10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

Commission file number 1-10777

Ambac Financial Group, Inc.

(Exact name of Registrant as specified in its charter)

Delaware (State of incorporation)	13-3621676 (I.R.S. employer identification no.)
One State Street Plaza New York, New York (Address of principal executive offices)	10004 (Zip code)

(212) 668-0340

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange on which registered
Common Stock, $0.01 per share	New York Stock Exchange, Inc.
5.875% Debentures, Due March 24, 2103	New York Stock Exchange, Inc.
5.95% Debentures, Due February 28, 2103	New York Stock Exchange, Inc.

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x    No ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨    No x

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer x    Accelerated filer ¨    Non-accelerated filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨    No x

The aggregate market value of voting stock held by non-affiliates of the Registrant as of the close of business on June 30, 2006 was $8,635,586,450 (based upon the closing price of the Registrant’s shares of the New York Stock Exchange on that date, which was $81.98). For purposes of this information, the outstanding shares of Common Stock which were owned by all directors and executive officers of the Registrant were deemed to be shares of Common Stock held by affiliates.

As of February 22, 2007, 102,358,610 shares of Common Stock, par value $0.01 per share, (net of 6,834,486 treasury shares) were outstanding.

Documents Incorporated By Reference

Portions of Ambac Financial Group, Inc.’s Proxy Statement for its 2007 Annual Meeting of Stockholders scheduled to be held on May 8, 2007 are incorporated by reference into the Annual Report on Form 10-K in response to Part III, Items 10, 11, 12 and 14.

TABLE OF CONTENTS

		Page
PART I
Item 1.	Business
	Introduction	1
	Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995	1
	Business Segments	2
	Employees	27
	Corporate Governance	27
Item 1A.	Risk Factors	27
Item 1B.	Unresolved Staff Comments	32
Item 2.	Properties	33
Item 3.	Legal Proceedings	33
Item 4.	Submission of Matters to a Vote of Security Holders	33
PART II
Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters	34
Item 6.	Selected Financial Data	35
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	67
Item 8.	Financial Statements and Supplementary Data	71
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	125
Item 9A.	Controls and Procedures	125
Item 9B.	Other Information	125
PART III
Item 10.	Directors and Executive Officers of the Registrant	125
Item 11.	Executive Compensation	126
Item 12.	Security Ownership of Certain Beneficial Owners and Management	126
Item 13.	Certain Relationships and Related Transactions	126
Item 14.	Principal Accountant Fees and Services	126
PART IV
Item 15.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	126
SIGNATURES		134
FINANCIAL STATEMENT SCHEDULES		S-1

Part I

Item 1. Business.

INTRODUCTION

Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose subsidiaries provide financial guarantee products and other financial services to clients in both the public and private sectors around the world. Ambac was incorporated on April 29, 1991. Ambac’s activities are divided into two business segments: (i) Financial Guarantee and (ii) Financial Services. Ambac provides financial guarantees for public and structured finance obligations through its principal operating subsidiary, Ambac Assurance Corporation. Ambac Assurance is the successor to the founding financial guarantee insurance company, which wrote the first bond insurance policy in 1971. Through its financial services subsidiaries, Ambac provides financial and investment products including investment agreements, funding conduits, interest rate, currency and total return swaps, principally to its clients of the financial guarantee business.

Ambac Assurance has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc. (“Moody’s”), in 1987, Standard & Poor’s Ratings Services (“S&P”), in 1979, and Fitch, Inc. (“Fitch”), in 1994. These ratings are an essential part of Ambac Assurance’s ability to provide credit enhancement and any reduction in these ratings could have a material adverse affect on Ambac Assurance’s ability to compete in the financial guarantee business. See “Rating Agencies” section below for further information.

As a holding company, Ambac is largely dependent on dividends from Ambac Assurance to pay dividends on its capital stock, to pay principal and interest on its indebtedness, to pay its operating expenses, to purchase its common stock in the open market and to make capital investments in its subsidiaries. Dividends from Ambac Assurance are subject to certain insurance regulatory restrictions. See “Insurance Regulatory Matters—Wisconsin Dividend Restrictions” section and “Management’s Discussion and Analysis—Liquidity and Capital Resources” located in Part II, Item 7 for further information.

Ambac’s internet address is www.ambac.com. We make available free of charge, or through the investor relations section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934.

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

In this Annual Report, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These statements may relate to our future plans and objectives, among other things. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K.

