OCTAVE SPECIALTY GROUP INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The objectives of our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) are to provide users of our consolidated financial statements with the following: • A narrative explanation from the perspective of management of our financial condition, results of operations, cash flows, liquidity and certain other factors that may affect future results; • Context to the unaudited consolidated financial statements; and • Information that allows assessment of the likelihood that past performance is indicative of future performance. The following discussion should be read in conjunction with our consolidated financial statements in Part I, Item 1 and the matters described under Part II, Item 1A Risk Factors in this Quarterly Report and under Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2022. Refer to Item 1. Business and Note 1. Background and Business Description for a description of our business and our key strategies to achieve our primary goal to maximize shareholder value. Organization of Information MD&A includes the following sections: Page Executive Summary 33 Critical Accounting Estimates 35 Financial Guarantees in Force 36 Results of Operations 38 Liquidity and Capital Resources 43 Balance Sheet 45 Variable Interest Entities 50 Accounting Standards 50 U.S. Insurance Statutory Basis Financial Results 50 Ambac UK Financial Results under UK Accounting Principles 50 Non-GAAP Financial Measures 51 EXECUTIVE SUMMARY ($ in millions) AFG Net Assets AFG has the following net assets to support its goals and strategies, including the development and growth of its Specialty Property and Casualty Insurance and Insurance Distribution businesses, acquisitions and capital management. AFG does not have any commitment or other obligation to provide capital or liquidity to AAC, whose financial guarantee business has been in run-off since 2008. As of June 30, 2023, AFG's stand alone net assets, excluding its equity investments in subsidiaries, were $223. Cash and short-term investments $ 177 Other investments (1) 29 Other net assets 16 Total $ 223 (1) Includes strategic minority investments in insurance services businesses of $25. | Ambac Financial Group, Inc. 33 2023 Second Quarter FORM 10-Q | Segments AFG's subsidiaries/businesses are divided into three segments with results for the three and six months ended June 30, 2023 and 2022 as follows: Three Months Ended June 30, 2023 Three Months Ended June 30, 2022 ($ in millions) Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consoli-dated Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consoli-dated Premiums placed $ 41 41 $ 24 24 Gross premiums written $ 1 $ 53 $ 55 $ (4) $ 41 $ 37 Net premiums written (54) 9 (45) 1 8 9 Total revenues 39 11 10 $ 2 62 75 4 6 $ 2 86 Total expenses 47 11 9 6 73 68 5 6 1 80 Pretax income (loss) (8) — 1 (4) (11) 7 (1) — 1 6 Ambac Stockholders’ Equity (1) 823 112 92 223 1,250 450 112 65 157 784 Non-redeemable noncontrolling interest 51 2 53 60 2 62 Total stockholders’ equity $ 874 $ 114 $ 92 $ 223 $ 1,303 $ 510 $ 114 $ 65 $ 157 $ 846 Six Months Ended June 30, 2023 Six Months Ended June 30, 2022 Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consoli-dated Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consoli-dated Premiums placed $ 118 $ 118 $ 69 $ 69 Gross premiums written $ 10 $ 105 $ 115 $ 2 $ 65 $ 67 Net premiums written $ (45) $ 18 $ (27) $ 8 $ 13 $ 21 Total revenues $ 71 $ 20 $ 25 $ 4 $ 120 $ 184 $ 5 $ 15 $ 2 $ 206 Total expenses $ 111 $ 21 $ 20 $ 8 $ 160 $ 170 $ 9 $ 13 $ 4 $ 197 Pretax income (loss) $ (40) $ (1) $ 4 $ (3) $ (40) $ 13 $ (4) $ 2 $ (3) $ 9 (1) Represents Ambac's stockholders equity for each segment, including intercompany eliminations. Legacy Financial Guarantee: 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 4. 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, 2023, AAC and Ambac UK owned $332 of distressed Ambac-insured bonds, including significant concentrations of insured RMBS bonds. Subject to internal and regulatory guidelines, market conditions and other constraints, Ambac may continue to opportunistically purchase or sell Ambac-insured securities, surplus notes and/or other Ambac issued securities, and may consider opportunities to exchange securities issued or insured by it from time to time for other securities issued by it. Liability and Insured Exposure Management Ambac'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. Ambac completed risk reduction transactions of $22 and $159 of net par exposure related to Puerto Rico for the three and six months ended June 30, 2023, respectively. Ambac also reinsured, through an existing quota share reinsurance agreement, $2,069 of insured par, consisting of primarily of military housing risk of $1,958, during the three months ended June 30, 2023. The following table provides a comparison of total, adversely classified ("ACC") and watch list credit net par outstanding in the | Ambac Financial Group, Inc. 34 2023 Second Quarter FORM 10-Q | insured portfolio at June 30, 2023 and December 31, 2022. 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, 2023 December 31, 2022 Decrease Total $ 20,364 $ 22,613 $ (2,249) (8) % ACC 4,389 4,735 (346) (7) % Watch list 1,701 3,044 (1,343) (44) % The decrease in total, ACC and watch list credit net par outstanding resulted from active de-risking (primarily from the reinsurance cession noted above), scheduled maturities, amortizations, refundings and calls, partially offset by a weakening of the USD versus the GBP and EURO. Banking Sector Crisis of 2023 The collapse of several banks in early 2023 precipitated a sudden loss of confidence in the banking system, prompting bank runs and the U.S. government to provide direct support to failed banks and, through an expansive emergency lending program, the system more broadly. In the U.S., this crisis was in part a consequence of rising interest rates, resulting in large declines in the market value of U.S. Treasury and government-backed debt held by banking institutions. The risk of additional bank financial stress and/or failures due to asset-liability mismatches or other risks, such as outsized exposure to commercial real estate, remains. Despite actions by government agencies and regulators to mitigate the consequences of these bank failures by providing liquidity and guaranteeing uninsured deposits, there is no guarantee that they will provide similar support in the event of additional bank failures. In Europe, regulators stepped in to facilitate mergers of stressed banks into more stable institutions. The ability or willingness of healthy banks to merge with stressed banks in the future is also subject to significant uncertainty. Ambac's cash balances held at banks was $40 as of June 30, 2023 and $42 as of December 31, 2022. Substantially all of these cash balances were uninsured as of June 30, 2023 and December 31, 2022 because they either (i) exceeded the $250,000 FDIC insurance limit or (ii) were held in foreign banks. These cash balances were held primarily with Ambac's main operating banks which are large money center and/or global banks. Ambac actively manages its cash balances to reduce bank risk and to enhance yield by transferring most of its funds to government and prime money market funds. Included in the cash balances above is $15 of cash of companies Ambac has acquired within its insurance distribution businesses that are held in regional banks. The management of these balances and the associated bank exposure is under consideration as part of Ambac's ongoing integration of these acquired businesses. Ambac also has exposure to banks through its fixed maturity investment portfolio totaling $152 and $119 as of June 30, 2023 and December 31, 2022, respectively. All of these investments are managed by third-party asset management firms which follow single and sector risk limits established by Ambac. The average rating of our fixed income investment in banks was BBB+ as of June 30, 2023. Russia and Ukraine Conflict The current conflict between Russia and Ukraine and the related sanctions and other penalties imposed by countries across the globe against Russia are creating substantial uncertainty in the global economy. We do not have operations in Russia or Ukraine or any insured exposures in those countries. Ambac's investment portfolio exposure to Russian issuers is not meaningful. Given our insignificant exposure, we have not experienced, and do not expect this conflict to have, a material adverse impact on our results of operations, financial condition or cash flows. However, as the conflict continues and if it were to escalate, the global economy and capital markets may be adversely impacted in ways that we cannot predict and therefore we are unable to estimate the ultimate impact that this conflict may have on our future financial condition, results of operations, and cash flows. 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, 2023, included the following: Net income (1) $ (3) Gain (loss) on foreign currency translation (net of tax), included in other comprehensive income 37 Foreign currency impact on unrealized gains (losses) on non-functional currency available-for-sale securities (net of tax), included in other comprehensive income (4) Impact on total comprehensive income (loss) $ 30 (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. Other than the foreign currency impact on unrealized gains (losses) on available-for-sale securities, which is included in Other comprehensive income, foreign currency transaction gains/(losses) as a result of changes to foreign currency rates are reported through Net income in the 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, 2022, for further information on the impact of future currency rate changes on Ambac's financial instruments. CRITICAL ACCOUNTING 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, 2022. | Ambac Financial Group, Inc. 35 2023 Second Quarter FORM 10-Q | FINANCIAL GUARANTEES IN FORCE ($ in millions) Financial guarantee products were sold in three principal markets: U.S. public, U.S. structured and international finance. The following table provides a breakdown of guaranteed net par outstanding by market at June 30, 2023 and December 31, 2022. 