have a material adverse effect on Ambac’s business, operations, financial position, profitability or cash flows; (33) actions of stakeholders whose interests are not aligned with broader interests of the Ambac's stockholders; (34) system security risks, data protection breaches and cyber attacks; (35) changes in accounting principles or practices that may impact Ambac’s reported financial results; (36) regulatory oversight of Ambac Assurance UK Limited (“Ambac UK”) and applicable regulatory restrictions may adversely affect our ability to realize value from Ambac UK or the amount of value we ultimately realize; (37) operational risks, including with respect to internal processes, risk and investment models, systems and employees, and failures in services or products provided by third parties; (38) Ambac’s financial position that may prompt departures of key employees and may impact the its ability to attract qualified executives and employees; (39) fluctuations in foreign currency exchange rates could adversely impact the insured portfolio in the event of loss reserves or claim payments denominated in a currency other than US dollars and the value of non-US dollar denominated securities in our investment portfolio; (40) disintermediation within the insurance industry or greater competition that negatively impacts our managing general agency/underwriting business; (41) changes in law or in the functioning of the healthcare market that impair the business model of our accident and health managing general underwriter; (42) greater competition for our specialty property & casualty program insurance business; and (43) other risks and uncertainties that have not been identified at this time. 
 
 EXECUTIVE SUMMARY ($ in millions) 
 Company Overview: 
 See Note 1. Background and Business Description to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q and Note 1. Background and Business Description in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for a description of the Company and our key strategic priorities to achieve our primary goal to maximize stockholder value. 
 AFG 
 During 2021, AFG progressed the development of its specialty property and casualty program insurance business. Developments included the following: 
 • AFG contributed $82 of additional capital to the Everspan Group. 
 • The Everspan Group platform received an A- Financial Strength Rating from A.M. Best in February 2021. 
 • The Everspan Group launched its first insurance program in May 2021. 
 • To support expansion of the admitted insurance component of its business, during the second quarter of 2021 Everspan Group entered into stock purchase agreements to acquire several insurance shell companies. These acquisitions are subject to the approval of the insurance regulators in the States of domicile of the companies to be acquired, which may occur in 2021. 

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 • During the second quarter of 2021, AFG made minority investments in certain insurance related businesses, including insurtech platforms, that we believe will be synergistic to our specialty property & casualty program insurance and MGA/MGU businesses. 
 AFG Net Assets 
 As of June 30, 2021, net assets of AFG, excluding its equity investments in subsidiaries, were $281. 
 
 Cash and short-term investments $ 128 
 Other investments (1) 
 147 
 Other net assets 5 
 Total $ 281 

 (1) Includes surplus notes (fair value of $116) issued by AAC that are eliminated in consolidation. 
 AAC and Subsidiaries 
 A key strategy for Ambac is to increase the value of its investment in AAC by actively managing its assets and liabilities. Asset management primarily entails maximizing the risk-adjusted return on non-VIE invested assets and managing liquidity to help ensure resources are available to meet operational and strategic cash needs. These strategic cash needs include activities associated with Ambac's liability management and loss mitigation programs. 
 Asset Management 
 Investment portfolios are subject to internal investment guidelines, as well as limits on the types and quality of investments imposed by insurance laws and regulations. The investment portfolios of AAC and Ambac UK hold fixed maturity securities and various pooled investment funds. Refer to Note 9. Investments to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q for further details of fixed maturity investments by asset category and pooled investment funds by investment type. 
 At June 30, 2021, Ambac and its subsidiaries owned $611 of distressed Ambac-insured bonds, including significant concentrations of insured Puerto Rico and RMBS bonds, and excluding Ambac's holdings of secured notes issued by Ambac LSNI. Subject to internal and regulatory guidelines, market conditions and other constraints, Ambac may continue to opportunistically purchase or sell Ambac-insured securities. 
 Liability and Insured Exposure Management 
 AAC's Risk Management Group focuses on the implementation and execution of risk reduction, defeasance and loss recovery strategies. Analysts evaluate the estimated timing and severity of projected policy claims as well as the potential impact of loss mitigation or remediation strategies in order to target and prioritize policies, or portions thereof, for commutation, reinsurance, refinancing, restructuring or other risk reduction strategies. For targeted policies, analysts will engage with issuers, bondholders and other economic stakeholders to negotiate, structure and execute such strategies. AAC completed risk reduction transactions consisting of quota share reinsurance, refinancings, and commutations of $666 and $2,040 for the three and six months ended June 30, 2021, respectively. 

 
 The following table provides a comparison of total, adversely classified ("ACC") and watch list credit net par outstanding in the insured portfolio at June 30, 2021 and December 31, 2020. 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. 
 
 June 30,
2021 December 31,
2020 Decrease 
 Total $ 30,234 $ 33,888 $ (3,654) (10) % 
 ACC 6,924 8,458 (1,534) (18) % 
 Watch list 4,213 4,720 (507) (11) % 

 
 
 The decrease in total, ACC and watch list credit net par outstanding resulted from active de-risking initiatives, as noted above, as well as scheduled maturities, amortizations, refundings and calls. 
 
 
 The COVID-19 pandemic had, and to a lesser degree, 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 together with an increasing COVID-19 vaccination rate in the first half of 2021 have supported the economic recovery which began in the second half of 2020. Outside of the U.S., 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 of the pandemic. Overall, the ongoing global recovery should be a benefit to most issuers in Ambac's insured portfolio negatively impacted by the COVID-19 pandemic. Nonetheless, credit risk in the insured portfolio remains elevated due to, among other things, uncertainty over the trajectory and continuity of the economic recovery due to still elevated COVID-19 infection rates globally as well as the spread of new virus variants. In addition, the near-term efficacy of fiscal stimulus and related measures on certain exposures in the insured portfolio impacted by the COVID-19 pandemic is uncertain. 
 Since 2020, COVID-19 has adversely impacted Ambac's financial position and results of operations as credit risk in the insured and investment portfolios has increased. We continue to evaluate and update our view of the macro economic environment as well as our specific credit view of each of our insured exposures considering the 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. 

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 Ambac has exposure to reinsurance counterparties for their portion of future financial guaranty claim payments. Ambac has reinsured approximately 16.4% of its gross par outstanding to five 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 also exposed to the risk that contractual counterparties (including those under our RMBS litigations and derivative counterparties) may default on 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. 
 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 incorporates the impact of COVID-19 on business prospects. 
 Financial Statement Impact of Foreign Currency: 
 The impact of foreign currency as reported in Ambac's Unaudited Consolidated Statement of Total Comprehensive Income for the six months ended June 30, 2021, included the following: 
 
 
 Net income (1) 
 $ (7) 
 Gain (loss) on foreign currency translation (net of tax) 
 8 
 Unrealized gains (losses) on non-functional currency available-for-sale securities (net of tax) 
 2 
 Impact on total comprehensive income (loss) 
 $ 3 

 (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 Unaudited Consolidated Statement of Total Comprehensive Income (Loss). 
 Future changes to currency rates may adversely affect our financial results. Refer to Part II, Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for further information on the impact of future currency rate changes on Ambac's financial instruments. 
 LIBOR Sunset 
 Ambac continuously monitors regulatory and industry developments related to the transition from LIBOR to alternative reference rates. On April 6, 2021, New York State passed 

 
 legislation addressing the cessation of U.S. Dollar ("USD") LIBOR and specified a recommended benchmark replacement based on the Secured Overnight Financing Rate ("SOFR") for certain legacy transactions. The Alternative Reference Rates Committee, the Federal Reserve Board and several industry associations and groups have expressed support for the new law and are encouraging comparable Federal legislation. While Ambac believes the New York LIBOR law is generally a positive step, there remains significant uncertainty about how it will be interpreted or challenged as well as about other aspects of the discontinuance of LIBOR, including the impact of any Federal legislation. See 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 Ambac’s Annual Report on Form 10-K for the year ended December 31, 2020. Also, for further background and information about management's evaluation of Ambac's potential exposures to LIBOR transition, see "Executive Summary — LIBOR Sunset" in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Ambac’s Annual Report on Form 10-K for the year ended December 31, 2020. 
 
 CRITICAL ACCOUNTING POLICIES AND ESTIMATES 
 Ambac’s Unaudited Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”), which require the use of material estimates and assumptions. For a discussion of Ambac’s critical accounting policies and estimates, see “Critical Accounting Policies and Estimates” in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Ambac’s Annual Report on Form 10-K for the year ended December 31, 2020. 
 
 
 
 FINANCIAL GUARANTEES IN FORCE
($ in millions) 
 Financial guarantee products were sold in three principal markets: U.S. public finance, U.S. structured finance and international finance. The following table provides a breakdown of guaranteed net par outstanding by market at June 30, 2021 and December 31, 2020. Net par exposures within the U.S. public finance market include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bonds. Guaranteed net par outstanding includes the exposures of policies insuring variable interest entities (“VIEs”) consolidated in accordance with the Consolidation Topic of the ASC. 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 insured the notes issued by Ambac LSNI as defined in Note 3. Variable Interest Entities in the Notes to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Quarterly Report on Form 10-Q: 

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 June 30,
2021 December 31,
2020 
 Public Finance (1) (2) 
 $ 13,642 $ 15,497 
 Structured Finance 5,398 6,337 
 International Finance 11,194 12,054 
 Total net par outstanding $ 30,234 $ 33,888 

 (1) Includes $5,533 and $5,575 of Military Housing net par outstanding at June 30, 2021 and December 31, 2020, respectively. 

 
 (2) Includes $1,067 and $1,070 of Puerto Rico net par outstanding at June 30, 2021 and December 31, 2020, 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. 

 
 
 The table below shows Ambac’s ten largest insured exposures, by repayment source, as a percentage of total financial guarantee net par outstanding at June 30, 2021: 
 
 Risk Name 
 Country-Bond Type 
 Ambac 
 Ratings (1) 
 Ultimate
Maturity
Year Net Par
Outstanding (3) 
 % of Total 
 Net Par 
 Outstanding 
 
 IF AUK Mitchells & Butlers Finance plc-UK Pub Securitisation UK-Asset Securitizations BBB 2033 $ 944 3.1 % 
 IF AUK Capital Hospitals plc (2) 
 UK-Infrastructure A- 2046 922 3.0 % 
 IF AUK Anglian Water UK-Utility A- 2035 886 2.9 % 
 IF AUK Aspire Defence Finance plc UK-Infrastructure A- 2040 866 2.9 % 
 IF AUK National Grid Gas UK-Utility BBB+ 2037 818 2.7 % 
 PF AAC New Jersey Transportation Trust Fund Authority - Transportation System US-Lease and Tax-backed Revenue BBB- 2036 767 2.5 % 
 IF AUK Posillipo Finance II S.r.l Italy-Sub-Sovereign BIG 2035 704 2.3 % 
 IF AUK RMPA Services plc UK-Infrastructure BBB+ 2038 571 1.9 % 
 IF AUK National Grid Electricity Transmission UK-Utility BBB+ 2036 550 1.8 % 
 IF AUK Catalyst Healthcare (Manchester) Financing plc (2) 
 UK-Infrastructure BBB- 2040 541 1.8 % 
 Total 
 $ 7,569 24.9 % 
 PF = Public Finance, SF = Structured Finance, IF = International Finance 
 AAC = Ambac Assurance, AUK = Ambac UK 
 

 (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. BIG denotes credits deemed below investment grade. 
 (2) 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"). 
 (3) 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. 
 Net par related to the top ten exposures reduced $150 from December 31, 2020. Exposures are impacted by changes in foreign exchange rates, certain indexation rates and scheduled and unscheduled paydowns. The concentration of net par amongst the top ten (as a percentage of net par outstanding) increased slightly to 25% at June 30, 2021, from 23% at December 31, 2020. National Grid Gas had an Ambac rating downgrade since December 31, 2020. Excluding the top ten exposures, the remaining insured portfolio of financial guarantees has an average net par outstanding of $32 per single risk, with insured exposures ranging up to $458 and a median net par outstanding of $5. 
 Given that Ambac has not written any new insurance policies since 2008, the risk exists that the insured portfolio becomes increasingly concentrated to large and/or below investment grade exposures. 