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Any or all of management’s forward-looking statements here or in other publications may turn out to be wrong and are based on current expectations and the current economic environment. Ambac’s actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among factors that could cause actual results to differ materially are: (1) changes in the economic, credit, or interest rate environment in the United States and abroad; (2) the level of activity within the national and worldwide debt markets; (3) competitive conditions and pricing levels; (4) legislative and regulatory developments; (5) changes in tax laws; (6) the policies and actions of the United States and other governments; (7) changes in capital requirements or other criteria of rating agencies; (8) changes in accounting principles or practices that may impact Ambac’s reported financial results; (9) the amount of reserves established for losses and loss expenses; (10) default of one or more of Ambac Assurance’s reinsurers; (11) market spreads and pricing on insured pooled debt obligations and other derivative products insured or issued by Ambac; (12) prepayment speeds on insured asset-backed securities and other factors that may influence the amount of installment premiums paid to Ambac Assurance; and (13) other risks and uncertainties that have not been identified at this time. Ambac is not obligated to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in Ambac’s reports to the SEC.

BUSINESS SEGMENTS

The following paragraphs describe the business operations of Ambac and its subsidiaries for its two reportable segments: Financial Guarantee and Financial Services.

Financial Guarantee

Financial guarantee represented 74%, 79% and 83% of total revenues for 2006, 2005 and 2004, respectively. The financial guarantee segment includes financial guarantee insurance and other credit enhancement products, such as credit derivatives. Financial guarantee insurance provides an unconditional and irrevocable guarantee that protects the holder of a fixed income obligation against non-payment of principal and interest when due. Essentially, Ambac Assurance or Ambac Assurance UK makes payments if the obligor responsible for making payments fails to do so. Ambac Assurance and its subsidiaries serve the global capital markets by providing financial guarantee insurance for public finance and structured finance obligations. Total net premiums earned and other credit enhancement fees from external customers, by geographic location of risk is located in Part II, Item 8 under Note 19 of Notes to Consolidated Financial Statements. Both issuers and investors benefit from financial guarantee insurance. Issuers benefit when the insurance has the effect of lowering their cost of borrowing because the insurance premium is less than the value of the spread between the yield on the insured obligation (carrying the credit rating of Ambac Assurance) and the yield of the uninsured obligation. Financial guarantee insurance also increases the marketability of obligations issued by infrequent or unknown issuers or in connection with complex financings. Investors benefit from increased liquidity in the secondary market, reduced exposure to price volatility caused by changes in the credit quality of the underlying obligor and added protection against a potential loss in the event that the obligor defaults on its obligation.

In certain floating rate insured transactions, the issuer of insured securities is party to an interest rate swap that hedges their risk to interest rates effectively creating a synthetic fixed rate obligation. In such transactions, Ambac Assurance has, from time-to-time, insured the issuer’s obligations under both the insured securities and the derivative contract.

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As an alternative to financial guarantee insurance, credit protection relating to a particular pool of assets, security or issuer can be provided through a credit derivative. Ambac Credit Products LLC, a wholly owned subsidiary of Ambac Assurance, provides credit protection in the global markets in credit derivative form. These credit derivatives, which are privately negotiated contracts, provide the counterparty with credit protection against the occurrence of a specific event such as a payment default or bankruptcy relating to an underlying obligation. Upon a credit event, Ambac Credit Products is required to either (i) make payments for the difference between the scheduled debt service payment due and the actual payment made by the issuer, (ii) make a payment equivalent to the difference between the par value and market value of the underlying obligation or (iii) purchase the underlying obligation at its par value and a loss is realized for the difference between the par and market value of the underlying obligation. Substantially all of Ambac Credit Product’s credit derivative contracts relate to senior tranches of structured finance transactions. Credit derivatives issued by Ambac Credit Products are insured by Ambac Assurance. See “Quantitative and Qualitative Disclosures About Market Risk” located in Part II, Item 7A for further information about credit derivatives.

Ambac Assurance and its subsidiaries also guarantee or provide credit protection on obligations already carrying insurance from other financial guarantors, with Ambac Assurance generally obligated to pay only upon a default by both the underlying obligor and the original financial guarantor.