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. June 30, 2023 December 31, 2022 Public Finance (1) $ 8,068 $ 10,547 Structured Finance 3,445 3,612 International Finance 8,851 8,454 Total net par outstanding $ 20,364 $ 22,613 (1) Includes $3,403 and $5,400 of Military Housing net par outstanding at June 30, 2023 and December 31, 2022, respectively. 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, 2023: Sector Co. Bond Kind Country-Bond Type Ambac Ratings (1) Ultimate Maturity Year Net Par Outstanding % of Total Net Par Outstanding IF AUK Investor Owned Utility Gas - unsecured UK-Utility BBB+ 2037 $ 887 4.4 % IF AUK PFI - Accommodation UK-Infrastructure A- 2040 748 3.7 % IF AUK PFI - Hospitals UK-Infrastructure A- 2046 746 3.7 % IF AUK Other Asset Securitizations UK-Asset Securitizations BBB 2033 734 3.6 % IF AUK Investor Owned Utility Other - unsecured UK-Utility A- 2035 675 3.3 % IF AUK Investor Owned Utility Electric - unsecured UK-Utility BBB+ 2036 607 3.0 % IF AUK Sub-Sovereign Italy-Sub-Sovereign BIG 2035 586 2.9 % IF AUK PFI - Accommodation UK-Infrastructure BBB+ 2038 486 2.4 % PF AAC US State Lease/Appropriation US-Lease and Tax-backed Revenue BBB- 2036 428 2.1 % IF AUK PFI - Roads UK-Infrastructure BIG 2039 311 1.5 % Total $ 6,208 30.6 % 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. Net par related to the top ten exposures increased $92 from December 31, 2022. Exposures are impacted by changes in foreign exchange rates ($251 increase during the six months ended June 30, 2023), certain indexation rates, reinsurance transactions and scheduled and unscheduled paydowns. As a result of recent increases in inflation, such indexation exposures have increased at a faster pace than they have historically. The concentration of net par amongst the top ten (as a percentage of net par outstanding) was 31% at June 30, 2023, and 27% at December 31, 2022. Excluding the top ten exposures, the remaining insured portfolio of financial guarantees has an average net par outstanding of $27 per single risk, with insured exposures ranging up to $305 and a median net par outstanding of $5. Given that Ambac has not written any new financial guaranty insurance policies since 2008, the legacy financial guarantee insured portfolio is expected to become increasingly concentrated to large and/or below investment grade exposures. Exposure Currency The table below shows the distribution by currency of AAC’s insured exposure as of June 30, 2023: Currency Net Par Amount Outstanding in Base Currency Net Par Amount Outstanding in U.S. Dollars U.S. Dollars $ 11,688 $ 11,688 British Pounds £ 5,923 7,519 Euros € 822 897 Australian Dollars A$ 391 260 Total $ 20,364 | Ambac Financial Group, Inc. 36 2023 Second Quarter FORM 10-Q | 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, 2023 and December 31, 2022. 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. Summary of Below Investment Grade Exposure: Net Par Outstanding Bond Type June 30, 2023 December 31, 2022 Public Finance: Military Housing $ 363 $ 366 General Obligations 96 151 Lease and Tax-Backed Revenue 87 252 Other 53 54 Total Public Finance 599 823 Structured Finance: RMBS 1,734 1,841 Student Loans 269 275 Total Structured Finance 2,004 2,117 International Finance: Sovereign/sub-sovereign 705 701 Transportation 311 310 Other — 2 Total International Finance 1,016 1,013 Total $ 3,619 $ 3,953 The net decline in below investment grade exposures is primarily due de-risking activities, including Puerto Rico of $159 and the above mentioned reinsurance transaction of $50. Below investment grade exposures could increase as a relative proportion of the guarantee portfolio given that stressed borrowers generally have less ability to prepay or refinance their debt. Accordingly, due to these and other factors, it is not unreasonable to expect the proportion of below investment grade exposure in the guarantee portfolio to increase in the future. | Ambac Financial Group, Inc. 37 2023 Second Quarter FORM 10-Q | Results of Operations ($ in millions) Consolidated Results A summary of our financial results is shown below: Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Gross premiums written $ 55 $ 37 $ 115 $ 67 Revenues: Net premiums earned $ 15 $ 14 $ 29 $ 28 Commission income 10 6 25 15 Program fees 2 1 4 1 Net investment income (loss) 35 (21) 69 (16) Net investment gains (losses), including impairments (3) 7 (8) 17 Net gains (losses) on derivative contracts — 29 (3) 86 Net realized gains on extinguishment of debt — 57 — 57 Income (loss) on variable interest entities — (6) (1) 15 Other income 2 — 5 3 Expenses: Losses and loss adjustment expenses 7 (12) 25 12 Amortization of deferred acquisition costs, net 1 — 3 — Commission expense 6 4 14 8 General and administrative expenses 36 30 72 59 Intangible amortization 7 13 13 28 Interest expense 16 45 32 89 Provision for income taxes 2 1 6 1 Net income (loss) (13) 5 (46) 8 Less: net (gain) loss attributable to noncontrolling interest — — (1) — Net income (loss) attributable to common stockholders $ (13) $ 5 $ (47) $ 7 Significant items impacting Ambac's results for the six months ended June 30, 2023 and June 30, 2022 include the following: • AAC successfully implemented the restructuring of a significant portion of its Puerto Rico exposures, following the occurrence of the effective dates for the Plan of Adjustment related to AAC-insured Puerto Rico General Obligation bonds (“GO”) and Public Buildings Authority (“PBA”) bonds, and Qualifying Modifications for AAC-insured Puerto Rico Infrastructure Authority (“PRIFA”) and Convention Center District Authority (“CCDA”) bonds, all effective March 15, 2022. As a result of these successful restructurings, Ambac recorded a gain in the amount of $198 as part of its first quarter 2022 consolidated financial results. This gain included (i) a net benefit in losses and (ii) a gain on the consolidation of newly established variable interest entities; partially offset by losses from sales and changes to the fair value of securities received in the restructuring and accelerated amortization of the insurance intangible asset. In the second quarter 2022, the newly created VIEs combined with changes to the fair value of securities received by AAC resulted in losses totaling $17. • During the six months ended June 30, 2022 management recorded a reduction to AAC’s estimated R&W subrogation recoveries in the amount of $242, primarily from the evaluation of the potential effect on certain of AAC's R&W litigations of the New York Court of Appeals’ decision in the case entitled U.S. Bank National Association v. DLJ Mortgage Capital, Inc. relating to Home Equity Asset Trust 2007-1, a residential mortgage-backed securities trust. The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for the three and six months ended June 30, 2023 and 2022, respectively. Gross Premiums Written. Gross premiums written increased $18 and $49 for the three and six months ended June 30, 2023, compared to the same period in the prior year, as shown by segment below. Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Legacy Financial Guaranty Insurance $ 1 $ (4) $ 10 $ 2 Specialty Property & Casualty Insurance 53 41 105 65 Total $ 55 $ 37 $ 115 $ 67 Legacy Financial Guarantee Insurance gross written premiums relate to changes in expected and contractual premium cash flows for existing financial guarantees in force. Specialty Property & Casualty Insurance growth in gross premiums written is a driven by new programs and growth in existing programs. Net Premiums Earned. Net premiums earned increased $2 and $1 for the three and six months ended June 30, 2023, compared to the same period in the prior year as shown by segment below. Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Legacy Financial Guaranty Insurance $ 8 $ 11 $ 14 $ 24 Specialty Property & Casualty Insurance 8 3 15 4 Total $ 15 $ 14 $ 29 $ 28 The reduction in Legacy Financial Guarantee Insurance segment was primarily due to de-risking activities, including the Puerto Rico restructurings, and run-off of the insured portfolio. Growth of Specialty Property & Casualty Insurance net premiums earned was due to both new programs and growth in existing programs. Net Investment Income. Net investment income primarily consists of interest and net discount accretion on fixed maturity securities classified as available-for-sale, interest and changes in fair value of fixed maturity securities classified as trading, 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 | Ambac Financial Group, Inc. 38 2023 Second Quarter FORM 10-Q | 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 4. Investments to the Unaudited Consolidated Financial Statements, included in Part I, Item 1 in this Form 10-Q. Net investment income for the periods presented were driven by the Legacy Financial Guarantee segment; other segments' results were not significant. 