 
 COVID-19 
 COVID-19 and the public health responses by the US federal and state governments at the onset of the pandemic resulted in a shut down for several months of significant portions of the US economy, including areas that Ambac's insured obligors rely upon to generate the revenues and cash flows necessary to service debts we insure. Governments outside the US, in markets in which Ambac operates, also implemented similar measures to the US. Ambac undertook a detailed analysis of the potential impact of the closure of certain portions of the US economy and certain other economies, including the UK, Italy, and Australia, to assess the impact of the resulting global economic contraction on its insured financial guarantee portfolio. 
 The economic contraction and the subsequent ongoing recovery; actions such as fiscal stimulus and related programs and monetary policy decisions; and our insured obligors' financial flexibility 

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 and ability to mitigate the operational and economic impact of the recession will determine the ultimate impact to Ambac's insured portfolio. 
 Fiscal Stimulus and Monetary Policy 
 In the U.S., significant fiscal stimulus measures, monetary policy actions and other relief measures have helped to moderate the negative economic impacts of COVID-19 and have supported the economic recovery which began in the second half of 2020 and continues into 2021. These measures included the $1.9 trillion American Rescue Plan Act or ARPA, signed into law in March 2021, which together with other fiscal stimulus measures put in place in 2020, provide for, among other things, funding to state and local governments, direct payments to households, support for small businesses, renter assistance and funding for transport, airlines, healthcare and education. Monetary policy decisions have included quantitative easing and the provision of liquidity to financial institutions and credit markets. 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, 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 negative economic impact and support recovery. 
 We continue to evaluate and update 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. 
 Despite the above measures, which are designed to help mitigate the economic impact of the COVID-19 pandemic generally, certain of these measures may adversely affect Ambac. These include the federal government's 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. Forbearances increased sharply across the AAC's insured first lien RMBS obligations during the second and third quarters of 2020, but then began to drop later in the third quarter of 2020 through June 30, 2021, 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 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 as these measures are unwound. 
 While Ambac expects the foregoing measures to continue 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 still experience material losses that would adversely impact our future results of operations and financial condition. 
 Insured Portfolio: 
 The U.S. economy continues to recover from COVID-19 pandemic, aided by rapid vaccine diffusion, increased fiscal stimulus, and a continued reopening of the economy. After contracting in 2020, the U.S. economy is projected to grow strongly in 2021, exceeding 2019 levels of economic output during the course of the year. Unemployment has recovered from the high of about 15% in April 2020, but still remains elevated at about 5.9% relative to pre-pandemic levels of about 3.5%. Potential headwinds include rising COVID-19 infection rates globally and the spread of COVID-19 variants. 
 The improving economy, increased fiscal stimulus and other relief measures should benefit the overall credit quality of Ambac's insured portfolio. In particular, the expanded fiscal stimulus resulting from March 2021's $1.9 trillion ARPA should significantly benefit state and local governments that have faced significant budget constraints as tax revenues faltered as a result of COVID-19 related shutdowns, job losses and travel restrictions. ARPA provides $350 billion to state and local governments, including to Public Finance issuers with debt insured by Ambac. However, the ultimate impact of ARPA and the economic recovery in general on the Ambac insured portfolio remains to be seen, as it will not benefit all insured exposures equally and may not benefit certain exposures at all. 
 As part of a 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 pandemic. Our near-term concerns are concentrated on exposures substantially reliant on narrow, economically sensitive revenue streams. The ability of issuers of certain of these obligations to pay has been and may continue to be stressed although several issuers expressed a willingness to use their balance sheets to support their obligations and avoid defaults and thus far there have been no defaults of these obligations attributable to the COVID-19 pandemic. Ambac's insured par outstanding, net of reinsurance ("NPO"), to these Public Finance sectors are as follows: 
 
 Market / Sector Total NPO Total Debt Service Due Next Twelve Months 
 
 Toll Roads / Bridges $ 457 $ 43 
 Dedicated Tax 341 49 
 Rail / Mass Transit 288 15 
 Hotels / Convention Centers 187 40 
 Higher Education Auxiliary 138 16 
 Stadiums 92 8 
 Airports 22 14 
 Total Public Finance $ 1,525 $ 185 

 
 
 The RMBS insured portfolios were adversely impacted by the previously mentioned forbearances and the moratorium on 

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 foreclosures as well as the general uncertainty about the trajectory of the economic recovery and the impact of fiscal stimulus on the U.S. households. This has been offset by the benefit to excess spread within the securitization structures as a result of the reduction in interest rates over the past year, which is expected to result in higher excess spread recoveries to Ambac. 
 Ambac's 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. Ambac's remaining NPO with respect to these international demand dependent policies are as follows: 
 
 Market / Sector Total NPO Total Debt Service Due for Twelve Months 
 
 
 Asset Securitizations 
 $ 944 $ 88 
 Toll Roads / Bridges 
 424 34 
 Airports 
 209 7 
 Higher Education 
 179 10 
 Total 
 $ 1,756 $ 139 

 At this time, there are still 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. 
 Puerto Rico 
 We continue to experience stress in our exposure to Puerto Rico (the "Commonwealth") that consists of several different issuing entities (all below investment grade) with total net par exposure of $1,067 as of June 30, 2021. Each issuing entity has its own credit risk profile attributable to, as applicable, discreet revenue sources, direct general obligation pledges and general obligation guarantees. Refer to Part 1, Item 1 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for additional information regarding the different issuing entities that encompass Ambac's exposures to Puerto Rico. 
 COVID-19 
 The COVID-19 pandemic had a significant impact on Commonwealth of Puerto Rico much as it did in the 50 U.S. states and other U.S. territories. However, the Puerto Rico economy is currently in recovery with vaccination rates increasing and infection rates declining. Overall, the Commonwealth's general fund revenues in the 10-month period ending April 2021 were up 10.7% year-on-year to $8,900 from $8,000 and were about $540 higher than the budgeted amount for the period. As reported in the April 23, 2021, Commonwealth Fiscal Plan, Puerto Rico is also expected to benefit from about $43,500 in COVID-19-related federal funds from the initial 

 
 CARES related measures in 2020 through the more recently enacted ARPA. 
 It is unclear if the recovery will hold, what this implies for the Commonwealth’s ability and willingness to pay debt service, and what if any lasting effects COVID-19 will have on the economic and financial profile of Puerto Rico. 
 Over the longer-term, Puerto Rico's recovery profile will be impacted by a wide range of factors as well as financial considerations including, but not limited to: 
 • the fiscal and monetary policies of the federal government which will shape the trajectory of the U.S. economy; 
 • the speed and efficacy of targeted federal aid packages to (1) help Puerto Rico address the negative economic effects of the pandemic and (2) rebuild better and more resilient infrastructure post-Hurricanes Irma and Maria in 2017 and earthquakes in 2020; 
 • supplemental Medicaid funding relief; and 
 • the willingness and ability of the Commonwealth government to implement much needed fiscal and structural reforms. 
 Commonwealth Fiscal Plan 
 On April 23, 2021, the Oversight Board certified its own version of a new Commonwealth Fiscal Plan. This most recent Commonwealth Fiscal Plan purports to incorporate the impact of the $120,000 of federal recovery money stemming from the 2017 hurricanes, 2019-2020 earthquakes, and COVID-19 pandemic, including the American Rescue Plan Act or ARPA. The current certified Commonwealth Fiscal Plan projects a surplus of $15,200 in years 2022-2035, with deficits beginning in 2036, whereas as May 2020's COVID-19 affected certified Commonwealth Fiscal Plan projected a surplus of $5,800 over a similar period. Debt sustainability analysis in the new plan suggests a modest increase to $5,600 from $5,000 (based upon mid-point of ranges shown in the plan). 
 As with previous fiscal plans, the current certified Commonwealth Fiscal Plan may significantly inform the Commonwealth Plan of Adjustment in the Commonwealth's Title III proceeding. However, as was also the case with previous versions of the Commonwealth Fiscal Plan, the current version of the Commonwealth Fiscal Plan lacks a high degree of transparency regarding the underlying data, assumptions and rationales supporting those assumptions, making reconciliation and due diligence difficult. 
 No assurances can be given that Ambac's financial condition will not suffer a materially negative impact as an ultimate result of decisions based on the Commonwealth Fiscal Plan or any future changes or revisions to the Commonwealth Fiscal Plan or future fiscal plans for Puerto Rico Highways and Transportation Authority ("PRHTA") or other Puerto Rico instrumentalities. 
 Commonwealth Plan of Adjustment 
 On July 30, 2021, the Oversight Board, as representative of the Commonwealth of Puerto Rico, the Puerto Rico Public Buildings Authority, and the Employees Retirement System of the Government of the Commonwealth of Puerto Rico, filed a Seventh Amended Title III Joint Plan of Adjustment of the 

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 Commonwealth of Puerto Rico (“Seventh Amended POA”) that proposes to restructure approximately $35,000 of debt and approximately $50,000 in pension obligations. The Seventh Amended POA, among other things, incorporates the settlement reflected in the PRIFA Related Plan Support Agreement (“PRIFA PSA”) that was signed on July 27, 2021, by the Oversight Board, as representative of the Commonwealth of Puerto Rico, AAC, FGIC, and other holders of bonds issued by the Puerto Rico Infrastructure Financing Authority ("PRIFA"). On July 29, 2021, Judge Laura Taylor Swain of the United States District Court for the District of Puerto Rico approved the disclosure statement for the Commonwealth's plan of adjustment, thereby enabling the Oversight Board to proceed towards confirmation of the Seventh Amended POA. Earlier in July 2021, Judge Swain approved several days between November 8th through November 23rd for a hearing to confirm the Commonwealth's plan of adjustment, although these dates may change. A successful confirmation and consummation of the Seventh Amended POA would represent a significant step towards resolution of AAC's remaining Puerto Rico exposures; however, the ultimate outcome of the hearing and the subsequent emergence of the Commonwealth of Puerto Rico from the Title III proceedings is not certain and subject to challenge and other developments. 
 The PRIFA PSA reflects a July 14, 2021, agreement between the Oversight Board, AAC and FGIC to resolve claims related to bonds issued by PRIFA. Under the PRIFA PSA, PRIFA creditors will receive, on account of approximately $1,900 of allowed claims arising from PRIFA bonds, consideration in the form of (i) $193.5 cash and (ii) a contingent value instrument ("CVI") premised on outperformance of general fund rum tax collections relative to the certified 2021 Commonwealth Fiscal Plan's projections (the "Rum Tax CVI"). The Rum Tax CVI is subject to a lifetime nominal cap of about $1,300, and is also subject to various permitted rum tax waterfall deductions and caps on distributions, including the lesser of (a) 40% of cumulative outperformance (net of waterfall deductions), starting on July 1, 2021, less Rum Tax CVI payments made to PRIFA creditors in previous years, (b) 50% of annual rum tax outperformance (net of waterfall deductions), and (c) $30 annually. Both the cash consideration and the Rum Tax CVI will be deposited into a trust held for the benefit of PRIFA bondholders (the "PRIFA Trust"); the PRIFA Trust will also be funded with a share (approximately 27%) of the Clawback CVI, described below. The lifetime sum of the Rum Tax CVI and the Clawback CVI cannot exceed the $1,300 lifetime nominal cap (75% of allowed PRIFA claim) under the Seventh Amended POA. Further, under the PRIFA PSA, AAC and other creditors may also receive fees in connection with negotiating the PRIFA PSA and supporting the restructuring agreement reflected therein. The value of the PRIFA Trust is highly uncertain given the contingent, outperformance-driven structure of the CVIs coupled with the likely back-ended nature of most of the potential cash flows. Changes in our assumed values of the PRIFA Trust or the actual performance of the CVIs could cause an adverse change in our reserves which could be material. As a result, a decrease in our assumed values of the PRIFA Trust could have a material adverse impact on our results of operations and financial condition. 
 In addition to the PRIFA PSA, AAC signed a joinder to the PRHTA/CCDA Related Plan Support Agreement (“PRHTA/ 