In addition to the guarantees on fixed income obligations described above, Ambac Assurance, from time to time, enters into transactions that expose the company to risks which may not be correlated to credit risk, for example weather-related or other disasters, mortality or other property and casualty type risk characteristics. Ambac underwrites such risks so that a substantial level of first loss protection would have to be exhausted before Ambac would become liable in respect of such risks. Additionally, Ambac underwrites such business primarily in relation to broad indices and reference pools which embody diverse risk characteristics.

Ambac Assurance seeks to minimize the risk inherent in its financial guarantee portfolio by maintaining a diverse portfolio which spreads its risk across a number of criteria, including issue size, type of obligation, geographic area and obligor.

Ambac derives financial guarantee revenues from: (i) premiums earned from insurance contracts; (ii) net investment income; (iii) revenue from credit derivative transactions; (iv) net realized gains and losses from sales of investment securities; and (v) certain structuring and other fees. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” located in Part II, Item 7 and Note 19 of Notes to Consolidated Financial Statements located in Part II, Item 8 for further information.

Pricing:

Ambac Assurance determines premium rates on the basis of the type of transaction and its assessment of the risk it is guaranteeing. Factors considered in pricing include underlying credit ratings, term to maturity, structure of the issue and credit and market factors including security features and other credit enhancement features. Additionally, the interest rate spread between insured and uninsured obligations with characteristics similar to those of the proposed issue is considered in the pricing process as well as the cost and the projected return to Ambac Assurance.

Overall, the business environment has become more competitive with increased competition from bank funding, the uninsured market, senior/subordinate securitizations, other providers of credit

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derivatives and other triple-A rated financial guarantors. This increased competition has had an adverse impact on pricing, however this competition and credit trends such as the ones we are now experiencing are a normal part of Ambac Assurance’s business. See “Competition” section below for further information.

Financial guarantee products are sold in three principal markets: the U.S. public finance market, the U.S. structured finance and asset-backed market and the international finance market.

U. S. Public Finance Market

The U.S. public finance market includes all U.S. municipal issuance including general obligations, lease and tax-backed obligations, health care, public utilities, transportation and higher education, as well as certain infrastructure privatization transactions, such as toll road and bridge financings, public transportation financings, stadium financings, military housing and student housing. Public finance obligations are generally supported by either the taxing authority of the issuer or the issuer’s or underlying obligor’s ability to collect fees or assessments for certain projects or public services. Although Ambac Assurance guarantees the full range of Public Finance obligations, Ambac Assurance concentrates on those projects that require more structuring skills. Certain projects, which had been financed by the local or U.S. government alone, are now being financed through public-private partnerships. In these transactions, debt service on the bonds, rather than being paid solely by tax revenues or other governmental funds, is being paid from a variety of revenue sources, including revenues derived from the project itself. Examples of these transactions include toll road financings, stadium financings, student housing and military housing. The following table sets forth the volume of new issues of long-term (longer than 12 months) public finance bonds and the volume of new issues of insured long-term public finance bonds over the past ten years in the United States.

U.S. Public Finance Long-Term Market

($ in Billions)	New Money	Refundings	Total Volume	Refundings as Percentage of Total Volume	Insured Volume	Insured Bonds as Percentage of Total Volume
1997	160.3	60.2	220.5	27.3	107.5	48.8
1998	204.7	82.0	286.7	28.6	145.5	50.7
1999	189.3	38.3	227.6	16.8	105.6	46.4
2000	181.3	19.5	200.8	9.7	79.3	39.5
2001	223.5	64.7	288.2	22.4	134.4	46.6
2002	266.7	92.1	358.8	25.7	178.9	49.9
2003	288.7	95.0	383.7	24.8	190.7	49.7
2004	271.7	88.4	360.1	24.5	192.7	53.5
2005	277.6	130.7	408.3	32.0	233.0	57.1
2006	306.3	77.1	383.4	20.1	184.8	48.2

Source: Amounts are reported by The Bond Buyer. Amounts represent gross par amounts issued or insured, respectively, during such year.

Changes in volume of public finance bond issuance during this period are primarily attributable to changes in refunding activity related to the then-current interest rate environment, along with the issuers’ new money requirements. Volume since 2002 has exceeded historical levels as a result of the low interest rate environment and considerable infrastructure finance needs. Insured volume as a percentage of total volume (“insured penetration”) during 2001 through 2005 increased, largely the result of budget deficits experienced by municipalities and the corresponding flight to quality by investors. In 2006, insured penetration returned to more historical levels. In the U.S. public finance

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market, an issuer typically pays an up-front premium to Ambac Assurance at the time the policy is issued. Premiums are usually quoted as a percentage of the total amount of principal and interest that is scheduled to become due during the life of the insured bonds.