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, 2023 2022 2023 2022 Securities available-for-sale and short-term other than Ambac-insured $ 16 $ 8 32 15 Other investments (includes trading securities) 13 (34) 27 (43) Securities available-for-sale: Ambac-insured (including secured notes) 6 5 $ 11 $ 12 Net investment income (loss) $ 35 $ (21) $ 69 $ (16) Net investment income (loss) increased $56 and $86 and for the three and six months ended June 30, 2023 compared to the prior year periods. • Net investment income from available-for-sale and short-term securities, other than Ambac-insured increased for the three and six months ended June 30, 2023, compared to the same periods in the prior year due primarily to higher portfolio yields and, to a lesser extent, higher average holdings. • Other investments income (loss) increased $48 and $70 for the three and six months ended June 30, 2023, compared to the same periods in the prior year. Pooled fund investments results increased $32 and $45 for the three and six months ended June 30, 2023, compared to the prior year period, driven by improved performance on equities, high-yield and leveraged loans and hedge funds, partially offset by negative performance on real estate. Investments in pooled funds may be volatile, but are generally expected to produce higher returns over the long-term than available-for-sale investments. Changes in fair value of securities received in the Puerto Rico restructurings and classified as trading, resulted in increased investment income of $16 and $25 for the three and six months ended June 30, 2023, compared to the same periods in the prior year. • Net investment income from Ambac-insured securities for the three and six months ended June 30, 2023, increased $1 and decreased $1, respectively, compared to prior year periods, as additional purchases of AAC-insured student loan securities in 2023 offset the impact of the 2022 settlements of insured Puerto Rico bonds. Net Investment Gains (Losses), including Impairments. The following table provides a breakdown of net investment gains (losses) for the periods presented: Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Net gains (losses) on securities sold or called $ (1) $ (2) $ (3) $ 7 Net foreign exchange gains (losses) (2) 8 (4) 11 Credit impairments — — (1) — Intent / requirement to sell impairments — — — — Net investment gains (losses), including impairments $ (3) $ 7 $ (8) $ 17 Net gains (losses) on securities sold or called for the six months ended June 30, 2022, included a recovery of $9 from a class-action settlement relating to certain RMBS securities previously held in the investment portfolio. Other net realized gains (losses) 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 Company is 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 are driven primarily by results from the Company's interest rate derivatives portfolio. Through the first quarter of 2023, the interest rate derivatives portfolio was positioned to benefit from rising rates as a partial economic hedge against interest rate exposure in the financial guarantee insurance and investment portfolios. This economic hedge was substantially reduced since the first half of 2022 and was fully removed during the three months ended June 30, 2023. Net gains (losses) on interest rate derivatives 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. The removal of the economic hedge will not change the exposure of future results to counterparty credit adjustments. Results from other derivatives were not significant to the periods presented. Net gains (losses) on interest rate derivatives for the three and six months ended June 30, 2023, were $0 and $(3) compared to $29 and $86 for the three and six months ended June 30, 2022. Results for the three and six months ended June 30, 2023, reflect the net impact of interest rate shifts and counterparty credit adjustments described below. The net gains in 2022 were driven primarily by the significant rate increases in the periods. | Ambac Financial Group, Inc. 39 2023 Second Quarter FORM 10-Q | Counterparty credit adjustments are generally applicable for uncollateralized derivative assets that may not be offset by derivative liabilities under a master netting agreement. In periods when credit spreads are stable, counterparty credit adjustments will generally have a proportionate offsetting impact to gains or losses on derivative assets, relative to fully collateralized assets. 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. Generally, narrowing (widening) of credit spreads will increase (decrease) derivative gains relative to a period of stable credit spreads. Inclusion of counterparty credit adjustments in the valuation of interest rate derivatives resulted in gains (losses) within Net gains (losses) on derivative contracts of $1 and $0 for the three and six months ended June 30, 2023, respectively, and $2 and $4 for the three and six months ended June 30, 2022, respectively. The counterparty credit adjustments for all periods were driven primarily by changes to the underlying asset values. Net Realized Gains on Extinguishment of Debt. Net realized gains on extinguishment of debt was $57 for three and six months ended June 30, 2022, resulting from repurchases of surplus notes below their carrying values. Commission Income and Commission Expense. Commission income for the three and six months ended June 30, 2023 was $10 and $25 compared to $6 and $15, for the three and six months ended June 30, 2022. Commissions include both base and profit sharing commissions of the Insurance Distribution segment. The increase was driven by (i) commissions earned on All Trans and Capacity Marine, which were purchased in November 2022 and (ii) greater premiums placed by Xchange Benefits. Gross commission income has an accompanying expense, commission expense, which will largely track changes in gross commission. For the three and six months ended June 30, 2023, commission expense of $6 and $14 compared to $4 and $8 in three and six months ended June 30, 2022, driven primarily by the same factors as commission income. Income (Loss) on Variable Interest Entities. Included within Income (loss) on variable interest entities are income statement amounts relating to FG 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 FG VIEs during the periods reported. Generally, the Company’s consolidated FG 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 FG VIEs are initially reported at fair value and the related insurance assets and liabilities are eliminated. However, the amount of FG VIE net assets (liabilities) that remain in consolidation generally result from the net positive (negative) projected cash flows from (to) the FG VIEs which are attributable to Ambac’s insurance subsidiaries in the form of financial guarantee insurance premiums, fees and losses. In the case of FG 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 FG 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 FG VIE and Ambac could result in gains or losses, even if such policy changes do not result in deconsolidation of the FG VIE. Income (loss) on variable interest entities was $0 and $(1) for the three and six months ended June 30, 2023, compared to $(6) and $15 for the three months ended June 30, 2022. Results for the three months ended June 30, 2023 reflect the offsetting effects of fair value gains on a Puerto Rico restructuring VIE's assets and accelerated interest cost upon redemption of its debt. The loss for the six months ended June 30, 2023 include accelerated interest costs from the Puerto Rico VIE trust, partially offset by gains on higher valuation of net assets on other FG VIEs. Results for three and six months ended June 30, 2022, related primarily to two VIE trusts created in connection with the Puerto Rico restructurings in March 2022. The three months ended June 30, 2022 included losses of $7 from these VIEs driven by interest costs and changes in fair value of assets received in the restructuring. The six months ended June 30, 2022 also included first quarter losses of $6 from changes to fair value of these VIEs' assets and the initial $28 gain upon consolidation on March 15, 2022. Refer to Note 9. 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 FG VIEs. Losses and Loss Expenses. Loss and loss expenses increased $19 and $13 for the three and six months ended June 30, 2023, compared to the same period in the prior year. Legacy financial guarantee loss and loss expenses (benefit) were $2 and $15 for the three and six months ended June 30, 2023. Specialty Property and Casualty Insurance loss and loss expenses were $6 and $10 for the three and six months ended June 30, 2023. Intangible Amortization. Insurance intangible amortization for the three and six months ended June 30, 2023, was $6 and $11, a decrease of $7 and $15 as compared to the the three and six months ended June 30, 2022. The decrease was driven primarily by the timing of de-risking (including Puerto Rico in the six months ended June 30, 2022) and the reduced size of the financial guarantee insured portfolio. Insurance intangible amortization will decline after policies mature or they are de-risked. Other intangible amortization for the three and six months ended June 30, 2023, was $1 and $2, respectively. General and Administrative Expenses (G&A). The following table provides a summary of G&A expenses for the periods presented: Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Compensation $ 18 $ 16 $ 34 $ 32 Non-compensation 18 13 38 27 Total G&A expenses 36 30 72 59 | Ambac Financial Group, Inc. 40 2023 Second Quarter FORM 10-Q | The increase in Compensation G&A expenses during the three and six months ended June 30, 2023 was due to higher compensation costs from a net increase in staffing from the development and growth, both organic and via acquisitions, of the Specialty Property & Casualty Insurance and Insurance Distribution segments. For the six months ended June 30, 2023, these factors were partially offset by lower incentive compensation expense including the impact of performance factor adjustments. The increase in Non-Compensation G&A expenses during the three and six months ended June 30, 2023, as compared to the three and six months ended June 30, 2022, was due to higher Legacy Financial Guarantee Insurance segment's legal defense costs of $5 and $10, respectively. Interest Expense. All interest expense relates to the Legacy Financial Guarantee Insurance segment and includes accrued interest on the Sitka AAC Note (fully redeemed during the fourth quarter of 2022), Tier 2 Notes (fully redeemed during the first quarter of 2023), 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, 2023 2022 2023 2022 Surplus notes $ 16 $ 20 $ 31 $ 41 Sitka AAC note — 17 — 34 Tier 2 Notes — 7 1 14 Other — — 1 1 Total interest expense $ 16 $ 45 $ 32 $ 89 The decrease in interest expense for the three and six months ended June 30, 2023, compared to the three and six months ended June 30, 2022, reflects the impact of the 2022 redemption of secured notes as further described in Note 1. Background and Business Description, in the Notes to the Consolidated Financial Statements included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022. Interest expense for 2023 also declined as a result of repurchases of surplus notes during 2022. These benefits were partially offset by the effects of interest compounding on surplus notes. Surplus note principal and interest payments require the approval of OCI. In May 2023, OCI declined the request of AAC to pay the principal amount of the surplus notes, plus all accrued and unpaid interest thereon, on the then next scheduled payment date of June 7, 2023. As a result, the scheduled payment date for interest, and the scheduled maturity date for payment of principal of the surplus notes, was 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 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 was $450 at June 30, 2023. 