 
 CCDA PSA”) on July 15, 2021. The PRHTA/CCDA PSA, originally executed on May 5, 2021, among other things provides for certain consideration for holders of bonds issued by certain Commonwealth instrumentalities, including PRHTA, CCDA, and PRIFA, on account of their claims against the Commonwealth arising from such bonds ("Clawback" claims). This consideration consists of a contingent value instrument tied to the outperformance of the Commonwealth's sales and use tax ("SUT") relative to the certified 2020 Commonwealth Fiscal Plan's projections (the "Clawback CVI"). For years one through 30, a portion of the Clawback CVI consideration reflects a 40% share of cumulative outperformance, starting July 1, 2021, subject to a combined 95% outperformance limit with the subsequently described amounts subject to a waterfall. The other portion of the Clawback CVI receives, on an annual basis, the lesser of (i) 50% of cumulative outperformance, less payments previously made, and (ii) 75% of annual outperformance, and is subject to a waterfall. The waterfall provides that in years one through 22, (a) holders of general obligation ("GO") bonds will receive the first $100 of outperformance, (b) the Clawback creditors will receive the next $11.1, and (c) any amounts received thereafter will be split 90%/10% between GO creditors and Clawback creditors; in years 23 through 30, subject to the limits in (i) and (ii) above, 100% of the outperformance goes to the Clawback creditors. Overall, Clawback CVI recoveries are subject to a lifetime cap of 75% of allowed claim amounts under the Commonwealth plan of adjustment. PRHTA creditors will receive an approximately 69% share of the Clawback CVI, subject to a lifetime nominal cap of about $3,700, and subject to a PRHTA-specific waterfall: holders of PRHTA ’68 bonds will receive the first dollars of Clawback CVI, followed by holders of PRHTA ’98 bonds. CCDA bondholders will receive a 4% share of the Clawback CVI, subject to a lifetime nominal cap of about $217. PRIFA bondholders, as discussed above, will receive a 27% share of the Clawback CVI. The value of the Clawback CVI is highly uncertain, given the contingent, outperformance-driven structure of the instrument coupled with the likelihood that cash flows in later years (years 23 through 30) will significantly exceed those in earlier years. Changes in our assumed values of the Clawback CVI or in the actual performance of the Clawback CVI could cause an adverse change in our reserves which could be material. As a result, a decrease in our assumed values of the Clawback CVI could have a material adverse impact on our results of operations and financial condition. 
 Under the PRHTA/CCDA PSA, the PRHTA creditors will also receive new PRHTA bonds with a face amount of $1,245, maturities of up to 40 years and an average interest rate of 5.0%. Of the $1,245 in new bonds, approximately $646.4 will be allocated to holders of PRHTA '68 bonds and approximately $598.6 will be allocated to holders of PRHTA '98 bonds. PRHTA creditors will also share $389 of cash proceeds, including a $264 interim distribution, payable at the effective date of the Commonwealth plan of adjustment. In addition, certain restriction fees and consummation costs are payable at the effective date of the PRHTA plan. Of the $264 interim cash distribution, $184.8 would be allocated to holders of PRHTA ’68 bonds and $79.2 would be allocated to holders of PRHTA ’98 bonds. Claim recovery expectations for PRHTA creditors under the PRHTA/CCDA PSA are uncertain and subject to interpretation due to the 

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 aforementioned uncertainty related to the value of and/or the actual performance of the Clawback CVI. 
 Under the PRHTA/CCDA PSA, CCDA creditors will receive $112 of cash, inclusive of up to $15 related to restriction fees and consummation costs payable at the effective date of the Commonwealth plan of adjustment. 
 On July 27, 2021, Ambac joined the July 12, 2021, Amended and Restated Plan Support Agreement with 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 ("Amended and Restated GO / PBA PSA"). In general, this PSA follows the Second Amended GO/PBA PSA, originally signed on February 23, 2021, which provided for lower Commonwealth debt service payments per annum relative to the Plan Support Agreement signed in February 2020 (the "Amended GO/PBA PSA"), and extended the tenor of new recovery bonds, increased the amount of cash distributed to creditors, and provided additional consideration in the form of a CVI, intended to provide creditors with additional returns tied to outperformance of the SUT against the certified 2020 Commonwealth Fiscal Plan's projections. Fixed consideration as part of the Amended and Restated GO/PBA PSA, as in the Second Amended GO/PBA PSA, includes a combination of cash, new GO current interest bonds, and new GO capital appreciation bonds. Recovery derived from fixed consideration is estimated to vary between approximately 67% and 77% (as of the petition date) for GO creditors, and between approximately 75% and 80% (as of the petition date) for PBA creditors. 
 While Ambac has now signed onto plan support agreements covering all of its remaining exposures to unrestructured Puerto Rico instrumentalities, it is unclear whether the Seventh Amended POA will be modified further, or whether the Seventh Amended POA, a prospective PRHTA plan of adjustment, and other plans of adjustment or Title VI agreements for PRIFA and CCDA that reflect these plan support agreements ultimately will be confirmed or approved. It is possible that if the Seventh Amended POA is modified further, or the Seventh Amended POA or plans of adjustment or Title VI agreements reflecting the plan support agreements are not confirmed or approved, Ambac's financial condition would suffer a material negative impact. Refer to Note 6. Insurance Contracts to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for the possible increase in loss reserves under stress or other adverse conditions. There can be no assurance that losses may not exceed such estimates. 
 
 
 Ambac Title III Litigation Update 
 AAC is party to a number of litigations related to its Puerto Rico exposures, and actively participates in the Commonwealth’s Title III proceedings before the United States District Court for the District of Puerto Rico. In connection with the July 27, 2021, PRIFA PSA, Ambac filed urgent motions to stay or dismiss various pending matters related to outstanding litigation in connection with the Title III proceedings. 
 Refer to "Financial Guarantees in Force" in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in Ambac’s Annual Report 

 
 on Form 10-K for the year ended December 31, 2020 and Note 12. Commitments and Contingencies to the Consolidated Financial Statements, included in Part I, Item 1 of this Form 10-Q for further information about Ambac's litigation relating to Puerto Rico. 
 Federal Aid 
 The full extent of federal government support to Puerto Rico is estimated to be $120,000 per the April 23, 2021, certified Commonwealth Fiscal Plan and stretch from FY 2018 to FY 2035. The federal government support includes FEMA, HUD and other disaster relief funds stemming from the 2017 hurricanes and 2019-2020 earthquakes and includes about $43,000 of support related to the COVID-19 pandemic, including funding form the recently enacted ARPA. 
 While the previously allocated federal disaster relief funds and the more recent COVID-19 crisis-related funds are all expected to support economic recovery and growth in Puerto Rico, there can be no assurances as to the certainty, timing, usage, efficacy or magnitude of benefits to creditor outcomes related to disaster aid and ensuing economic growth, if any. 
 Summary 
 Ambac has considered these developments and other factors in evaluating its Puerto Rico loss reserves. While management believes its reserves are adequate to cover losses in its Public Finance insured portfolio, there can be no assurance that Ambac may not incur additional losses in the future, particularly given the developing economic, political, and legal circumstances in Puerto Rico and the overall uncertain impact of the COVID-19 crisis on the Commonwealth and the Domestic Public Finance Insured Portfolio in general. Such additional losses may have a material adverse effect on Ambac’s results of operations and financial condition. 
 Exposure Currency 
 The table below shows the distribution by currency of AAC’s insured exposure as of June 30, 2021: 
 
 Currency Net Par Amount
Outstanding in
Base Currency Net Par Amount
Outstanding in
U.S. Dollars 
 U.S. Dollars $ 19,284 $ 19,284 
 British Pounds £ 6,636 9,159 
 Euros € 1,167 1,382 
 Australian Dollars A$ 545 409 
 
 Total $ 30,234 

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 Ratings Distribution 
 The following charts provide a rating distribution of net par outstanding based upon internal Ambac credit ratings (1) and a distribution by bond type of Ambac's below investment grade ("BIG") net par exposures at June 30, 2021 and December 31, 2020. BIG is defined as those exposures with an Ambac internal credit rating below BBB-: 
 
 Note: AAA is less than 1% in both periods. 
 (1) Internal credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. 

 
 
 Net Par Outstanding 
 Summary of Below Investment
Grade Exposure June 30,
2021 December 31,
2020 
 Public Finance: 
 Lease and tax-backed (1) 
 $ 1,180 $ 1,194 
 General obligation (1) 
 314 325 
 Housing (2) 
 372 308 
 Stadium — 540 
 Transportation 29 30 
 
 Other 38 38 
 Total Public Finance 1,933 2,435 
 Structured Finance: 
 RMBS 2,460 2,800 
 
 Student loans 454 512 
 
 Total Structured Finance 2,914 3,312 
 International Finance: 
 Other 1,184 1,574 
 Total International Finance 1,184 1,574 
 Total $ 6,031 $ 7,321 

 (1) Lease and tax-backed revenue includes $965 and $969 of Puerto Rico net par at June 30, 2021 and December 31, 2020, respectively. General obligation includes $101 and $101 of Puerto Rico net par at June 30, 2021 and December 31, 2020, respectively. Components of Puerto Rico net par outstanding includes capital appreciation bonds which are reported at the par amount at the time of issuance of the related insurance policy as opposed to the current accreted value of the bonds. 
 (2) Relates to military housing net par. 
 The net decline in below investment grade exposures is primarily due to de-risking activities. 
 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 increase in the future. 

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 Results of Operations 
($ in millions) 
 A summary of our financial results is shown below: 
 
 Three Months Ended June 30, Six Months Ended June 30, 
 2021 2020 2021 2020 
 Revenues: 
 Net premiums earned $ 11 $ 11 $ 25 $ 21 
 Net investment income 42 52 91 31 
 
 Net realized investment gains (losses) (2) 10 1 18 
 
 Net gains (losses) on derivative contracts (11) 2 14 (68) 
 Net realized gains (losses) on extinguishment of debt — — 33 — 
 Other income (expense) 7 — 12 — 
 Income (loss) on variable interest entities 2 — 2 3 
 Expenses: 
 Losses and loss expenses (benefit) (26) 16 (18) 132 
 Insurance intangible amortization 14 14 33 27 
 Operating expenses 28 21 62 44 
 Interest expense 50 58 100 122 
 
 
 Provision (benefit) for income taxes 11 2 13 (4) 
 
 
 
 Net income (loss) attributable to common stockholders $ (29) $ (35) $ (12) $ (315) 

 Ambac's results of operations and financial position have been adversely impacted by the COVID-19 pandemic's effect on the global economy and financial markets. Significant interest rate declines during the first quarter of 2020 contributed materially to a net increase in loss reserves and losses on interest rate derivative contracts for the six months ended June 30, 2020. Credit driven losses were also recognized in the six months ended June 30, 2021, within losses incurred (primarily from public finance insurance policies) and losses from 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 remaining quarters of 2020 and into 2021, credit spreads 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 Item 1A to 

 
 Part I, "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2020. 
 The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for the three and six months ended June 30, 2021 and 2020, respectively. 
 Net Premiums Earned . Net premiums earned primarily represent the amortization into income of insurance premiums. We present accelerated premiums, which result from calls and other accelerations of financial guarantee insured obligations separate from normal net premiums earned. When an insured bond has been retired, any remaining unearned premium revenue ("UPR") is recognized at that time to the extent the financial guarantee contract is legally extinguished, causing accelerated premium revenue. For installment premium paying transactions, we offset the recognition of any remaining UPR by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement), which may cause negative accelerated premium revenue. 
 Net premiums earned increased $0 and $4 for the three and six months ended June 30, 2021, compared to the same periods in the prior year. Normal net premiums earned and accelerated premiums are reconciled to total net premiums earned in the table below. The following table provides a breakdown of normal premiums earned by market: 
 
 Three Months Ended June 30, Six Months Ended June 30, 
 2021 2020 2021 2020 
 Normal premiums earned 
 Public finance $ 4 $ 5 $ 9 $ 10 
 Structured finance 2 2 5 4 
 International finance 5 3 11 6 
 Total normal premiums earned 11 10 26 20 
 
 
 
 
 Accelerated earnings — 1 — 1 
 Total Net Premiums Earned (1) 
 $ 11 $ 11 $ 25 $ 21 

 (1) Specialty property and casualty net premiums earned included above is deminimis 
 The increase in normal premiums earned for the six months ended June 30, 2021, is primarily due to changes in allowances for credit losses on premium receivables, partially offset by the continued runoff of the financial guaranty insured portfolio in all markets. 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. The three and six months ended June 30, 2021, includes a decrease in the allowance for credit losses of $2 and $6, respectively, as c ompared to an increase of $2 and $4 for the three and six months ended June 30, 2020. Terminations and accelerations, including those which occurred in prior periods, result in lower normal premiums earned in current and future periods. Public Finance normal earned premiums for the three and six months ended June 30, 2021, were also impacted by reinsurance cessions in the first quarter of 2021. 