Proposed new public finance bond issues are submitted to Ambac Assurance by issuers (or their investment bankers or financial advisors) to determine their suitability for financial insurance. Public finance bond issues are sold on either a competitive or a negotiated basis. With respect to competitive issues, an issuer will publish a notice of sale soliciting bids for the purchase of a proposed issue of bonds. Potential bidders on the bonds then form syndicates. These syndicates then solicit a determination from some or all of the financial guarantors whether an issue is suitable for financial guarantee and at what premium rate and on what terms. The syndicate then determines whether to bid on the issue with a financial guarantee (and if so, with which financial guarantor) or without a financial guarantee. The issuer then generally selects the syndicate with the lowest bid. In a negotiated offering, the issuer has already selected an investment bank and that investment bank solicits premium quotes and terms from the financial guarantors.

Ambac Assurance also provides financial guarantees on public finance bonds outstanding in the secondary market that are typically purchased by an institution to hedge or facilitate the sale of bonds in its portfolio or inventory. The financial guarantee generally increases the sale price of bonds (typically by an amount greater than the cost of the policy) and affords a wider secondary market and therefore greater marketability to a given issue of previously issued bonds. As is the case with new issues, the premium is generally payable in full at the time of policy issuance. Ambac Assurance employs the same underwriting standards on secondary market issues that it does on new public finance issues.

Ambac Assurance guaranteed gross par of $43.1 billion, $53.8 billion and $44.6 billion in 2006, 2005 and 2004, respectively, in the U.S. public finance market. Public Finance new business guaranteed represented 35%, 43% and 38% of total gross par guaranteed for 2006, 2005 and 2004, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” located in Part II, Item 7 for further information.

The table below shows our ten largest Public Finance exposures, by repayment source, as a percentage of total Financial Guarantee net par outstanding at December 31, 2006:

(Dollars in Millions)	Ambac Ratings (1)	Net Par Outstanding		% of Total Net Par Outstanding
California State—GO	A	$	2,464	0.5	%
Washington State—GO	AA		2,092	0.4	%
MTA, NY, Transportation Revenue (Farebox)	A		1,724	0.3	%
California Department of Water Resources, Power Supply	A		1,694	0.3	%
NYS Thruway Authority, Highway & Bridge Revenue	AA-		1,660	0.3	%
New Jersey Turnpike Authority Revenue	A		1,380	0.3	%
New Jersey Transportation Trust Fund Authority – Transportation System	A+		1,370	0.3	%
New York City, NY – GO	A+		1,291	0.2	%
Connecticut Housing Authority, Housing Mortgage Finance Program	AAA		1,259	0.2	%
Citizens Property Insurance Corporation, FL	A-		1,213	0.2	%
Total		$	16,147	3.0	%

(1) Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. 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. Ambac Assurance, or one of its affiliates, has insured the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.

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U.S. Structured Finance and Asset-backed Market

Financial guarantees of securities in the U.S. structured finance and asset-backed market are typically issued in connection with transactions in which the securities being issued are secured by or payable from a specific pool of financial or cash flow generating assets. This pool of assets has an identifiable cash flow or market value and is generally held by a special purpose entity. Structured finance and asset-backed obligations insured by Ambac Assurance generally have the benefit of over-collateralization and/or other forms of credit enhancement to mitigate credit risks associated with the related assets. These forms of credit enhancement are designed to absorb the expected losses in these transactions.

Structured finance obligations include the securitization of a variety of asset types such as mortgages, home equity loans, auto loans, student loans, credit card debt, leases, operating assets and pooled debt obligations originated in the United States (“Structured Finance”). Included within the operating asset sector are securitizations of aircraft, rental car, shipping container and rail cars fleets, as well as film rights, franchise fees, pharmaceutical royalties, and intellectual property. Exposures to Enhanced Equipment Trust Certificates, included in operating assets, were $1.5 billion at December 31, 2006. Enhanced Equipment Trust Certificates are secured financings used by the airline industry to finance aircraft. The financings are tranched to create a priority of interests in the aircraft collateral.