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. Provision for Income Taxes. The provision for income taxes primarily relate to international operations and was $2 and $6 for the three and six months ended June 30, 2023, compared to $1 and $1 for the three and six months ended June 30, 2022, an increase of $1 for the quarter and an increase of $4 for the year-to-date period. Results of Operations by Segment Legacy Financial Guarantee Insurance Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Revenues: Net premiums earned $ 8 $ 11 $ 14 $ 24 Net investment income 32 (22) 63 (18) Net investment gains (losses), including impairments (3) 7 (8) 17 Net gains on derivative contracts 1 28 (3) 85 Net realized gains on extinguishment of debt — 57 — 57 Other income 2 (6) 4 18 Total 39 75 71 184 Expenses: Loss and loss expenses (benefit) 2 (14) 15 9 General and administrative expenses 23 23 52 44 Total 25 10 66 54 Earnings before interest, taxes, depreciation and amortization (1) 14 65 5 130 Interest expense 16 45 32 89 Depreciation — — 1 1 Intangible amortization 6 13 11 26 Pretax income (loss) $ (8) $ 7 $ (40) $ 13 Stockholders equity (2) $ 823 $ 450 (1) Abbreviated as "EBITDA" in future references (2) Represents the share of Ambac stockholders equity for each subsidiary within the Legacy Financial Guarantee Insurance segment, including intercompany eliminations. The Legacy Financial Guarantee Insurance segment is in active runoff. This will generally result in declining premiums earned, investment income, G&A expenses and intangible amortization. The variability in the segment financial results are primarily driven by (i) changes in loss and loss expenses resulting from, amongst other items, credit developments, interest rates and de-risking transactions; and (ii) volatility from Other investments income (loss) resulting from changes in market conditions and other performance factors. Key variances not discussed above in the Consolidated Results section are as follows: | Ambac Financial Group, Inc. 41 2023 Second Quarter FORM 10-Q | Net premiums earned. Net premiums earned decreased $3 and $10 for the three and six months ended June 30, 2023, compared to the same period in the prior year. Net premiums earned were impacted by the organic and active runoff of the financial guarantee insured portfolio, resulting in a reduction to current and future normal net premiums earned and the following: • Changes to the allowance for credit losses on the premium receivable asset. The positive impact on net premiums earned related to credit losses amounted to $1 and $1 fo r the three and six months ended June 30, 2023, as compared to $1 and $3 for the three and six months ended June 30, 2022. • Accelerated financial guarantee premiums earned as a result of calls and other accelerations on insured obligations, largely due to active de-risking of the insured portfolio, were deminimis for the three and six months ended June 30, 2023, as compared to $2 and $6 for the three and six months ended June 30, 2022. Losses and Loss Expenses. 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, 2023 2022 2023 2022 Structured Finance $ 1 $ (11) $ 21 $ 202 Domestic Public Finance (2) (3) 1 (194) Other, including International Finance 3 — (7) 1 Totals $ 2 $ (14) $ 15 $ 9 Loss and loss expenses (benefit) for the the six months ended June 30, 2023, were largely driven by unfavorable loss development in the RMBS portfolio resulting from a first quarter 2023 decline in discount rates, partially offset by assumption changes in the international portfolio. Loss and loss expenses (benefit) for the three months ended June 30, 2022, were largely driven by the positive impact of higher discount rates and stronger recoveries, partially offset by a reduction to R&W subrogation recoveries (driven by higher discount rates and lower credit losses) and loss expenses incurred. Losses and loss expenses (benefit) for the six months ended June 30, 2022, were driven by a reduction to AAC’s estimated R&W subrogation recoveries in the amount of $242, partially offset by favorable loss development in domestic public finance (primarily due to the Puerto Rico restructuring) and the positive impact of discount rates during 2022. G&A Expenses. The comparability of expenses for the three months ended June 30, 2023 to the prior year period is impacted by the timing of expense reimbursements to Corporate that are recognized when approved by the Office of the Commissioner of Insurance for the State of Wisconsin (“OCI”). This inter-segment charge was recognized in the first quarter of 2023 and in the second quarter of 2022. Adjusting for this timing, Legacy Financial Guarantee Insurance G&A expenses for the three months ended June 30, 2023 increased $4 million from the prior year period. Segment G&A expenses increased during the three and six months ended June 30, 2023, as compared to the three and six months ended June 30, 2022, primarily due to higher legal defense costs in the 2023 periods, partially offset by lower compensation costs due to reduced headcount in the three and six months ended June 30, 2022. The timing of incentive compensation performance factor adjustments resulted in an increase to second quarter 2023 expenses, but a decrease for the six months ended June 30, 2023 compared to the prior year periods. Specialty Property and Casualty Insurance Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Gross premiums written $ 53 $ 41 $ 105 $ 65 Net premiums written 9 8 18 13 Revenues: Net premiums earned $ 8 $ 3 $ 15 $ 4 Program fees 2 1 4 1 Investment income 1 — 2 1 Net investment gains (losses), including impairments — — — — Total 11 4 20 5 Expenses: Losses and loss expenses incurred 6 2 10 3 Amortization of deferred acquisition costs, net 1 — 3 — General and administrative expenses 4 3 8 6 Total 11 5 21 9 EBITDA — $ (1) (1) $ (4) Pretax income (loss) $ — $ (1) $ (1) $ (4) Loss and LAE Ratio 73.7 % 66.5 % 70.4 % NM Combined Ratio 125.5 % 161.7 % 127.4 % NM Ambac's stockholders equity (1) $ 112 $ 114 (1) Represents Ambac stockholders equity in the Specialty Property and Casualty Insurance segment, including intercompany eliminations. The Specialty Property and Casualty Insurance segment has grown significantly since underwriting its first program in May 2021. Sixteen programs were authorized to issue policies as of June 30, 2023. The growth in both the number and size of these programs has contributed to the increase in gross and net premiums written, net premiums earned and net loss and loss expenses incurred. Loss and loss expenses incurred increased for the three and six months ended June 30, 2023, relative to the three and six months ended June 30, 2022, as a result of a number of factors, including growth of the business. While the Loss and LAE ratio increased on a relative basis, Everspan's selected loss ratio (including ULAE) was approximately 69% at June 30, 2023 and 66% at June 30, 2022, which is in line with expectations. Everspan's loss ratio is expected to experience some volatility as the inforce book of business grows and diversifies. The increase in the Loss and LAE ratio for the three months ended June 30, 2023, compared to | Ambac Financial Group, Inc. 42 2023 Second Quarter FORM 10-Q | June 30, 2022, was substantially offset by a benefit to acquisition costs as a result of sliding scale commission arrangements. Certain Everspan programs were structured to include sliding scale commission arrangements in order to reduce volatility and improve underwriting results. Loss and loss expenses incurred may be adversely impacted by increasing economic and social inflation, particularly within the commercial auto business. The impact of inflation on ultimate loss reserves is difficult to estimate, particularly in light of recent disruptions to the judicial system, supply chain and labor markets. In addition, on a going forward basis, we may not be able to offset the impact of inflation on our loss costs with sufficient price increases. The estimation of loss reserves may also be more difficult during extreme events, such as a pandemic, or during the persistence of volatile or uncertain economic conditions, due to, amongst other reasons, unexpected changes in behavior of claimants and policyholders, including an increase in fraudulent reporting of exposures and/or losses. Due to the inherent uncertainty underlying loss reserve estimates, the final resolution of the estimated liability for loss and loss expenses will likely be higher or lower than the related loss reserves at the reporting date. In addition, our estimate of losses and loss expenses may change. These additional liabilities or