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 Net Investment Income. Net investment income primarily consists of interest and net discount accretion on fixed maturity securities classified as available-for-sale and net gains (losses) on pooled investment funds which include changes in fair value of the funds' net assets. Fixed maturity securities include investments in Ambac-insured securities that are made opportunistically based on their risk/reward and asset-liability management characteristics. Investments in pooled investment funds and certain other investments are either classified as trading securities with changes in fair value recognized in earnings or are reported under the equity method. These funds and other investments are reported in Other investments on the Unaudited Consolidated Balance Sheets, which consists primarily of pooled fund investments in diversified asset classes. For further information about investment funds held, refer to Note 9. Investments to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q. 
 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: 
 
 Three Months Ended June 30, Six Months Ended June 30, 
 2021 2020 2021 2020 
 Securities available-for-sale: Ambac-insured (including LSNI Secured Notes) $ 14 $ 16 $ 29 $ 32 
 Securities available-for-sale and short-term other than Ambac-insured 8 10 15 25 
 Other investments (includes trading securities) 20 27 47 (25) 
 Net investment income $ 42 $ 52 $ 91 $ 31 

 Net investment income decreased $11 and increased $59 for the three and six months ended June 30, 2021, respectively, compared to the same periods in the prior year. As described further below, the variances were primarily driven by pricing volatility within fund investments resulting from the impact of the COVID-19 pandemic on financial markets and re-allocation of the investment portfolio during 2020 toward pooled funds and Ambac-insured bonds from investment grade corporate bonds, commercial mortgage backed securities and certain CLOs. 
 • Other investments income (loss) decreased $7 and increased $72 for the three and six months ended June 30, 2021, respectively, compared to the same periods in the prior year. Pooled fund investments have continued to perform well overall in 2021, particularly in hedge and equity funds. Despite a higher asset base and sound returns in 2021, other investment income declined for the three months ended June 30, 2021, reflecting the challenging comparison against a very strong market recovery in the second quarter of 2020. The increase in other investment income for the six month period reflects favorable performance and a higher invested asset base in 2021, compared to net losses on other 

 
 investments for the six months ended June 30, 2020. The losses for the first six months of 2020, were primarily in hedge and equity fund investments driven by adverse changes in fair values as a consequence of the initial economic and financial market impact of the COVID-19 pandemic in the first quarter of 2020, partially offset by a generally strong second quarter 2020 market recovery. 
 • Income from Ambac-insured securities was lower for the three and six months ended June 30, 2021, as compared to the same periods in the prior year, due to the ongoing redemptions of Secured Notes issued by Ambac LSNI, lower LIBOR indexed coupon rates and sales and redemptions of RMBS, partially offset by a higher 2021 allocation to Ambac-insured Puerto Rico bonds. 
 • Net investment income from available-for-sale securities other than Ambac-insured securities decreased as a result of a lower asset base and average yield for this portion of the portfolio. The lower asset base resulted primarily from re-allocation of the portfolio in the first half of 2020 toward pooled funds and Ambac-insured bonds from investment grade corporate and certain asset-backed securities. Additionally, cash has been used to fund operations, early debt redemptions, and Ambac's acquisition of Xchange. Lower yields in the three and six months ended June 30, 2021, compared to the same periods in the prior year, reflect the higher rated securities purchased during the 2020 portfolio re-allocation, lower relative yields on new investments and near-zero short term rates prevailing during the first six months of 2021. 
 Net Realized Investment Gains (Losses). The following table provides a breakdown of net realized gains (losses) for the periods presented: 
 
 Three Months Ended June 30, Six Months Ended June 30, 
 2021 2020 2021 2020 
 Net gains (losses) on securities sold or called $ 1 $ 9 $ 7 $ 16 
 Net foreign exchange gains (losses) (2) 1 (6) 3 
 Credit impairments — — — — 
 Intent / requirement to sell impairments — — — — 
 Total net realized gains (losses) $ (2) $ 10 $ 1 $ 18 

 Net realized gains on securities sold or called for the six months ended June 30, 2021, included a gain of $4 realized on the sale AFG's equity interest in the Corolla Trust in connection with the Corolla Exchange Transaction. Other net realized gains on securities sold or called during both periods were primarily from sales in connection with routine portfolio management. 
 Credit impairments are recorded as an allowance for credit losses with changes in the allowance recorded through earnings. When credit impairments are recorded, any non-credit related impairment amounts on the securities are recorded in other comprehensive income. If management either: (i) has the intent to sell its investment in a debt security or (ii) determines that the 

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 Company more likely than not will be required to sell the debt security before its anticipated recovery, then the amortized cost of the security is written-down to fair value with a corresponding impairment charge recognized in earnings. 
 Net Gains (Losses) on Derivative Contracts. Net gains (losses) on derivative contracts include results from the Company's interest rate derivatives portfolio and its runoff credit derivatives 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. Net gains (losses) 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 gains (losses) on interest rate derivatives for the three and six months ended June 30, 2021, were ($11) and $14, respectively, compared to $1 and $(67) for the three and six months ended June 30, 2020, respectively. The net loss for the three months ended June 30, 2021, reflects changes in fair value from declines in forward interest rates and portfolio carrying costs as well as higher counterparty credit adjustments on certain derivative assets. The gain for the six months ended June 30, 2021, was driven by higher forward interest rates during the period and lower counterparty credit adjustments on certain derivative assets, partially offset by portfolio carrying costs. The net gain for the three months ended June 30, 2020, reflects a gain from reduced counterparty credit adjustments, partially offset by the impact of interest rate movements on the portfolio. The net loss for the six months ended June 30, 2020, reflects significant declines in forward interest rates, triggered by the COVID-19 pandemic, and losses from the application of counterparty credit adjustments, described further below. 
 Counterparty credit adjustments are generally applicable for uncollateralized derivative assets that may not be offset by derivative liabilities under a master netting agreement. Inclusion of counterparty credit adjustments in the valuation of interest rate derivatives resulted in gains (losses) within Net gains (losses) on derivative contracts of $(3) and $6 for the three and six months ended June 30, 2021, respectively, and $8 and $(21) for the three and six months ended June 30, 2020, respectively. In addition to the impact of interest rates on the underlying derivative asset values, the changes in counterparty credit adjustments are driven by movement of credit spreads. Credit spreads were relatively unchanged in the second quarter of 2021, and narrowed in six months ended June 30, 2021. Spreads narrowed in the second quarter of 2020 partially reversing the spread widening experienced in the first quarter of 2020 associated with the market disruption from the COVID-19 pandemic. 
 Other income (expense) . Other income (expense) includes commission revenues of Xchange, ceding fees from the specialty property and casualty business and various financial guarantee fees and foreign exchange gains/(losses) unrelated to investments or loss reserves. For the three and six months ended June 30, 2020, other income includes Xchange revenues of $6 and $13, respectively. 

 
 Net Realized Gains on Extinguishment of Debt . Net realized gains on extinguishment of debt was $33 for the six months ended June 30, 2021, resulting from the first quarter 2021 exchanges of junior surplus notes below their carrying values. Refer to Note 1. Background and Business Description for further discussion of the 2021 Surplus Notes Exchanges. 
 Income (Loss) on Variable Interest Entities . Included within Income (loss) on variable interest entities are income statement amounts relating to VIEs, consolidated under the Consolidation Topic of the ASC as a result of Ambac's variable interest arising from financial guarantees written by Ambac's subsidiaries, including gains or losses attributable to consolidating or deconsolidating VIEs during the periods reported. Generally, the Company’s consolidated VIEs are entities for which Ambac has provided financial guarantees on all of or a portion of its assets or liabilities. In consolidation, assets and liabilities of the VIEs are initially reported at fair value and the related insurance assets and liabilities are eliminated. However, the amount of VIE net assets (liabilities) that remain in consolidation generally result from the net positive (negative) projected cash flows from (to) the VIEs which are attributable to Ambac’s insurance subsidiaries in the form of financial guarantee insurance premiums, fees and losses. In the case of VIEs with net negative projected cash flows, the net liability is generally to be funded by Ambac’s insurance subsidiaries through insurance claim payments. Differences between the net carrying value of the insurance accounts under the Financial Services—Insurance Topic of the ASC and the carrying value of the consolidated VIE’s net assets or liabilities are recorded through income at the time of consolidation. Additionally, terminations or other changes to Ambac's financial guarantee insurance policies that impact projected cash flows between a consolidated VIE and Ambac could result in gains or losses, even if such policy changes do not result in deconsolidation of the VIE. 
 Income (loss) on variable interest entities was $2 and $2 for the three and six months ended June 30, 2021, respectively, compared to a loss of less than a million and income of $3 for the three and six months ended June 30, 2020, respectively. Results for the three months ended June 30, 2021, were due primarily to gains on higher valuation of net assets on VIEs. Results for the six months ended June 30, 2021 included realized gains of $1 on sales of assets, together with higher valuation of net assets on VIEs. Results for the three and six months ended June 30, 2020, were due primarily to realized gains of $8 on sales of assets partially offset by the lower valuation of net assets on VIEs impacted by COVID-19. 
 Refer to Note 3. Variable Interest Entities to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q for further information on the accounting for VIEs. 
 Losses and Loss Expenses. Losses and loss expenses are based upon estimates of the aggregate losses inherent in the non-derivative portfolio for insurance policies issued to beneficiaries, excluding consolidated VIEs. 

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 Ambac records as a component of its loss reserve estimate subrogation recoveries related to securitized loans in RMBS transactions with respect to which AAC is pursuing claims for breaches of representations and warranties. Ambac does not include potential recoveries attributed solely to fraudulent inducement claims in our litigations in our estimate of subrogation recoveries. Generally, the sponsor of an RMBS transaction provided representations and warranties with respect to the securitized loans, including representations with respect to the loan characteristics, the absence of borrower fraud in the underlying loan pools or other misconduct in the origination process and attesting to the compliance of loans with the prevailing underwriting policies. Ambac has recorded representation and warranty subrogation recoveries, net of reinsurance, of $1,715 and $1,725 at June 30, 2021, and December 31, 2020, respectively. Refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for more information regarding the estimation process for R&W subrogation recoveries. 
 The following provides details for losses and loss expenses (benefit) incurred for the periods presented: 
 
 Three Months Ended June 30, Six Months Ended June 30, 
 2021 2020 2021 2020 
 Structured Finance $ (16) $ (31) $ (23) $ (100) 
 Domestic Public Finance (11) 42 (2) 220 
 Other 1 5 7 12 
 Totals (1) (2) 
 $ (26) $ 16 $ (18) $ 132 

 (1) Includes loss expenses incurred of $13 and $23 for the three and six months ended June 30, 2021, respectively, and $34 and $37 for the three and six months ended June 30, 2020, respectively. 
 (2) Specialty property and casualty loss and loss expenses incurred included above is deminimis 
 Losses and loss expenses (benefit) for the three and six months ended June 30, 2021, were largely driven by structured finance credits as a result of improved credit and the positive impact of interest rates on excess spread, partially offset by the negative impact of discount rates. 
 Losses and loss expenses (benefit) for the three and six months ended June 30, 2020, were driven by the following: 
 • Higher projected losses in domestic public finance (primarily relating to Puerto Rico) driven by lower discount rates and estimated losses related to transactions directly impacted by the economic impact from COVID-19; 
 • Favorable structured finance development as a result of the positive impact of lower interest rates on excess spread, reduced by the negative impact of lower discount rates and estimated losses from COVID-19 related delinquencies. 