Structured finance includes credit enhancement for asset-backed commercial paper conduits (“conduits”). Conduits are used by issuers to efficiently fund assets in the commercial paper market. Typically sponsored by financial institutions, the conduits usually purchase financial assets and asset-backed securities, and issue commercial paper to fund the purchase of the assets. The typical conduit structure provides Ambac with significant credit protection prior to a claim on Ambac’s insurance policy. A conduit requires program-wide credit enhancement as one of several elements needed to support the conduit’s credit rating for the structure, of which Ambac provides a senior portion.

Structured finance also includes the credit enhancement of pooled debt obligations. These transactions involve the securitization of a diverse portfolio of corporate bonds and loan obligations and asset-backed securities (the “Securitized Assets”). The transaction structure provides certain financial protection to Ambac Assurance. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread. In the case of over-collateralization (i.e., the principal amount of the Securitized Assets exceeds the principal amount of the structured finance obligations guaranteed by Ambac Assurance), the structure allows the transaction to experience defaults among the Securitized Assets before a default is experienced on the structured finance obligations that have been guaranteed by Ambac Assurance. In the case of first loss, the financial guarantee insurance policy only covers a senior layer of losses. A subordinated layer of losses is either retained by the seller or sold off in the form of equity and mezzanine debt to other investors. In the case of excess spread, the Securitized Assets generate cash flow in the form of interest that is in excess of the interest payments on the related debt.

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Unlike the public finance market in which a substantial portion of the deals is bid competitively by the financial guarantors, the structured and asset-backed market is often a negotiated one. The financial guarantor will work directly with the investment bank or client to create an acceptable structure once having been awarded the business. Ambac participates in these markets through the issuance of financial guarantee insurance policies and credit default swaps.

The U.S. structured finance and asset-backed market in which Ambac Assurance provides financial guarantees is broad and varied, comprising public issues, private placements and bank loans. The increasing array of classes of assets securitized or guaranteed, and the ongoing rapid changes to the market, makes estimating the aggregate size of the market that we participate in difficult.

Premiums for structured finance and asset-backed policies are typically based on a percentage of principal insured. Structured finance and asset-backed premiums can be collected in a single payment at policy inception date or collected periodically (e.g., monthly, quarterly or annually) from the cash flow generated by the underlying assets.

Ambac Assurance guaranteed gross par of $62.4 billion, $58.8 billion and $53.4 billion in 2006, 2005 and 2004, respectively, in the U.S. structured finance and asset-backed market. U. S. Structured Finance and asset-backed new business guaranteed represents 50%, 47% and 45% of total gross par guaranteed for 2006, 2005 and 2004, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” located in Part II, Item 7 for further discussion.

The table below shows our ten largest Structured Finance and asset-backed transactions, as a percentage of total financial guarantee net par outstanding at December 31, 2006:

($ in Millions)	Ambac Rating(1)	Net Par Outstanding		% of Total Net Par Outstanding
Private Structured Finance Pool	AA +	$	2,026	0.4	%
Capital One Auto Finance Trust, 2006-A	BBB		1,995	0.4	%
Iowa Student Loan Liquidity Corporation Revenue Bonds	A		1,900	0.4	%
Private Structured Finance Pool	AAA		1,875	0.4	%
Michigan Higher Education Student Loan Authority	AA		1,782	0.3	%
Hertz Vehicle Financing, LLC	BBB		1,744	0.3	%
Private Structured Finance Pool	AAA		1,676	0.3	%
Private Structured Finance Pool	AAA		1,570	0.3	%
Vermont Student Assistance Corporation Revenue Bonds	A		1,531	0.3	%
Private Structured Finance Pool	AAA		1,524	0.3	%
Total		$	17,623	3.4	%

(1) Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. 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. Ambac Assurance, or one of its affiliates, has insured the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.

International Finance Market

Outside of the United States, structured finance and asset-backed issuers, utilities, sub-sovereigns, banks and investors have used financial guarantee products, particularly in markets throughout

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Western Europe. In the United Kingdom, ongoing privatization efforts have shifted certain risks associated with the development or operation of infrastructure projects from the government to market participants, thus prompting sponsors to secure long term financing and investors in such projects to seek the security of financial guarantee products. These privatization efforts are currently being initiated in most other European countries and Australia as well.

While the principles of securitization have been increasingly applied in overseas markets, development in particular countries has varied as a result of the relative sophistication of the local capital markets, level of bank disintermediation and the impact of legal and financial regulatory requirements. It is anticipated that securitization will continue to expand internationally, albeit at varying rates in each country. Ambac Assurance UK Limited, insures a wide array of obligations in the international markets including infrastructure financings, asset-securitizations, pooled debt obligations, utility obligations, whole company securitizations (e.g. securitizations of substantially all of the operating assets of a corporation) and other obligations.