increases in estimates, or a range of either, could vary significantly from period to period. General and administrative costs increased for the three and six months ended June 30, 2023 relative to the three and six months ended June 30, 2022 primarily resulting from the ramp up in Everspan's staffing and operations. Additionally, the three and six months ended June 30, 2022 included costs associated with the acquisition of additional shell insurance companies in January 2022. Insurance Distribution Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Premiums placed $ 41 $ 24 $ 118 $ 69 Commission income $ 10 $ 6 $ 25 $ 15 Commission expense 6 4 14 8 Net commissions 4 2 11 6 Expenses: General and administrative expenses (1) 2 2 5 3 EBITDA 2 1 6 4 Depreciation (1) — — — — Intangible amortization 1 1 1 1 Pretax income (loss) $ 1 $ — $ 4 $ 2 Ambac's stockholders equity (2) $ 92 $ 65 (1) The Consolidated Statements of Comprehensive Income presents the sum of these items as General and Administrative Expenses. (2) Represents the share of Ambac stockholders equity for each subsidiary within the Insurance Distribution segment, including intercompany eliminations. Ambac's Insurance Distribution businesses are compensated for their services primarily by commissions paid by insurance carriers for underwriting, structuring and/or administering polices. Commission revenues are usually based on a percentage of the premiums placed. In addition, we are eligible to receive profit sharing contingent commissions on certain programs based on the underwriting results of the policies placed with carriers, which may cause some variability in revenue and earnings. The Insurance Distribution segment placed premiums for its carriers of approximately $41 for the three and six months ended June 30, 2023, up $17 or 72% as compared to the three and six months ended June 30, 2022. Higher premiums placed were driven by organic growth at Xchange, the acquisition of All Trans and Capacity Marine, and the Employer Stop Loss renewal rights acquisition on April 29, 2022. The increase in premiums placed and changes to the mix of business written led to the growth in commission income and commission expense of 69% and 76%, respectively. Employer Stop Loss business underwritten by Xchange has seasonality in January and July, which results in revenue and earnings concentrations in the first and third quarters each calendar year. Employer Stop Loss is Xchange's largest business. On August 7, 2023, Ambac acquired a controlling interest (80%) in Riverton Insurance Agency, Corp. ("Riverton") which will add approximately $40 of annual premiums placed to the Insurance Distribution segment. Riverton is an MGA and retail agency specializing in professional liability insurance programs to licensed architects, engineers, construction mangers and real estate professional. G&A Expenses. G&A expenses for the three and six months ended June 30, 2023, increased compared to the three and six months ended June 30, 2022, as a result of the All Trans and Capacity Marine acquisitions as well as employees hired to support the Employer Stop Loss renewal rights acquisition. LIQUIDITY AND CAPITAL RESOURCES ($ in millions) Holding Company Liquidity AFG is organized as a legal entity separate and distinct from its operating subsidiaries. AFG is a holding company with no outstanding debt. AFG's liquidity is primarily dependent on its net assets, excluding the operating subsidiaries that it owns, totaling $223 as of June 30, 2023, and secondarily on distributions and expense sharing payments from its operating subsidiaries. • 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 2022 and 2021 expenses was approved by OCI and paid to AFG during March of 2023 and April of 2022, respectively. • Substantial uncertainty remains as to AAC's ability to pay dividends to AFG and the timing of any such dividends. | Ambac Financial Group, Inc. 43 2023 Second Quarter FORM 10-Q | • Everspan's ability to make future dividend payments will mostly depend on its future profitability relative to its capital needs to support growth. Everspan is not expected to pay dividends in the near term. • Cirrata does not have any regulatory restrictions on its ability to make distributions. AFG received distributions from Cirrata of $3.6 and $2.5 during the six months ended June 30, 2023 and 2022. AFG's principal uses of liquidity are: (i) the payment of G&A expenses, including costs to explore opportunities to grow and diversify Ambac, (ii) the making of strategic investments, which are generally illiquid and (iii) making capital investments to acquire, grow and/or capitalize new and/or existing businesses. AFG may also provide short-term financial support, primarily in the form of loans, to its operating subsidiaries to support their operating requirements. In the opinion of the Company’s management the net assets of AFG are sufficient to meet AFG’s current liquidity requirements. However, events, opportunities or circumstances could arise that may cause AFG to seek additional capital (e.g. through the issuance of debt, equity or hybrid securities). Operating Companies' Liquidity Insurance Sources of liquidity for the Company’s insurance subsidiaries are through funds generated from premiums; recoveries on claim payments; reinsurance recoveries; fees; investment income and maturities and sales of investments. • See Note 6. Insurance Contracts to the Consolidated Financial Statements included in Part I, Item 1., in this Form 10-Q for a summary of future gross financial guarantee premiums to be collected by AAC and Ambac UK. Termination of financial guarantee policies on an accelerated basis may adversely impact AAC’s liquidity. Cash provided from these sources is used primarily for claim payments and commutations, loss expenses and acquisition costs (Specialty Property & Casualty Insurance segment only), debt service on outstanding debt (Legacy Financial Guarantee segment only), G&A expenses, reinsurance payments and purchases of securities and other investments, some of which may not be immediately convertible into cash. • Interest and principal payments on surplus notes are subject to the approval of OCI, which has full discretion over payments regardless of the liquidity position of AAC. 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, 2023. Current principal outstanding on AAC's long-term debt consisted of $519 of surplus notes. AAC's future interest obligations on long-term debt include $496 of accrued and unpaid interest that would be payable on surplus notes if approved by OCI on the next scheduled payment date of June 7, 2024. • AFS's remaining derivatives include interest rate swaps previously provided to asset-backed issuers and other entities in connection with their financings. AAC lends AFS cash and securities as needed to fund payments under these derivative contracts, collateral posting requirements and G&A expenses. Intercompany loans are governed by an established lending agreement with defined borrowing limits that has received non-disapproval from OCI. Insurance subsidiaries manage their liquidity risk by maintaining comprehensive analyses of projected cash flows and maintaining specified levels of cash and short-term investments at all times. It is the opinion of the Company’s management that the insurance subsidiaries’ near term liquidity needs will be adequately met from the sources described above. Insurance Distribution: The liquidity requirements of our Insurance Distribution subsidiaries are met primarily by funds generated from commission receipts (both base and profit commissions). Base commissions are generally received monthly, whereas profit commissions are received only if the business underwritten is profitable. Cash provided from these sources is used primarily for commissions paid to sub-producers, G&A expenses and distributions to AFG and other members. Consolidated Cash Flow Statement Discussion The following table summarizes the net cash flows for the periods presented. Six Months Ended June 30, 2023 2022 Cash provided by (used in): Operating activities $ 101 $ 11 Investing activities 489 440 Financing activities (1) (343) (434) Foreign exchange impact on cash and cash equivalents 1 (1) Net cash flow $ 248 $ 16 (1) Because the trusts established under the Puerto Rico restructurings are consolidated VIEs, certain payments made by AAC to accelerate AAC-insured bonds that were deposited into trusts are reflected as payments of VIE liabilities within financing activities. Cash used in financing activities includes $113 and $274 from such AAC payments, for the six months ended June 30, 2023 and 2022, respectively. Operating activities The following represents the significant cash operating activity during the six months ended June 30, 2023 and 2022: • Cash provided by (i) gross premiums were $90 and $55 for the six months ended June 30, 2023 and 2022, respectively; (ii) interest rate derivatives were $22 and $32 for the six months ended June 30, 2023 and 2022, respectively; (iii) investment portfolio income were $51 and $29 for the six months ended June 30, 2023 and 2022, respectively; and (iv) cash settlements from the Puerto Rico restructuring | Ambac Financial Group, Inc. 44 2023 Second Quarter FORM 10-Q | transactions to the consolidated trusts was $47 for the three months ended March 31, 2022. • Interest payments, including accumulated paid-in-kind interest on the Tier 2 Notes, were $50 for the six months ended June 30, 2023 and $32 for the six months ended June 30, 2022. • Payments related to (i) G&A expenses we re $65 and $54 for the six months ended June 30, 2023 and 2022, respectively; and (ii) reinsurance premiums paid were $56 and $22 for the six months ended June 30, 2023 and 2022, respectively • Net Legacy Financial Guarantee Insurance loss and loss expenses paid, including commutation payments, during the six months ended June 30, 2023 and 2022 are detailed below: Six Months Ended