 
 Intangible Amortization 
 Insurance intangible amortization for the three and six months ended June 30, 2021, was $13 and $31, a decrease of $(1) and an increase of $5 over the three and six months ended June 30, 2020. The YTD increase was driven primarily by de-risking activity. O ther intangible amortization for the three and six months ended June 30, 2021, was $1 and $1, respectively. 
 Operating Expenses. Operating expenses consist of gross operating expenses plus reinsurance commissions. The following table provides a summary of operating expenses for the periods presented: 
 
 Three Months Ended June 30, Six Months Ended June 30, 
 2021 2020 2021 2020 
 Compensation 
 $ 14 $ 11 $ 30 $ 25 
 Non-compensation 
 14 10 31 19 
 Gross operating expenses 
 28 20 61 44 
 Reinsurance commissions, net — — — — 
 
 Total operating expenses $ 28 $ 21 $ 62 $ 44 

 Gross operating expenses increased $8 and $17 for the three and six months ended June 30, 2021, respectively, compared to the same period in the prior year. 
 The increase in operating expenses during the three months ended June 30, 2021, as compared to the three months ended June 30, 2020, was due to the following: 
 • Higher compensation costs due to a net increase in staffing resulting from the inclusion of the specialty property & casualty insurance and the managing general agency/underwriting businesses and performance based incentive compensation adjustments recorded in the second quarter of 2021. 
 • Higher non-compensation costs primarily due to the inclusion of commissions to sub-producers as part of the managing general agency/underwriting business of $4 for the three months ended June 30, 2021. 
 The increase in operating expenses during the six months ended June 30, 2021, as compared to the six months ended June 30, 2020, was due to the following: 
 • Higher compensation costs primarily due to a net increase in staffing resulting from the inclusion of the specialty property & casualty insurance and the managing general agency/underwriting businesses, higher incentive compensation costs and lower capitalization of compensation costs associated with internal software projects. 
 • Higher non-compensation costs primarily due to the inclusion of commissions to sub-producers of $7, costs associated with the Corolla exchange and junior surplus notes exchange transactions, a UK Value Added Tax refund in 2020 and increased software and legal fees. 
 
 

 | Ambac Financial Group, Inc. 59 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 Interest Expense. Interest expense includes accrued interest on the LSNI Ambac Note, Tier 2 notes, surplus notes and other debt obligations. Additionally, interest expense includes discount accretion when the debt instrument carrying value is at a discount to par. The following table provides details by type of obligation for the periods presented: 
 
 Three Months Ended June 30, Six Months Ended June 30, 
 2021 2020 2021 2020 
 Surplus notes (1) 
 $ 19 $ 24 $ 37 $ 50 
 
 LSNI Ambac note 24 27 49 58 
 Tier 2 notes 7 7 13 14 
 Other — — 1 — 
 
 Total interest expense $ 50 $ 58 $ 100 $ 122 

 (1) Includes junior surplus notes 
 The decrease in interest expense for the three and six months ended June 30, 2021, compared to the three and six months ended June 30, 2020, was primarily driven by lower discount accretion on surplus notes, together with optional redemptions and lower rate resets of the floating rate LSNI Ambac Note, partially offset by interest compounding on the surplus notes and the Tier 2 Notes. The first quarter 2021 transactions resulting in the acquisition and retirement of all junior surplus notes in exchange for re-issuance of surplus notes did not significantly impact the interest expense for the three and six months ended June 30, 2021, compared to the prior year periods. 
 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 two exceptional payments. 
 In May 2021, OCI declined the request of AAC to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on the next scheduled payment date of June 7, 2021. As a result, the scheduled payment date for interest, and the scheduled maturity date for payment of principal of the surplus notes, shall be extended until OCI grants approval to make the payment. Interest will accrue, compounded on each anniversary of the original scheduled payment date or scheduled maturity date, on any unpaid principal or interest through the actual date of payment, at 5.1% per annum. Holders of surplus notes will have no rights to enforce the payment of the principal of, or interest on, surplus notes in the absence of OCI approval to pay such amount. The interest on the outstanding surplus notes and junior surplus notes were accrued for and AAC is accruing interest on the interest amounts following each scheduled payment date. Total accrued and unpaid interest for surplus notes outstanding to third parties were $532 at June 30, 2021. 
 Provision for Income Taxes . The provision for income taxes for the three and six months ended June 30, 2021, was $11, an increase of $8 compared to the provision for income taxes reported for three and six months ended June 30, 2020. The change for the three and six months ended June 30, 2021, as compared to the three and six months ended June 30, 2020, resulted from the impact of the 2021 enactment of an increase in U.K. tax rates on Ambac's deferred tax liability, and state income 

 
 tax related to the gains on the Corolla and junior surplus note exchange transactions, and in 2020 Ambac UK losses on investment in pooled funds. 
 
 LIQUIDITY AND CAPITAL RESOURCES 
($ in millions) 
 Ambac Financial Group, Inc. ("AFG") Liquidity . AFG's liquidity is primarily dependent on its net assets, excluding its equity investments in subsidiaries totaling $281 as of June 30, 2021, and secondarily on distributions and expense sharing payments from its subsidiaries. 
 • During the six months ended June 30, 2021, AFG further capitalized the Everspan Group with a cash contribution to Everspan Indemnity Insurance Company of approximately $82. 
 • 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 per year to cover expenses not otherwise reimbursed. The $4 reimbursement for 2020 expenses was approved (by OCI) and paid (by AAC) in April 2021. 
 • AFG received its first distribution from Xchange in the second quarter of 2021 for approximately $3. 
 AFG's investments include securities directly and indirectly issued by and/or insured by AAC, some of which are eliminated in consolidation. Securities issued and/or insured by AAC are generally less liquid than investment grade and other traded investments. 
 AFG's available liquidity from subsidiary distributions is dependent upon the subsidiaries' earnings, operating cash flow and applicable regulatory and contractual restrictions, as well as the strategic decisions of management. 
 • It is highly unlikely that AAC will be able to make dividend payments to AFG for the foreseeable future. Therefore, payments under the intercompany cost allocation agreement will be AFG’s principal sources of liquidity from AAC in the near-term. Refer to Part I, Item 1, “Insurance Regulatory Matters — Dividend Restrictions, Including Contractual Restrictions” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, and Note 8. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for more information on dividend payment restrictions. 
 • Everspan does not have sufficient earned surplus at this time to pay ordinary dividends under the Arizona Insurance Laws. Payments from Everspan to AFG may include expense allocation payments and tax payments. 
 • Xchange currently does not have any regulatory restrictions on its ability to make distributions. 
 The principal uses of liquidity include the payment of operating expenses, including costs to explore opportunities to grow and diversify Ambac; the making of investments, which may include 

 | Ambac Financial Group, Inc. 60 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 securities issued or insured by AAC or Ambac UK and other less liquid investments; and the acquisition or capitalization of new businesses. Contingencies could cause material liquidity strains. 
 Ambac Assurance Liquidity . AAC’s liquidity is dependent on the balance of liquid investments and, over time, the net impact of sources and uses of funds. The principal sources of AAC’s liquidity are gross installment premiums on insurance policies; principal and interest payments from investments; sales of investments; proceeds from repayment of affiliate loans; and recoveries on claim payments, including from litigation and reinsurance recoveries. Termination of installment premium policies on an accelerated basis may adversely impact AAC’s liquidity. 
 The principal uses of AAC’s liquidity are the payment of operating and loss adjustment expenses; claims; commutation payments on insurance policies; ceded reinsurance premiums; principal and interest payments on the LSNI Ambac Note (refinanced by the Sitka AAC Note as described in Note 1. Background and Business Description to the Unaudited Consolidated Financial Statements included in this Form 10-Q), surplus notes and Tier 2 Notes; additional loans to affiliates; and purchases of securities and other investments that may not be immediately converted into cash. 
 • Although AAC has not yet experienced incremental claim payments as a result of the impact of COVID-19, such claims may occur as issuers, particularly those with revenues that have been interrupted by the effects of the pandemic (including social distancing, other restrictions on activities and the increase in unemployment) may not have sufficient cash inflows to pay debt service on Ambac-insured debt. Refer to "Financial Guarantees in Force" in this Management's Discussion and Analysis for further discussion of the potential impact of the COVID-19 pandemic on claim payments. 
 • Interest and principal payments on surplus notes are subject to the approval of OCI, which has full discretion over payments regardless of the liquidity position of AAC. Any such payment on surplus notes would require either payment or collateralization of a portion of the Tier 2 Notes under the terms of the Tier 2 Note indenture. See Note 13. Long-term Debt in the Notes to Consolidated Financial Statements, included in Part II, Item 8, in the Company's Annual Report on Form 10-K for the year ended December 31, 2020, for further discussion of the payment terms and conditions of the Tier 2 Notes. As discussed more fully in "Results of Operations" above in this Management's Discussion and Analysis, OCI declined AAC's request to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on June 7, 2021 and on each prior scheduled payment date. 
 AAC's intercompany loans are to 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 AAC’s financial guarantee exposures. AFS's derivatives include interest rate swaps previously provided to asset-backed issuers and other entities in connection with their financings. AAC loans cash and securities to AFS as needed 

 
 mostly to fund payments under these derivative contracts and collateral posting requirements. Intercompany loans are governed by an established lending agreement with defined borrowing limits that has received non-disapproval from OCI. 
 AAC manages its liquidity risk by maintaining comprehensive analyses of projected cash flows and maintaining specified levels of cash and short-term investments at all times. 
 AAC is limited in its ability to pay dividends pursuant to the terms of its Auction Market Preferred Shares (“AMPS”), which state that dividends may not be paid on the common stock of AAC unless all accrued and unpaid dividends on the AMPS for the then current dividend period have been paid, provided that dividends on the common stock may be made at all times for the purpose of, and only in such amounts as are necessary for enabling AFG (i) to service its indebtedness for borrowed money as such payments become due or (ii) to pay its operating expenses. If dividends are paid on the common stock for such purposes, dividends on the AMPS become cumulative until the 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, and Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for more information on dividend payment restrictions. 
 Our ability to realize RMBS representation and warranty ("R&W") subrogation recoveries is subject to significant uncertainty, including risks inherent in litigation, including adverse rulings or decisions in our cases or in litigations to which AAC is not a party that set precedents or resolve questions of law that impact our own claims; collectability of such amounts from counterparties (and/or their respective parents and affiliates); timing of receipt of any such recoveries, including uncertainty due to delays in court proceedings as a result of the COVID-19 pandemic; intervention by the OCI, which could impede our ability to take actions required to realize such recoveries; and uncertainty inherent in the assumptions used in estimating the amount of such recoveries. The amount of these subrogation recoveries is significant and if we are unable to recover any amounts or recover materially less than our estimated recoveries, our future available liquidity to pay claims, debt service and meet our other obligations would be reduced materially. See Part I, Item 1A. Risk Factors in the Company's Annual Report on Form 10-K for the year ended December 31, 2020, and Part II, Item 1A. Risk Factors in this Form 10-Q, for more information about risks relating to our RMBS R&W subrogation recoveries. 

 | Ambac Financial Group, Inc. 61 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 Cash Flow Statement Discussion. The following table summarizes the net cash flows for the periods presented. 
 
 Six Months Ended June 30, 2021 2020 
 Cash provided by (used in): 
 
 Operating activities $ (83) $ (112) 
 Investing activities 187 270 
 Financing activities (107) (205) 
 Foreign exchange impact on cash and cash equivalents — — 
 Net cash flow 
 $ (4) $ (47) 

 Operating activities 
 The following represents the significant cash operating activity during the six months ended June 30, 2021 and 2020: 
 • Debt service payments on the LSNI Ambac Note were $49 and $58 for the six months ended June 30, 2021 and 2020, respectively. 
 • Receipts (payments) for operating activities related to interest rate derivatives were $(3) and $(19) for the six months ended June 30, 2021 and 2020, respectively. 
 • Operating expenses were $45 and $44 for the six months ended June 30, 2021 and 2020, respectively. 
 • Cash provided by the investment portfolio was $44 and $58 for the six months ended June 30, 2021 and 2020, respectively. 
 • Net loss and loss expenses paid, including commutation payments, during the six months ended June 30, 2021 and 2020 are detailed below: 
 
 Six Months Ended June 30, 2021 2020 
 Net loss and loss expenses paid (recovered): 
 
 Net losses paid $ 54 $ 64 
 Net subrogation received (54) (56) 
 Net loss expenses paid 38 53 
 Net cash flow 
 $ 38 $ 61 

 
 
 Future operating cash flows will primarily be impacted by interest payments on outstanding debt, claim and expense payments, investment coupon receipts and premium collections. 
 Financing Activities 
 Financing activities for the six months ended June 30, 2021, include paydowns of the LSNI Ambac Note of $16 and paydowns and maturities of VIE debt obligations of $85. 
 Financing activities for the six months ended June 30, 2020, include paydowns of the LSNI Ambac Note of $103 and paydowns and maturities of VIE debt obligations of $99. 
 Collateral 
 AFS hedges a portion of the interest rate risk in the financial guarantee and investment portfolio, along with legacy customer interest rate swaps, with standardized derivative contracts, including financial futures contracts, which contain collateral or margin requirements. Under these hedge agreements, AFS is required to post collateral or margin to its counterparties and 

 
 futures commission merchants to cover unrealized losses. In addition, AFS is required to post collateral or margin in excess of the amounts needed to cover unrealized losses. All AFS derivative contracts containing ratings-based downgrade triggers that could result in collateral or margin posting or a termination have been triggered. If terminations were to occur, AFS would be required to make termination payments but would also receive a return of collateral or margin in the form of cash or U.S. Treasury obligations with market values equal to or in excess of market values of the swaps and futures contracts. AFS may look to re-establish hedge positions that are terminated early, resulting in additional collateral or margin obligations. The amount of additional collateral or margin posted on derivatives contracts will depend on several variables including the degree to which counterparties exercise their termination rights (or agreements terminate automatically) and the terms on which hedges can be replaced. All collateral and margin obligations are currently met. Collateral and margin posted by AFS totaled a net amount of $134 (cash and securities collateral of $14 and $120, respectively), including independent amounts, under these contracts at June 30, 2021. 
 Ambac Credit Products (“ACP”) is not required to post collateral under any of its outstanding credit derivative contracts. 
 