Ambac Assurance’s strategy in the international markets is to strengthen its franchise in developed markets by focusing on high quality infrastructure, structured finance, securitization, and utility finance transactions, and in emerging markets by focusing on future flow transactions from top tier issuers (structured transactions secured by U.S. Dollar and Euro cash flows generated from exports or payment remittances) and pooled debt obligations.

Ambac UK, which is authorized and regulated in the United Kingdom to provide certain classes of general financial guarantees (and is also authorized to conduct business throughout much of the European Union), has been Ambac Assurance’s primary vehicle for directly issuing financial guarantee policies in the United Kingdom and the European Union. In February 2005, Ambac UK established a branch office in Milan, Italy. Ambac UK has entered into net worth maintenance and reinsurance agreements with Ambac Assurance, which support its triple-A ratings.

Ambac Assurance is party to an alliance in Japan with Sompo Japan Insurance Inc. (“Sompo Japan”), one of the largest property and casualty insurance companies in Japan. Although the development of the Japanese securitization market has been slow, we believe that this alliance is competitively positioned for future growth.

European securitization issuance achieved record levels in 2006. This was driven by strong economic growth, improved employment and continued housing market strength. The residential mortgage-backed, collateralized debt obligations and commercial mortgage-backed sectors represented more than 85% and 71% of total issuance in 2006 and 2005, respectively. Tight credit spreads during 2006 continued to impact the volume available for insurance by Ambac. Accordingly, while active in other sectors, Ambac did not underwrite any mortgage-backed transactions in 2006. The following table sets forth the volume of new issues European securitizations:

(€ in Billions)	Total Volume
2000	78.2
2001	152.6
2002	157.7
2003	217.3
2004	243.5
2005	327.0
2006	458.9

Source: Amounts are reported by the ESF Securitization Data Report

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Premiums for international finance policies are generally based on a percentage of principal insured. The timing of the collection of international finance premiums varies among individual transactions; some are collected in a single payment at policy inception date and others are collected periodically (e.g., monthly, quarterly or annually).

Ambac Assurance guaranteed gross par of $19.0 billion, $12.7 billion and $20.1 billion in 2006, 2005 and 2004, respectively, in the international market. International Finance new business guaranteed represented 15%, 10% and 17% of total gross par guaranteed for 2006, 2005 and 2004, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” located in Part II, Item 7 for further discussion.

The table below shows our ten largest International Finance transactions as a percentage of total financial guarantee net par outstanding at December 31, 2006:

($ in Millions)	Ambac Rating(1)	Net Par Outstanding		% of Total Net Par Outstanding
Synthetic CDO-IG Corporate Pool	AAA	$	2,695	0.5	%
Mitchells & Butlers Finance plc-UK Pub Securitisation	A +		2,547	0.5	%
Telereal Securitisation plc	AA –		2,087	0.4	%
Synthetic CDO-IG Corporate Pool	AAA		1,781	0.3	%
Synthetic CDO-IG Corporate Pool	AAA		1,577	0.3	%
RMAC Mortgage Services Limited 2004-NSP2	A –		1,186	0.2	%
Synthetic RMBS	AAA		1,143	0.2	%
Synthetic RMBS	AAA		1,141	0.2	%
Punch Taverns Finance plc-UK Pub Securitisation	A		1,123	0.2	%
Synthetic RMBS	AAA		1,069	0.2	%
Total		$	16,349	3.0	%

(1) Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. 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. Ambac Assurance, or one of its affiliates, has insured the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.

Risk Management

Ambac has a Portfolio Risk Management Committee (“PRMC”) which has established various procedures and controls to monitor and manage credit risk. The PRMC consists of senior risk management professionals and senior management of Ambac. Its purview is enterprise-wide and its focus is on credit risk limits and measurement, concentration and correlation of risk and the attribution of economic and regulatory capital in a portfolio context.

Ambac has a Transaction Standards Committee which evaluates the suitability of transactions and products for Ambac participation with particular emphasis on potential legal, accounting, regulatory and/or reputation risks.