June 30, 2023 2022 Net loss and loss expenses paid (recovered): Net losses paid $ 17 $ 225 Net subrogation received (1) (158) (208) Net loss expenses paid 6 4 Net cash flow $ (135) $ 21 (1) 2023 includes Nomura R&W settlement proceeds of $140 Future operating flows will primarily be impacted by net premium collections and investment coupon receipts, G&A expenses, net claim and loss expense payments and interest payments on outstanding debt. Financing Activities Financing activities for the six months ended June 30, 2023, included redemption of the Tier 2 Notes of $97, share repurchases of $3, and paydowns and maturities of VIE debt obligations of $235 (including payments for the accelerations of the VIE trusts created from the Puerto Rico restructuring). Financing activities for the six months ended June 30, 2022, include paydowns and maturities of VIE debt obligations of $359. Collateral AFS hedged a portion of the interest rate risk in the Legacy Financial Guarantee Insurance segment financial guarantee and investment portfolios, along with legacy customer interest rate swaps, with standardized derivative contracts, which contain collateral or margin requirements. As of June 30, 2023, AFS's only remaining derivative positions include a limited number of legacy customer swaps and their associated hedges. Under these hedge agreements, AFS is required to post collateral in excess of the derivative unrealized loss amount. All AFS derivative contracts containing ratings-based downgrade triggers that could result in collateral posting or a termination have been triggered. AFS may look to re-establish hedge positions resulting in additional collateral obligations. The amount of additional collateral 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 obligations are currently met. Collateral posted by AFS totaled a net amount of $54 (cash and securities collateral of $17 and $36, respectively), including independent amounts, under these contracts at June 30, 2023. BALANCE SHEET ($ in millions) Total assets increased by approximately $159 from December 31, 2022, to $8,132 at June 30, 2023, primarily due to: (i) the increase in asset values of VIEs of $267, (ii) higher values on non-VIE invested assets and (iii) increases in premium receivables and reinsurance recoverables as a result of growth in the specialty P&C businesses. The increase in VIE assets was driven by collateral received by FG VIEs and increased asset values including due to the impact of the strengthening of the British Pound Sterling against the US dollar. These factors were partially offset by (i) debt payments of $146 for the full redemption of Tier 2 Notes, and (ii) $113 of payments from Ambac Assurance to support partial redemptions of HTA Trust Certificates. Total liabilities increased by approximately $162 from December 31, 2022, to $6,809 as of June 30, 2023, primarily due to increases in the value of VIE liabilities of $166 (consistent factors as noted above in assets, including redemptions of HTA Trust Certificates). Additional liability increases were driven by (i) higher loss and loss adjustment expense reserves and (ii) an increase in unearned premium from the specialty P&C businesses. These increases to total liabilities were partially offset by the redemption of the Tier 2 Notes of $146. As of June 30, 2023, total stockholders’ equity was $1,303, compared with total stockholders’ equity of $1,305 at December 31, 2022. This decrease was primarily due to the net loss for the three and six months ended June 30, 2022, partially offset by unrealized gains on invested assets and gains on foreign currency translation. 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 the year ended December 31, 2022, for further description of Ambac's investment policies and applicable regulations. 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. | Ambac Financial Group, Inc. 45 2023 Second Quarter FORM 10-Q | The following table summarizes the composition of Ambac’s investment portfolio, excluding VIE investments, at carrying value at June 30, 2023 and December 31, 2022: June 30, 2023 December 31, 2022 Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consolidated Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consolidated Fixed maturity securities $ 1,423 $ 116 $ — $ 13 $ 1,552 $ 1,281 $ 102 $ — $ 12 $ 1,395 Fixed maturity securities - trading 28 — — — 28 59 — — — 59 Short-term 168 25 — 171 364 303 29 — 175 507 Other investments 513 — — 17 530 552 — — 16 568 Fixed maturity securities pledged as collateral 36 — — — 36 64 — — — 64 Total investments (1) $ 2,168 $ 141 $ — $ 201 $ 2,510 $ 2,259 $ 131 $ — $ 203 $ 2,593 (1) Includes investments denominated in non-US dollar currencies with a fair value of £322 ($408) and €29 ($31) as of June 30, 2023 and £296 ($357) and €39 ($42) as of December 31, 2022. 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 4. 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, 2023 and December 31, 2022: (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 21% and 19% of the June 30, 2023, and December 31, 2022, combined fixed maturity portfolio, respectively. | Ambac Financial Group, Inc. 46 2023 Second Quarter FORM 10-Q | Premium Receivables Ambac's premium receivables increased to $276 at June 30, 2023, from $269 at December 31, 2022. As further discussed in Note 6. Insurance Contracts, the increase is primarily due to growth in the Specialty P&C Insurance Segment. At June 30, 2023, Legacy Financial Guarantee Insurance and Specialty P&C premiums receivables were $253 and $23, respectively. Premium receivables by payment currency were as follows: Currency Premium Receivable in Payment Currency Premium Receivable in U.S. Dollars U.S. Dollars $ 187 $ 187 British Pounds £ 60 76 Euros € 12 14 Total $ 276 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 in the event of rating agency downgrades of a reinsurer (among other events and circumstances). Those reinsurance counterparties that do not currently post collateral are well capitalized, highly rated, authorized capacity providers. Ambac benefited from letters of credit and collateral amounting to approximately $113 from its reinsurers at June 30, 2023. Additionally, while legacy liabilities from the 21st Century Companies and PWIC acquisitions were fully ceded to certain reinsurers, Everspan also benefits from an unlimited, uncapped indemnity from the respective sellers to mitigate any residual risk to these reinsurers. As of June 30, 2023 and December 31, 2022, reinsurance recoverable on paid and unpaid losses were $149 and $115, respectively primarily due to growth in the Specialty P&C Insurance Segment. Intangible Assets Intangible assets primarily include (i) an insurance intangible asset that was established at AFG's emergence from bankruptcy (Legacy Financial Guarantee Insurance Segment) in 2013, representing the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities of $258 at June 30, 2023, (ii) intangible assets established as part of acquisitions in the Insurance Distribution business of $45 at June 30, 2023, (iii) indefinite-lived intangible assets in the Specialty P&C business as part of its acquisitions of $14 at June 30, 2023. As of June 30, 2023 and December 31, 2022, intangible assets were $317 and $326, respectively. The decline is driven by amortization; partially offset by translation gains from the consolidation of Ambac's foreign subsidiary (Ambac UK). Derivative Assets and Liabilities The interest rate derivative portfolio was positioned to benefit from rising rates, until the early part of the second quarter ended June 30, 2023, as a partial economic hedge against interest rate exposure in the Legacy Financial Guarantee insurance and investment portfolios. As of June 30, 2023, AFS' only remaining derivative positions include a limited number of legacy customer swaps and their associated hedges. Derivative assets decreased from $27 at December 31, 2022, to $26 as of June 30, 2023. Derivative liabilities decreased from $38 at December 31, 2022, to $37 as of June 30, 2023. Loss and Loss Expense Reserves and Subrogation Recoverable Loss and loss expense reserves are based upon estimates of the ultimate aggregate losses inherent in 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 8. 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, 2022, 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, 2023 and December 31, 2022, were $724 and $534, respectively. Loss and loss expense reserves are included in the Unaudited Consolidated Balance Sheets as follows: June 30, 2023: December 31, 2022: Specialty Property and Casualty Legacy Financial Guarantee Specialty Property and Casualty Legacy Financial Guarantee Present Value of Expected Net Cash Flows Unearned Premium Revenue Gross Loss and Loss Expense Reserves Present Value of Expected Net Cash Flows Unearned Premium Revenue Gross Loss and Loss Expense Reserves Balance Sheet Line Item Gross Loss and Loss Expense Reserves Claims and Loss Expenses Recoveries (1) Gross Loss and Loss Expense Reserves Claims and Loss Expenses Recoveries (1) Loss and loss expense reserves $ 130 $ 813 $ (50) $ (31) $ 863 $ 90 $ 787 $ (44) $ (28) $ 805 Subrogation recoverable — 2 (140) — (139) — 5 (276) — (271) Totals $ 130 $ 815 $ (190) $ (31) $ 724 $ 90 $ 791 $ (319) $ (28) $ 534 (1) Present value of future recoveries includes R&W subrogation recoveries of $0 and $140 at June 30, 2023 and December 31, 2022, respectively. | Ambac Financial Group, Inc. 47 2023 Second Quarter FORM 10-Q | Legacy Financial Guarantee Insurance: 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 91% of our ever-to-date insurance claims recorded, with RMBS comprising 61%. 