 BALANCE SHEET 
($ in millions) 
 Total assets decreased by approximately $313 from December 31, 2020, to $12,907 at June 30, 2021, primarily due to the payment of loss and loss expenses, interest and operating expenses, lower subrogation recoverables, lower consolidated VIE assets from paydowns of consolidated VIE liabilities, and the impact of the Corolla Trust Exchange described in Note 1. Background and Business Description to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q. Other significant changes during the six months ended June 30, 2021, were from partial redemptions of the LSNI Ambac Note, lower derivative assets caused by rising interest rates, and lower premium receivables and intangible assets from the continued runoff of the financial guarantee insurance portfolio. 
 Total liabilities decreased by approximately $310 from December 31, 2020, to $11,764 as of June 30, 2021, primarily due to the payment of loss and loss expenses, lower VIE and non-VIE long-term debt (from the surplus note exchange transactions and partial redemptions of the LSNI Ambac Note) and lower derivative liabilities caused by rising interest rates. 
 As of June 30, 2021, total stockholders’ equity was $1,123, compared with total stockholders’ equity of $1,140 at December 31, 2020. This decrease was primarily due to the $14 increase to the carrying value of redeemable NCI which is offset directly against retained earnings. 
 Investment Portfolio . 
 Ambac's investment portfolio is managed under established guidelines designed to meet the investment objectives of AAC, Everspan Group, Ambac UK and AFG. Refer to "Description of the Business — Investments and Investment Policy" located in Part I. Item 1 of the Company’s Annual Report on Form 10-K for 

 | Ambac Financial Group, Inc. 62 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 the year ended December 31, 2020, for further description of Ambac's investment policies and applicable regulations. 
 Refer to Note 9. Investments to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q for information about Ambac's consolidated investment portfolio. Ambac's investment policies and objectives do not apply to the assets of VIEs consolidated as a result of financial guarantees written by its insurance subsidiaries. 
 The following table summarizes the composition of Ambac’s investment portfolio, excluding VIE investments, at carrying value at June 30, 2021 and December 31, 2020: 
 
 June 30,
2021 December 31,
2020 
 Fixed maturity securities $ 2,253 $ 2,317 
 Short-term 416 492 
 Other investments 657 595 
 Fixed maturity securities pledged as collateral 120 140 
 Total investments (1) 
 $ 3,447 $ 3,544 

 (1) Includes investments denominated in non-US dollar currencies with a fair value of £314 ($433) and €43 ($51) as of June 30, 2021, and £317 ($434) and €39 ($48) as of December 31, 2020. 
 Ambac invests in various asset classes in its fixed maturity securities portfolio. Other investments primarily consist of diversified interests in pooled funds. Refer to Note 9. Investments to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q for information about fixed maturity securities and pooled funds by asset class. 

 
 The following charts provide the ratings (1) distribution of the fixed maturity investment portfolio based on fair value at June 30, 2021 and December 31, 2020: 
 
 
 (1) Ratings are based on the lower of Moody’s or S&P ratings. If ratings are unavailable from Moody's or S&P, Fitch ratings are used. If guaranteed, rating represents the higher of the underlying or guarantor’s financial strength rating. 
 (2) Below investment grade and not rated bonds insured by Ambac represent 43% and 41% of the June 30, 2021 and December 31, 2020 combined fixed maturity portfolio, respectively. 

 | Ambac Financial Group, Inc. 63 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 Premium Receivables . Ambac's premium receivables decreased to $345 at June 30, 2021, from $370 at December 31, 2020. As further discussed in Note 6. Insurance Contracts, the decrease is due to premium receipts and adjustments for changes in expected and contractual cash flows on financial guarantee insurance contracts, partially offset by decreases to the allowance for credit losses and accretion of the premium receivable discount. 
 Premium receivables by payment currency were as follows: 
 
 Currency Premium Receivable in
Payment Currency Premium Receivable in
U.S. Dollars 
 U.S. Dollars $ 206 $ 207 
 British Pounds £ 88 122 
 Euros € 13 16 
 
 
 Total $ 345 

 Reinsurance Recoverable on Paid and Unpaid Losses . Ambac has reinsurance in place pursuant to surplus share treaty and facultative agreements. To minimize its exposure to losses from reinsurers, Ambac (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 in the event of rating agency downgrades of a reinsurer (among other events and circumstances). Ambac benefited from letters of credit and collateral amounting to approximately $114 from its reinsurers at June 30, 2021. As of June 30, 2021 and December 31, 2020, reinsurance recoverable on paid and unpaid losses were $30 and $33, respectively. The decrease was primarily a result of favorable loss development. 
 Intangible Asset . Intangible assets include (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 and (ii) intangible assets established as part of the acquisition of Xchange on December 31, 2020. 

 
 As of June 30, 2021 and December 31, 2020, the intangible assets were $377 and $409, 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 economic hedge against interest rate exposure in the financial guarantee and investment portfolios. Derivative assets decreased from $93 at December 31, 2020, to $82 as of June 30, 2021. Derivative liabilities decreased from $114 at December 31, 2020, to $98 as of June 30, 2021. The net decreases resulted primarily from higher interest rates during the six months ended June 30, 2021, with the effect on assets partially offset by lower counterparty credit adjustments. 
 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, excluding consolidated 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 6. Insurance Contracts, respectively, of the Consolidated Financial Statements included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for further information on loss and loss expenses. 
 
 
 The loss and loss expense reserves, net of subrogation recoverables and before reinsurance as of June 30, 2021 and December 31, 2020, were $(456) and $(397), respectively. 

 
 
 Loss and loss expense reserves are included in the Unaudited Consolidated Balance Sheets as follows: 
 
 
 Balance Sheet Line Item Claims and 
 Loss 
 Expenses (1) 
 Recoveries (2) 
 Unearned
Premium
Revenue Gross Loss
and Loss
Expense
Reserves 
 June 30, 2021: 
 Loss and loss expense reserves $ 1,881 $ (180) $ (59) $ 1,641 
 Subrogation recoverable 90 (2,188) — (2,098) 
 Totals $ 1,971 $ (2,368) $ (59) $ (456) 
 
 December 31, 2020: 
 Loss and loss expense reserves $ 2,060 $ (229) $ (72) $ 1,759 
 Subrogation recoverable 100 (2,256) — (2,156) 
 Totals $ 2,160 $ (2,485) $ (72) $ (397) 

 (1) Includes a deminimus amount of loss and loss expense reserves for specialty property and casualty business. 
 (2) Present value of future recoveries includes R&W subrogation recoveries of $1,741 and $1,751 at June 30, 2021 and December 31, 2020, respectively. 
 | Ambac Financial Group, Inc. 64 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 Financial Guarantee: 
 Ambac has exposure to various bond types issued in the debt capital markets. Our experience has shown that, for the majority of bond types, we have not experienced significant claims. The bond types that have experienced significant claims, including through commutations, are residential mortgage-backed securities (“RMBS”), student loan securities and public finance securities. These bond types represent 93% of our ever-to-date insurance claims recorded, with RMBS comprising 75%. The table below indicates gross par outstanding and the components of gross loss and loss expense reserves related to policies in Ambac’s gross loss and loss expense reserves at June 30, 2021 and December 31, 2020: : 
 
 Gross 
 Par 
 Outstanding (1)(2) 
 Present Value of Expected
Net Cash Flows Unearned
Premium
Revenue Gross Loss
and Loss
Expense
Reserves (1)(3) 
 
 Claims and
Loss
Expenses Recoveries 
 June 30, 2021: 
 Structured Finance $ 2,647 $ 871 $ (2,069) $ (13) $ (1,211) 
 Domestic Public Finance 3,004 1,011 (293) (36) 682 
 Other 894 37 (6) (10) 21 
 Loss expenses — 52 — — 52 
 Totals $ 6,545 $ 1,971 $ (2,368) $ (59) $ (456) 
 December 31, 2020: 
 Structured Finance $ 2,945 $ 940 $ (2,136) $ (16) $ (1,212) 
 Domestic Public Finance $ 3,016 $ 1,112 $ (349) $ (39) $ 724 
 Other $ 1,612 $ 40 $ — $ (17) $ 23 
 Loss expenses $ — $ 68 $ — $ — $ 68 
 Total $ 7,573 $ 2,160 $ (2,485) $ (72) $ (397) 

 (1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves are $781 and $30 respectively, at June 30, 2021, and $739 and $33, respectively at December 31, 2020. Recoverable ceded loss and loss expense reserves are included in Reinsurance recoverable on paid and unpaid losses on the balance sheet. 
 (2) Gross Par Outstanding includes capital appreciation bonds, which are reported at the par amount at the time of issuance of the insurance policy as opposed to the current accreted value of the bond. 
 (3) Loss reserves are included in the balance sheet as Loss and loss expense reserves or Subrogation recoverable dependent on if a policy is in a net liability or net recoverable position. 
 
 
 Variability of Expected Losses and Recoveries 
 Ambac’s management believes that the estimated future loss component of loss reserves (present value of expected net cash flows) are adequate to cover future claims presented, but there can be no assurance that the ultimate liability will not be higher than such estimates. 
 It is possible that our estimated future losses for insurance policies discussed above could be understated or that our estimated future recoveries could be overstated. We have attempted to identify possible cash flows related to losses and recoveries using more stressful assumptions than the probability-weighted outcome recorded. The possible net cash flows consider the highest stress scenario that was utilized in the development of our probability-weighted expected loss at June 30, 2021, and assumes an inability to execute any commutation transactions with issuers and/or investors. Such stress scenarios are developed based on management’s view about all possible outcomes relating to losses and recoveries. In arriving at such view, management makes considerable judgments about the possibility of various future events. Although we do not believe it is possible to have stressed outcomes in all cases, it is possible that we could have stress case outcomes in some or even many cases. See “Risk Factors” in Part I, Item 1A as well as the descriptions of "RMBS Variability," "Public Finance Variability," "Student Loan Variability," and "Other Credits, including Ambac UK, 