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, 2023 and December 31, 2022: June 30, 2023: December 31, 2022: Gross Par Outstanding (1) Present Value of Expected Net Cash Flows Unearned Premium Revenue Gross Loss and Loss Expense Reserves (1)(2) Gross Par Outstanding (1) Present Value of Expected Net Cash Flows Unearned Premium Revenue Gross Loss and Loss Expense Reserves (1)(2) Claims and Loss Expenses Recoveries Claims and Loss Expenses Recoveries Structured Finance $ 1,979 $ 703 $ (168) $ (10) $ 525 $ 2,050 $ 664 $ (296) $ (10) $ 358 Domestic Public Finance 1,125 88 (8) (9) 71 1,215 96 (11) (10) 75 Other, including International finance 1,154 19 (14) (12) (7) 782 23 (12) (8) 3 Loss expenses — 5 — — 5 — 8 — — 8 Totals $ 4,258 $ 815 $ (190) $ (31) $ 594 $ 4,047 $ 791 $ (319) $ (28) $ 444 (1) Ceded par outstanding on policies with loss reserves and ceded loss and loss expense reserves were $472 and $33 respectively, at June 30, 2023, and $472 and $33, respectively at December 31, 2022. Recoverable ceded loss and loss expense reserves are included in Reinsurance recoverable on paid and unpaid losses on the balance sheet. (2) 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. 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. Accordingly, it is possible that our estimated loss reserves, gross of reinsurance, for financial guarantee insurance policies could be understated. 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, 2023, 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 2022 Annual Report on Form 10-K, and Part II, Item1A "Risk Factors" of this Quarterly Report, for further discussion of the risks relating to future losses and recoveries that could result in more highly stressed outcomes, as well as the descriptions of "Structured Finance Variability," "Domestic Public Finance Variability," and "Other 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 Ambac, including (without limitation) impairing the ability of AAC to honor its financial obligations, particularly its outstanding surplus note and preferred stock 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 : Changes to assumptions that could make our reserves under-estimated include an increase in interest rates, deterioration in housing prices, poor servicing, government intervention into the functioning of the mortgage market and the general effect of a weakened economy characterized by growing unemployment and wage pressures. During the first quarter of 2023, Ambac revised the model it uses to project RMBS collateral losses considering the seasoning of our RMBS exposure and management’s view that the most relevant determinant of prospective collateral performance is borrower payment status. Individual home price appreciation/depreciation has become less critical a determinant of performance considering the general appreciation in home values over the past few years as well as the impact of loan modifications. The average estimated loan-to-values of the collateral related to insured exposures have declined to under 50% from peaks above 110%. Projected losses in our RMBS exposures and related loss reserves, may increase or decrease in the future. Possible stress case losses assume higher default rates, loss severities and lower prepayments. | Ambac Financial Group, Inc. 48 2023 Second Quarter FORM 10-Q | 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 economic impact from public health crises and/or natural or other catastrophic events. Such factors may also 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. During the second quarter of 2023, we revised our approach to projecting future defaults to reflect the student loan collateral's seasoning. Structured Finance Variability: Using the approaches described above, the possible increase in loss reserves for structured finance credits for which we have an estimate of expected loss at June 30, 2023, could be approximately $70. There can be no assurance that losses may not exceed such amounts. Due to the uncertainties related to risks associated with structured finance credits, there can be no assurance that losses may not exceed our stress case estimates. Domestic Public Finance Variability: Ambac’s U.S. public finance portfolio consists of municipal bonds such as general and revenue obligations and lease and tax-backed obligations of state and local government entities; however, the portfolio also includes a wide array of non-municipal types of bonds, including transactions with public and private elements, which generally finance infrastructure, housing and other public purpose facilities and interests, the largest sector of which is U.S. military housing. It is possible our loss reserves for public finance credits may be under-estimated if issuers are faced with prolonged exposure to adverse political, judicial, economic, fiscal or socioeconomic events or trends. Additionally, our loss reserves may be under-estimated because of the local, regional or national economic impact from public health crises and/or natural or other catastrophic events. Our experience with the city of Detroit's bankruptcy and Commonwealth of Puerto Rico's Title III proceedings as well as other municipal bankruptcies demonstrates the preferential treatment of certain creditor classes, especially 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 exposure, such as Chicago's school district, the State of New Jersey and others. Less severe treatment of pension obligations in bankruptcy may lead to worse outcomes for traditional debt creditors. Variability of outcomes applies to even what are 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. Moreover, issuers in Chapter 9 or similar proceedings may obtain judicial rulings and orders that impair creditors' rights or their ability to collect on amounts owed. In certain cases, judicial decisions may be contrary to AAC's expectations or understanding of the law or its rights thereunder, which may lead to worse outcomes in Chapter 9 or similar proceedings than anticipated at the outset. 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 could deprive issuers access to funding at a level necessary to avoid defaulting on their obligations. Material additional losses on our public finance credits caused by the aforementioned would have a material adverse effect on our results of operations and financial condition. For the public finance credits for which we have an estimate of expected loss at June 30, 2023, the possible increase in loss reserves could be approximately $120 and there can be no assurance that losses may not exceed our stress case estimates. Other Credits, including International Finance 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 $335 greater than the loss reserves at June 30, 2023. There can be no assurance that losses may not exceed our stress case estimates. Long-term Debt Long-term debt includes AAC surplus notes and the Ambac UK debt issued in connection with a commutation. All long-term debt relates to the Legacy Financial Guarantee segment. The carrying value of each of these as of June 30, 2023 and December 31, 2022 is below: | Ambac Financial Group, Inc. 49 2023 Second Quarter FORM 10-Q | June 30, 2023 December 31, 2022 Surplus notes $ 485 $ 477 Tier 2 notes — 146 Ambac UK debt 16 16 Total Long-term Debt $ 501 $ 639 The decrease in long-term debt from December 31, 2022, resulted from redemption of the Tier 2 Notes during the quarter ended March 31, 2023, partially offset by accretion on the carrying value of surplus notes and Ambac UK debt. See Note 1. Background and Business Description in the Notes to the Consolidated Financial Statements included in Part II, Item 8 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, for further details on the redemption of the Tier 2 Notes. VARIABLE INTEREST ENTITIES Please refer to Note 9. 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 12. 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, 2022, for information regarding variable interest entities. ACCOUNTING STANDARDS There are no new accounting standards applicable to Ambac that have been issued but not yet adopted. 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, 2022. Ambac Assurance Corporation AAC’s statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were $575 and $1,174 at June 30, 2023, respectively, as compared to $598 and $1,191 at December 31, 2022, respectively. As of June 30, 2023, statutory policyholder surplus and qualified statutory capital included $519 principal balance of surplus notes outstanding and $115 liquidation preference of preferred stock outstanding. These surplus notes (in addition to related accrued interest of $450 that is not recorded under statutory basis accounting principles); preferred stock; and all other liabilities, including insurance claims 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 driver to the net decrease in policyholder surplus was the statutory net loss of $19 for the six months ended June 30, 2023 and a contingency reserve contribution of $6, partially offset by investment valuation changes that are direct charges to surplus of $2. AAC's statutory surplus and therefore AFG's ultimate ability to realize residual value and/or dividends from AAC is sensitive to multiple factors, including: (i) loss reserve development, (ii) approval by OCI of payments on surplus notes, (iii) ongoing interest costs associated with surplus notes, (iv) swap gains and losses at AFS, the financial position of which is supported by certain guarantees and financing arrangements from AAC, (v) first time payment defaults of insured obligations, which increase statutory loss reserves, (vi) commutations of insurance policies at amounts that differ from the amount of liabilities recorded, (vii) reinsurance contract terminations at amounts that differ from net assets recorded, (viii) changes to the fair value of pooled fund and other investments carried at fair value, (ix) realized gains and losses, including losses arising from other than temporary impairments of investment securities, (x) the ultimate residual value of Ambac UK, which may be impacted by numerous factors including foreign exchange rates, and (xi) future changes to prescribed practices by the OCI. Everspan