 
 Variability," in Part II, Item 7 of the Company's 2020 Annual Report on Form 10-K for further discussion of the risks relating to future losses and recoveries that could result in more highly stressed outcomes, and "Risk Factors" in Part II, Item 1A of this Quarterly Report on Form 10-Q as well as the descriptions of "RMBS Variability," "Public Finance Variability," "Student Loan Variability," and "Other Credits, including Ambac UK, Variability" appearing below. 
 The occurrence of these stressed outcomes individually or collectively would have a material adverse effect on our results of operations and financial condition and may result in materially adverse consequence for the Company, including (without limitation) impairing the ability of 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. 
 Structured Finance Variability 
 RMBS: 
 Ambac has exposure to the U.S. mortgage market primarily through direct financial guarantees of RMBS, including transactions collateralized by first and second lien mortgages. 
 Changes to assumptions that could make our reserves under-estimated include an increase in interest rates, deterioration in 

 | Ambac Financial Group, Inc. 65 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 housing prices, poor servicing, government intervention into the functioning of the mortgage market and the effect of a weakened economy characterized by growing unemployment and wage pressures. We utilize a model to project losses in our RMBS exposures and changes to reserves, either upward or downward, are not unlikely if we used a different model or methodology to project losses. 
 We established a representation and warranty subrogation recovery as further discussed in Note 6. Insurance Contracts to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q. Our ability to realize RMBS representation and warranty recoveries is subject to significant uncertainty, including risks inherent in litigation, including adverse rulings or decisions in our cases or in litigations to which AAC is not a party that set precedents or resolve questions of law that impact our own claims; collectability of such amounts from counterparties (and/or their respective parents and affiliates); delays in realizing such recoveries, including as a result of trial delays due to court closures related to 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 $1,715, net of reinsurance, as of June 30, 2021, if the sponsors of these transactions: (i) fail to honor their obligations to repurchase the mortgage loans, (ii) successfully dispute our breach findings or claims for damages, (iii) no longer have the financial means to fully satisfy their obligations under the transaction documents, or (iv) our pursuit of recoveries is otherwise unsuccessful. Failure to realize R&W subrogation recoveries for any reason or the realization of R&W subrogation recoveries materially below the amount recorded on Ambac's consolidated balance sheet would have a material adverse effect on our results of operations and financial condition. 
 In the case of both first and second-lien exposures, the possible stress case assumes a lower housing price appreciation projection, which in turn drives higher defaults and severities. Using this approach, the possible increase in loss reserves for RMBS credits for which we have an estimate of expected loss at June 30, 2021, could be approximately $10. Combined with the absence of any R&W subrogation recoveries, a possible increase in loss reserves for RMBS could be approximately $1,725. A loss of this 

 
 magnitude may render AAC insolvent. Additionally, loss payments are sensitive to changes in interest rates, increasing as interest rates rise. For example, an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately $30. 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 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. 
 Student Loans: 
 Changes to assumptions that could make our reserves under-estimated include, but are not limited to, increases in interest rates, default rates and loss severities on the collateral due to economic or other factors, including the COVID-19 related economic impact. Such factors may include lower recoveries on defaulted loans or additional losses on collateral or trust assets, including as a result of any enforcement actions by the Consumer Finance Protection Bureau. For student loan credits for which we have an estimate of expected loss at June 30, 2021, the possible increase in loss reserves could be approximately $20. Additionally, an increase in interest rates of 0.50% could increase our estimate of expected losses by approximately $15. Additionally, the student loan portfolio is sensitive to COVID-19 related payment moratoriums and delinquencies caused by the general economic downturn. There can be no assurance that losses may not exceed our stress case estimates. 
 Public Finance Variability: 
 Ambac’s U.S. public finance portfolio consists predominantly of municipal bonds such as general, revenue, lease and tax-backed obligations of state and local government entities; however, the portfolio also includes a wide array of non-municipal types of bonds, including financings for not-for-profit entities and transactions with public and private elements, which generally finance infrastructure, housing and other public purpose facilities and interests. The decrease in public finance gross loss reserves at June 30, 2021, as compared to December 31, 2020, was primarily related to claim payments. Total public finance gross loss reserves and related gross par outstanding on Ambac insured obligations by bond type were as follows: 

 
 June 30, 2021 December 31, 2020 
 Issuer Type Gross Par
Outstanding (1) 
 Gross Loss
Reserves Gross Par
Outstanding (1) 
 Gross Loss
Reserves 
 Lease and tax-backed $ 1,388 $ 650 $ 1,366 $ 693 
 General obligation 564 (31) 589 (37) 
 Housing 453 24 453 27 
 Transportation revenue 217 28 220 30 
 Other 382 11 388 11 
 Total $ 3,004 $ 682 $ 3,016 $ 724 

 (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- 

 | Ambac Financial Group, Inc. 66 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 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 impact could put additional stresses on these issuers as well as other types of municipal finance issuers and result in increased defaults and potential additional losses for Ambac. 
 Our experience with the city of Detroit in 2013 in its bankruptcy proceeding was not favorable and renders future outcomes with other public finance issuers even more difficult to predict and may increase the risk that we may suffer losses that could be sizable. We agreed to settlements regarding our insured Detroit general obligation bonds that provide better treatment of our exposures than the city planned to include in its plan of adjustment, but nevertheless required us to incur a loss for a significant portion of our exposure. An additional troubling precedent in the Detroit case, as well as other municipal bankruptcies, is the preferential treatment of certain creditor classes, especially the public pensions. The cost of pensions and the need to address frequently sizable unfunded or underfunded pensions is often a key driver of stress for many municipalities and their related authorities, including entities to whom we have 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 even to what is generally considered more secure municipal financings, such as dedicated sales tax revenue bonds that capture sales tax revenues for debt service ahead of any amounts being deposited into the general fund of an issuer. In the case of the Puerto Rico COFINA sales tax bonds that were part of the Commonwealth of Puerto Rico's Title III proceedings, AAC and other creditors agreed to settle at a recovery rate equal to about 93% of pre-petition amounts owed on the Ambac insured senior COFINA bonds. In the COFINA case, the senior bonds still received a reduction or "haircut" despite the existence of junior COFINA bonds, which received a recovery rate equal to about 56% of pre-petition amounts owed. 
 In addition, municipal entities may be more inclined to use bankruptcy to resolve their financial stresses if they believe preferred outcomes for various creditor groups can be achieved. We expect municipal bankruptcies and defaults to continue to be challenging to project given the unique political, economic, fiscal, legal, governance and public policy differences among municipalities as well as the complexity, long duration and relative infrequency of the cases themselves in forums with a scarcity of legal precedent. 
 Another potentially adverse development that could cause the loss reserves on our public finance credits to be underestimated is deterioration in the municipal bond market, resulting from reduced or limited access to alternative forms of credit (such as bank loans) or other exogenous factors, such as changes in tax law that could reduce certain municipal investors' appetite for tax-exempt municipal bonds or put pressure on issuers in states with high state and local taxes. These factors as well as 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, which found that under Sections 928(a) and 922(d) of the U.S. Bankruptcy Code, municipal issuers of revenue bonds secured by special revenues are permitted, but not required, to apply special revenues to pay debt service on such revenue bonds during the pendency of bankruptcy proceedings for such municipal issuers. The First Circuit's decision challenges what had been a commonly understood notion in the municipal finance marketplace that municipal revenue bondholders secured by special revenues (as defined in Chapter 9 of the U.S. Bankruptcy Code) would continue to receive payment during a bankruptcy of the municipal issuer. This decision introduces uncertainty into the public finance market and it may make it more difficult for municipal instrumentalities to procure revenue bond financings in the future and increases the credit risk to bondholders of existing special revenue bonds, particularly those from weaker issuers. 
 While our loss reserves consider our judgment regarding issuers’ financial flexibility to adapt to adverse markets, they may not adequately capture sudden, unexpected or protracted uncertainty that adversely affects market conditions, such as the developing COVID-19 related economic impact. 
 Our exposures to the Commonwealth of Puerto Rico are under stress arising from the Commonwealth’s weak financial condition and economy, loss of capital markets access, the severe damage caused by hurricanes Irma and Maria and other natural disasters as well as a narrow view on available debt capacity being taken by the Oversight Board and Commonwealth government. These factors, taken together with the payment moratorium on debt service of the Commonwealth and its instrumentalities; ongoing PROMESA Title III proceedings; certain other provisions under PROMESA; expected restructurings of debt insured by AAC, uncertainty with regards to AAC's valuation of the contingent value instruments or CVI to be made available as part of a final Plan of Adjustment; and the possibility of protracted litigation as a result of which our rights may be materially impaired, may cause losses to exceed current reserves in a material manner. See "Financial Guarantees in Force" section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Part II, Item 7 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for further details on the legal, economic and fiscal developments that have impacted or may impact AAC’s insured Puerto Rico bonds. In this Form 10-Q, refer to "Financial Guarantees in Force" in Part I, Item 2 in Management's Discussion and Analysis of Financial Condition and Results of Operation, Note 6. Financial Guarantee Insurance Contracts to the Unaudited Consolidated Financial Statements and Note 12. Commitments 

 | Ambac Financial Group, Inc. 67 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 and Contingencies to the Unaudited Consolidated Financial Statements for further updates related to Puerto Rico. 
 Material additional losses on our public finance credits caused by the aforementioned factors, including the possibility of a protracted recovery related to the COVID-19 crisis would have a material adverse effect on our results of operations and financial condition. For the public finance credits, including Puerto Rico, for which we have an estimate of expected loss at June 30, 2021, the possible increase in loss reserves could be approximately $545. However, there can be no assurance that losses may not exceed our stress case estimates. Among other things, this estimate includes the possibility that the amended Commonwealth plan of adjustment (as discussed above in the Financial Guarantees in Force section of this Management Discussion and Analysis) were to become effective. 
 Other Variability: 
 It is possible our loss reserves on other types of credits, including those insured by Ambac UK, may be under-estimated because of various risks that vary widely, including the risk that we may not be able to recover or mitigate losses through our remediation processes. For all other credits, including Ambac UK, for which we have an estimate of expected loss, the sum of all the highest stress case loss scenarios is approximately $365 greater than the loss reserves at June 30, 2021. 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 surplus notes issued by AAC, the LSNI Ambac Note and Tier 2 Notes issued in connection with the Rehabilitation Exit Transactions, and Ambac UK debt issued in connection with the 2019 Ballantyne commutation. The carrying value of each of these as of June 30, 2021 and December 31, 2020 is below: 
 
 June 30,
2021 December 31, 2020 
 Surplus notes (1) 
 $ 712 $ 778 
 
 Ambac note 1,626 1,641 
 Tier 2 notes 319 306 
 Ambac UK debt 14 14 
 
 
 Total Long-term Debt $ 2,671 $ 2,739 

 (1) Includes junior surplus notes as of December 31, 2020. All junior surplus notes were acquired and retired in the first quarter of 2021. 
 The decrease in long-term debt from December 31, 2020, resulted form the impacts of the surplus notes exchanges of $71 and optional LSNI Ambac Note redemption of $16, partially offset by the accretion on the carrying value of surplus notes, Tier 2 Notes and Ambac UK debt. 
 As further described in Note 1. Background and Business Description to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q, on July 6, 2021, Sitka, Ambac's newly formed non-consolidated VIE, issued the Sitka Senior Secured Notes that were used to fund a portion of the full redemption of the LSNI Secured Notes issued by LSNI, with the remaining balance redeemed utilizing other available sources 

 
 of liquidity. Comparable to LSNI, the Sitka Senior Secured Notes are secured by the assets of Sitka which include a new note receivable from AAC. Following these transactions, the long-term debt consisting of a secured Ambac note decreased by $463 to $1,163. 
 
 VARIABLE INTEREST ENTITIES 
 Please refer to Note 3. Variable Interest Entities to the Unaudited Consolidated Financial Statements included in Part I, Item 1 in this Form 10-Q and Note 2. Basis of Presentation and Significant Accounting Policies and Note 4. Variable Interest Entities to the Consolidated Financial Statements, included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for information regarding variable interest entities. 
 
 ACCOUNTING STANDARDS 
 The following accounting standards has been issued but has not yet been adopted. We do not expect this standard to have a consequential impact on Ambac's financial statements. 
 Equity-classified Written Call Options 
 In May 2021, the FASB issued ASU 2021-04, Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options . The ASU clarifies and reduces diversity in practice for an issuer's accounting for modifications or exchanges of equity-classified written call options (e.g. warrants) that remain equity-classified after the modification or exchange. The ASU requires an issuer to account for the modification or exchange based on the economic substance of the transaction. For example, if the modification or exchange is related to the issuance of debt or equity, any change in the fair value of the written call option would be accounted for as part of the debt issuance cost in accordance with the debt guidance or equity issuance cost in accordance with the equity guidance, respectively. The ASU is effective for fiscal years beginning after December 15, 2021, with early adoption permitted. Ambac will adopt this ASU on January 1, 2022. 
 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 beginning after December 15, 2021, with early adoption permitted. Ambac will adopt this ASU on January 1, 2022. 
 Please refer to Note 2. Basis of Presentation and Significant Accounting Policies to the Consolidated Financial Statements, included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, for a discussion of the impact of other recent accounting 

 | Ambac Financial Group, Inc. 68 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 pronouncements on Ambac’s financial condition and results of operations. 
 
 
 
 U.S. INSURANCE STATUTORY BASIS FINANCIAL RESULTS ($ in million) 
 AFG's U.S. insurance subsidiaries prepare financial statements under accounting practices prescribed or permitted by its domiciliary state regulator (“SAP”) for determining and reporting the financial condition and results of operations of an insurance company. The National Association of Insurance Commissioners (“NAIC”) Accounting Practices and Procedures manual (“NAIC SAP”) is adopted as a component of prescribed practices by each domiciliary state. For further information, see "Ambac Assurance Statutory Basis Financial Results," in Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Note 9. Insurance Regulatory Restrictions to the Consolidated Financial Statements included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. 
 Ambac Assurance Corporation 
 AAC’s statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were $774 and $1,331 at June 30, 2021, respectively, as compared to $865 and $1,413 at December 31, 2020, respectively. As of June 30, 2021, statutory policyholder surplus and qualified statutory capital included $853 principal balance of surplus notes outstanding and $138 liquidation preference of preferred stock outstanding. These surplus notes (in addition to related accrued interest of $589 that is not recorded under statutory basis accounting principles); preferred stock; and all other liabilities, including insurance claims, the LSNI Ambac Note (refinanced by the Sitka AAC Note as described in Note 1. Background and Business Description to the Unaudited Consolidated Financial Statements included in this Form 10-Q) and the Tier 2 Notes are obligations that, individually and collectively, have claims on the resources of AAC that are senior to AFG's equity and therefore impede AFG's ability to realize residual value and/or receive dividends from AAC. 
 The significant drivers to the net decrease in policyholder surplus are statutory net losses of $111 for the six months ended June 30, 2021, partially offset by net investment gains of $30 recorded directly through surplus. 
 AAC statutory surplus and therefore AFG's ability to realize residual value and/or dividends from AAC is sensitive to multiple factors, including: (i) loss reserve development, (ii) settlements or other resolutions of representation and warranty breach claims at amounts that differ from amounts recorded, including failures to collect such amounts or receive recoveries sufficient to pay or redeem obligations of AAC, including the Sitka AAC Note and Tier 2 Notes, (iii) approval by OCI of payments on surplus notes, (iv) ongoing interest costs associated with the Sitka AAC Note and Tier 2 Notes, including changes to interest rates as the Sitka AAC Note is a floating rate obligation, (v) deterioration in the financial position of AAC subsidiaries that have their obligations guaranteed by AAC, (vi) first time payment defaults of insured obligations, which increase statutory loss reserves, (vii) 

 
 commutations of insurance policies or credit derivative contracts at amounts that differ from the amount of liabilities recorded, (viii) reinsurance contract terminations at amounts that differ from net assets recorded, (ix) changes to the fair value of pooled fund and other investments carried at fair value, (x) realized gains and losses, including losses arising from other than temporary impairments of investment securities, and (xi) future changes to prescribed practices. 
 Everspan Indemnity Insurance Company 
 Everspan Indemnity Insurance Company’s statutory policyholder surplus was $105 at June 30, 2021, as compared to $26 at December 31, 2020. 
 The significant drivers to the increase in policyholder surplus were capital contributions of $82 partially offset by operating expenses during the six months ended June 30, 2021. 
 
 
 
 AMBAC UK FINANCIAL RESULTS UNDER UK ACCOUNTING PRINCIPLES (£ in millions) 
 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 £430 at June 30, 2021, as compared to £412 at December 31, 2020. At June 30, 2021, the carrying value of cash and investments was £487, an increase from £481 at December 31, 2020. 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, operating expenses and tax payments. 
 Ambac UK is also required to prepare financial information in accordance with the Solvency II Directive. The basis of preparation of this information is significantly different from both US GAAP and UK GAAP. 
 Available capital resources under Solvency II were a surplus of £238 at June 30, 2021, of which £230 were eligible to meet solvency capital requirements. This is an increase from December 31, 2020, when available capital resources were a surplus of £196 of which £184 were eligible to meet solvency capital requirements. Eligible capital resources at June 30, 2021, and December 31, 2020, were in comparison to regulatory capital requirements of £250 and £256, respectively. Therefore, Ambac UK remains deficient in terms of compliance with applicable regulatory capital requirements by £20 and £72 at June 30, 2021, and December 31, 2020, respectively. The deficit reduced as at June 30, 2021, due to an increase in eligible capital resources mainly caused by the increase over the period in long term discount rates which reduced the value of technical provision liabilities. 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. 
 
 

 | Ambac Financial Group, Inc. 69 2021 Second Quarter FORM 10-Q | 
 
 

 
 
 

 NON-GAAP FINANCIAL MEASURES 
 In addition to reporting the Company’s quarterly financial results in accordance with GAAP, the Company currently reports two non-GAAP financial measures: adjusted earnings and adjusted book value. The most directly comparable GAAP measures are net income attributable to common stockholders for adjusted earnings and Total Ambac Financial Group, Inc. stockholders’ equity for adjusted book value. A non-GAAP financial measure is a numerical measure of financial performance or financial position that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying drivers of our business. Adjusted earnings and adjusted book value are not substitutes for the Company’s GAAP reporting, should not be viewed in isolation and may differ from similar reporting provided by other companies, which may define non-GAAP measures differently. 
 Ambac has a significant U.S. tax net operating loss (“NOL”) that is offset by a full valuation allowance in the GAAP consolidated financial statements. As a result of this and other considerations, we utilized a 0% effective tax rate for non-GAAP adjustments; which is subject to change. 
 The following paragraphs define each non-GAAP financial measure and describe why it is useful. A reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure is also presented below. 
 Adjusted Earnings (Loss). Adjusted earnings (loss) is defined as net income (loss) attributable to common stockholders, as reported under GAAP, adjusted on an after-tax basis for the following: 

 
 • Non-credit impairment fair value (gain) loss on credit derivatives: Elimination of the non-credit impairment fair value gains (losses) on credit derivatives, which is the amount in excess of the present value of the expected estimated credit losses. Such fair value adjustments are affected by, and in part fluctuate with changes in market factors such as interest rates and credit spreads, including the market’s perception of Ambac’s credit risk (“Ambac CVA”), and are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee contracts to be accounted for consistent with the Financial Services – Insurance Topic of ASC, whether or not they are subject to derivative accounting rules. 
 • Insurance intangible amortization: Elimination of the amortization of the financial guarantee insurance intangible asset that arose as a result of Ambac’s emergence from bankruptcy and the implementation of Fresh Start reporting. This adjustment ensures that all financial guarantee contracts are accounted for consistent with the provisions of the Financial Services – Insurance Topic of the ASC. 
 • 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 results without the impact of fluctuations in foreign currency exchange rates and facilitates period-to-period comparisons of Ambac's operating performance. 

 | Ambac Financial Group, Inc. 70 2021 Second Quarter FORM 10-Q | 
 
 

 
 

 
 
 The following table reconciles net income (loss) attributable to common stockholders to the non-GAAP measure, Adjusted Earnings (loss) on a dollar amount and per diluted share basis, for all periods presented: 
 
 Three Months Ended June 30, 
 2021 2020 
 ($ in millions, except share data) $ Amount Per Diluted Share (1) 
 $ Amount Per Diluted Share 
 Net income (loss) attributable to common stockholders 
 $ (29) $ (0.63) $ (35) $ (0.77) 
 Adjustments: 
 Non-credit impairment fair value (gain) loss on credit derivatives — — (1) (0.01) 
 
 Insurance intangible amortization 13 0.28 14 0.30 
 
 
 Foreign exchange (gains) losses 2 0.05 (2) (0.04) 
 
 
 
 
 Adjusted earnings (loss) $ (13) $ (0.30) $ (24) $ (0.52) 
 
 Six Months Ended June 30, 
 2021 2020 
 ($ in millions, except share data) $ Amount Per Diluted Share $ Amount Per Diluted Share 
 Net income (loss) attributable to common stockholders 
 $ (12) $ (0.54) $ (315) $ (6.83) 
 Adjustments: 
 Non-credit impairment fair value (gain) loss on credit derivatives 
 — — 1 0.02 
 
 Insurance intangible amortization 31 0.68 27 0.58 
 
 
 Foreign exchange (gain) loss 
 7 0.16 (2) (0.04) 
 
 
 
 
 Adjusted earnings (loss) $ 27 $ 0.30 $ (289) $ (6.27) 

 (1) Per Diluted share includes the impact of adjusting redeemable noncontrolling interest to its redemption value 
 Adjusted Book Value. Adjusted book value is defined as Total Ambac Financial Group, Inc. stockholders’ equity as reported under GAAP, adjusted for after-tax impact of the following: 
 • Non-credit impairment fair value losses on credit derivatives: Elimination of the non-credit impairment fair value loss on credit derivatives, which is the amount in excess of the present value of the expected estimated economic credit loss. GAAP fair values are affected by, and in part fluctuate with, changes in market factors such as interest rates, credit spreads, including Ambac’s CVA that are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee contracts to be accounted for within adjusted book value consistent with the provisions of the Financial Services—Insurance Topic of the ASC, whether or not they are subject to derivative accounting rules. 
 • Insurance intangible asset: Elimination of the financial guarantee insurance intangible asset that arose as a result of Ambac’s emergence from bankruptcy and the implementation of Fresh Start reporting. This adjustment ensures that all financial guarantee contracts are accounted for within adjusted book value consistent with the provisions of the Financial Services—Insurance Topic of the ASC. 
 • Net unearned premiums and fees in excess of expected losses: Addition of the value of the unearned premium 

 
 revenue ("UPR") on financial guarantee contracts, in excess of expected losses, net of reinsurance. This non-GAAP adjustment presents the economics of UPR and expected losses for financial guarantee contracts on a consistent basis. In accordance with GAAP, stockholders’ equity reflects a reduction for expected losses only to the extent they exceed UPR. However, when expected losses are less than UPR for a financial guarantee contract, neither expected losses nor UPR have an impact on stockholders’ equity. This non-GAAP adjustment adds UPR in excess of expected losses, net of reinsurance, to stockholders’ equity for financial guarantee contracts where expected losses are less than UPR. 
 • Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income: Elimination of the unrealized gains and losses on the Company’s investments that are recorded as a component of accumulated other comprehensive income (“AOCI”). The AOCI component of the fair value adjustment on the investment portfolio may differ from realized gains and losses ultimately recognized by the Company based on the Company’s investment strategy. This adjustment only allows for such gains and losses in adjusted book value when realized. 

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 The following table reconciles Total Ambac Financial Group, Inc. stockholders’ equity to the non-GAAP measure Adjusted Book Value on a dollar amount and per share basis, for all periods presented: 
 
 June 30, 2021 December 31, 2020 
 ($ in millions, except share data) $ Amount Per Share $ Amount Per Share 
 Total Ambac Financial Group, Inc. stockholders’ equity $ 1,063 $ 23.01 $ 1,080 $ 23.57 
 Adjustments: 
 Non-credit impairment fair value losses on credit derivatives — 0.01 — 0.01 
 
 Insurance intangible asset (343) (7.42) (373) (8.14) 
 
 
 Net unearned premiums and fees in excess of expected losses 337 7.29 378 8.24 
 Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income (168) (3.64) (166) (3.63) 
 
 Adjusted book value $ 889 $ 19.25 $ 919 $ 20.05 

 
 
 The decrease in Adjusted Book Value was primarily attributable to the $14 reduction to retained earnings from the increase to the carrying value of redeemable NCI, the impact on expected future premiums from reinsurance and de-risking transactions and the Adjusted loss for the six months ended June 30, 2021 (excluding earned premium previously included in Adjusted Book Value). 
 Factors that impact changes to Adjusted Book Value include many of the same factors that impact Adjusted Earnings, including the majority of revenues and expenses, but generally exclude components of premium earnings since they are embedded in prior period's Adjusted Book Value through the net unearned premiums and fees in excess of expected losses adjustment. 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), (ii) changes to expected losses for policies which do not exceed their related unearned premiums and (iii) new reinsurance transactions. 
 
 
 
 Item 3. Quantitative and Qualitative Disclosure About Market Risk' 
 As of June 30, 2021, there were no material changes in the market risks that the Company is exposed to since December 31, 2020.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.
OCTAVE SPECIALTY GROUP INC 10-Q

Item 2. Management’s Discussion and Analysis