Indemnity Insurance Company Everspan Indemnity Insurance Company’s statutory policyholder surplus was $107.1 at June 30, 2023, as compared to $107.5 at December 31, 2022. The significant driver to the decrease was a net loss of $1.7 during the six months ended June 30, 2023, partially offset by capital contributions of $1.3 million. AMBAC UK FINANCIAL RESULTS UNDER UK ACCOUNTING PRINCIPLES (£ in millions) Ambac UK is required to prepare financial statements under FRS 102 "The Financial Reporting Standard applicable in the UK and Republic of Ireland." Ambac UK’s shareholder funds under UK GAAP were £477 at June 30, 2023, as compared to £468 at December 31, 2022. At June 30, 2023, the carrying value of cash and investments was £518, a increase from £508 at December 31, 2022. The increase in shareholders’ funds and cash and investments was primarily due to the continued receipt of premiums and investment gains, partially offset by foreign exchange losses, general and administrative expenses and tax payments. | Ambac Financial Group, Inc. 50 2023 Second Quarter FORM 10-Q | Ambac UK is also required to prepare financial information in accordance with the Solvency II Directive. The basis of preparation of this information is significantly different from both US GAAP and UK GAAP. Available capital resources under Solvency II were £361 at June 30, 2023, the most recently published position, of which £355 were eligible to meet solvency capital requirements. Eligible capital resources at June 30, 2023, were in comparison to regulatory capital requirements of £217. Therefore, Ambac UK was in a surplus position in terms of compliance with applicable regulatory capital requirements by £138 at June 30, 2023. Despite, Ambac UK being in an surplus capital position as of June 30, 2023, there can be no guarantee that it will be able to pay any dividends or other capital distributions to AAC in the near term. All dividends and capital distribution from Ambac UK are subject to the judgement and approval of the Prudential Regulatory Authority. NON-GAAP FINANCIAL MEASURES ($ in millions) In addition to reporting the Company’s quarterly financial results in accordance with GAAP, the Company is reporting non-GAAP financial measures: EBITDA, Adjusted Net Income and Adjusted Book Value. These amounts are derived from our consolidated financial information, but are not presented in our consolidated financial statements prepared in accordance with GAAP. We present non-GAAP supplemental financial information because we believe such information is of interest to the investment community, and that it provides greater transparency and enhanced visibility into the underlying drivers and performance of our businesses on a basis that may not be otherwise apparent on a GAAP basis. We view these non-GAAP financial measures as important indicators when assessing and evaluating our performance on a segmented and consolidated basis and they are presented to improve the comparability of our results between periods by eliminating the impact of the items that may not be representative of our core operating performance. These non-GAAP financial measures 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. Beginning January 1, 2023, Ambac replaced the non-GAAP measure Adjusted Earnings with a new non-GAAP measure Adjusted Net Income to better align with other participants in the Property & Casualty insurance industry, including insurance carriers and other peers in the insurance distribution business. We are presenting Adjusted Net Income for the current and prior periods contained within this Form 10-Q so this non-GAAP financial measure compares both periods on the same basis. The following paragraphs define each non-GAAP financial measure. A tabular reconciliation of the non-GAAP financial measure and the most comparable GAAP financial measure is also presented below. EBITDA — We define EBITDA as net income (loss) before interest expense, income taxes, depreciation and amortization of intangible assets. The following table reconciles net income (loss) to the non-GAAP measure, EBITDA on a consolidation and segment basis for all periods presented: Three Months Ended June 30, 2023 Three Months Ended June 30, 2022 Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consoli-dated Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consoli-dated Net income (loss) $ (9) $ — $ 1 $ (4) $ (13) $ 6 $ (1) $ — $ 1 $ 5 Adjustments: Interest expense 16 — — — 16 45 — — — 45 Income taxes 2 — — — 2 1 — — — 1 Depreciation — — — — — — — — — — Amortization of intangible assets 6 — 1 — 7 13 — 1 — 13 EBITDA (1) $ 14 $ — $ 2 $ (4) $ 12 $ 65 $ (1) $ 1 $ 1 $ 65 (1) EBITDA is prior to the impact of noncontrolling interests, and relates to subsidiaries where Ambac does not own 100% in the amounts, of $0 and $0 for the three months ended June 30, 2023 and 2022, respectively. These noncontrolling interests are primarily in the Insurance Distribution segment. Six Months Ended June 30, 2023 Six Months Ended June 30, 2022 Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consoli-dated Legacy Financial Guarantee Insurance Specialty Property & Casualty Insurance Insurance Distribution Corporate & Other Consoli-dated Net income (loss) $ (45) $ (1) $ 4 $ (4) $ (46) $ 12 $ (4) $ 2 $ (3) $ 8 Adjustments: Interest expense 32 — — — 32 89 — — — 89 Income taxes 5 — — — 6 1 — — — 1 Depreciation 1 — — — 1 1 — — — 1 Amortization of intangible assets 11 — 2 — 13 26 — 1 — 28 EBITDA (1) $ 5 $ (1) $ 6 $ (3) $ 7 $ 130 $ (4) $ 3 $ (3) $ 127 (1) EBITDA is prior to the impact of noncontrolling interests, and relates to subsidiaries where Ambac does not own 100% in the amounts, of $1 and $1 for the six months ended June 30, 2023 and 2022, respectively. These noncontrolling interests are primarily in the Insurance Distribution segment. | Ambac Financial Group, Inc. 51 2023 Second Quarter FORM 10-Q | Adjusted Net Income (Loss) — We define Adjusted Net Income (Loss) as net income (loss) attributable to common stockholders adjusted to reflect the following items: (i) net investment (gains) losses, including impairments; (ii) amortization of intangible assets; (iii) litigation costs, including attorneys fees and other expenses to defend litigation against the Company, excluding loss adjustment expenses; (iv) foreign exchange (gains) losses; (v) workforce change costs, which primarily include severance and other costs related to employee terminations; and (vi) net (gain) loss on extinguishment of debt. Adjusted Net Income is also adjusted for the effect of the above items on both income taxes and noncontrolling interests. The income tax effects are determined by applying the statutory tax rate in each jurisdiction that generate these adjustments. The noncontrolling interest adjustments relate to subsidiaries where Ambac does not own 100% The following table reconciles net income (loss) attributable to common stockholders to the non-GAAP measure, Adjusted net income: Three Months Ended June 30, 2023 2022 ($ in millions, except share data) $ Amount Per Share $ Amount Per Share Net income (loss) attributable to common shareholders $ (13) $ (0.29) $ 5 0.11 Adjustments: Net investment (gains) losses, including impairments 3 0.07 (7) (0.15) Intangible amortization 7 0.14 13 0.29 Litigation costs 8 0.17 3 0.07 Foreign exchange (gains) losses — — 3 0.06 Workforce change costs — — 1 0.01 Net (gain) loss on extinguishment of debt — — (57) (1.25) Pretax adjusted net income (loss) 4 $ 0.09 (39) $ (0.86) Income tax effects (1) (0.02) 1 0.02 Net (gains) attributable to noncontrolling interests — — — — Adjusted Net Income (Loss) $ 3 $ 0.07 $ (38) $ (0.84) Six Months Ended June 30, 2023 2022 ($ in millions, except share data) $ Amount Per Share $ Amount Per Share Net income (loss) attributable to common shareholders $ (47) $ (1.02) $ 7 $ 0.15 Adjustments: Net investment (gains) losses, including impairments 8 0.17 (17) (0.36) Intangible amortization 13 0.29 28 0.60 Litigation costs 16 0.36 7 0.15 Foreign exchange (gains) losses — (0.01) 4 0.08 Workforce change costs 1 0.02 — 0.01 Net (gain) loss on extinguishment of debt — — (57) (1.23) Pretax adjusted net income (loss) (9) $ (0.19) (28) $ (0.60) Income tax effects (2) (0.03) 1 0.02 Net (gains) attributable to noncontrolling interests — (0.01) — (0.01) Adjusted Net Income (Loss) $ (10) $ (0.23) $ (27) $ (0.59) 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: • 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. This adjustment is only made for financial guarantee contracts since such premiums are non-refundable. • 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”), net of income taxes. 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, tax planning strategies and other considerations, we utilized a 0% effective tax rate for non-GAAP operating adjustments to Adjusted Book. 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, 2023 December 31, 2022 ($ in millions, except share data) $ Amount Per Share $ Amount Per Share Total Ambac Financial Group, Inc. stockholders’ equity $ 1,250 $ 27.59 $ 1,252 $ 27.85 Adjustments: Insurance intangible asset (258) (5.70) (266) (5.91) Net unearned premiums and fees in excess of expected losses 164 3.61 214 4.76 Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income 67 1.47 71 1.59 Adjusted book value $ 1,222 $ 26.97 $ 1,272 $ 28.29 The decrease in Adjusted Book Value since December 31, 2022 was primarily attributable to Ambac's net loss (excluding earned | Ambac Financial Group, Inc. 52 2023 Second Quarter FORM 10-Q | premium previously included in Adjusted Book Value) and the impact of the reinsurance de-risking transaction executed during the quarter ended June 30, 2023, at AAC, partially offset by the positive effect foreign exchange rates. Item 3. Quantitative and Qualitative Disclosure About Market Risk As of June 30, 2023, there were no material changes in the market risks that the Company is exposed to since December 31, 2022.