Underwriting guidelines, policies and procedures have been developed by Ambac Assurance’s management with the intent that Ambac Assurance guarantees only those obligations which, in the

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opinion of Ambac Assurance underwriting officers, are of investment grade quality with a remote risk of loss. However, losses may occur and it is Ambac Assurance’s policy to provide for loss reserves on non-derivative insurance policies that are adequate to cover probable and estimable losses. For derivative insurance policies and structured credit derivatives, changes in fair value are reflected currently in net income. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 2 and Note 7 of Notes to Consolidated Financial Statements, located in Part II, Items 7 and 8, respectively, for further information.

The underwriting process involves review of structural, legal, political and credit issues, including compliance with current Ambac Assurance underwriting standards. These standards are reviewed periodically by management. Additionally, the underwriting process often entails on-site due diligence covering the parties to the transaction, such as the issuer, originator, servicer or manager.

The decision to guarantee an issue is based upon such credit factors as the issuer’s ability to repay the bonds, the bond’s security features and structure, rather than upon an actuarial prediction of the likelihood that the issuer will default on the underlying debt obligation.

Members of Ambac Assurance’s underwriting staff review all requests for guarantees. The underwriting process is designed to screen issues and begins with a credit analysis by the primary analyst assigned to the issue. The credit is then reviewed within the primary analyst’s underwriting group. At a minimum, the primary analyst’s recommendation to qualify or reject an issue must be approved by a concurring analyst and a credit officer. The number of additional approvals required for a particular credit depends in part on Ambac Assurance’s aggregate exposure to the credit. In some cases, the complexity of the credit or whether it is a new asset type are determining factors in the approval/review process. Ambac Assurance has three established credit committees comprised of senior credit officers, credit and market risk managers and attorneys. All large, complex or new types of credits recommended by the underwriting group must be formally presented to the credit committee for approval. For certain issues, the primary analyst’s recommendation must be approved by a concurring analyst and credit officer and need not be formally presented to the credit committee for approval.

Ambac Assurance assigns internal ratings to individual exposures as part of the underwriting process and at surveillance reviews. These internal ratings, which represent Ambac Assurance’s independent judgments, are based upon underlying credit parameters similar to those used by rating agencies.

Public Finance Underwriting:

In addition to general underwriting standards, asset classes, and bond types within those asset classes, have more specific underwriting criteria. For example, the critical risk factors for public finance credits will include the credit quality of the issuer, type of issue, the repayment source, the type of security pledged, the presence of restrictive covenants, and the bond’s maturity. Each bond issue is evaluated in accordance with, and the final premium rate is a function of, the particular factors as they relate to such issue.

Underwriting criteria that are applied for each bond type reflect the differences in, for example, economic and social factors, debt management, project essentiality, financial management, legal and administrative factors, revenue sources and security features.

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Structured Finance Underwriting:

Structured finance and asset-backed obligations generally entail three forms of risks: (i) asset risk, which relates to the amount and quality of the underlying assets; (ii) structural risk, which relates to the extent to which the transaction’s legal structure and credit support provides protection from loss; and (iii) servicer risk, which is the risk that poor performance at the servicer or manager level contributes to a decline in cash flow available to the transaction. Ambac Assurance addresses these risks through its credit underwriting guidelines, standards and procedures.

In general, the amount and quality of asset coverage required is determined by the historical performance of the underlying asset type or the transaction’s specific underlying assets. The future performance or value of the underlying pool of assets will generally determine whether the amount of over-collateralization or other credit enhancement ultimately is sufficient to protect investors, and therefore the guarantor, against adverse asset performance. The ability of the servicer or manager to properly service and/or manage the underlying assets often is a factor in determining future asset performance.

Structured and asset-backed securities are usually designed to protect the investors, and therefore the guarantor, from the bankruptcy or insolvency of the entity that originated the underlying assets as well as from the bankruptcy or insolvency of the servicer of those assets. The servicer of the assets is typically responsible for collecting cash payments on the underlying assets and forwarding such payments, net of servicing fees, to a trustee for the benefit of the issuer. Other issues include whether the sale of the assets by the originator to the issuer would be upheld in the event of the bankruptcy or insolvency of the originator and whether the servicer of the assets may be permitted or stayed from remitting to investors cash collections held by it or received by it after the servicer or the originator becomes subject to bankruptcy or insolvency proceedings.

International Finance Underwriting:

In the international markets, Ambac Assurance seeks to guarantee transactions of the same high credit standards it applies in its U.S. business. However, an understanding of the unique risks related to the particular country and region that could impact the credit of the issuer is necessary. These risks include legal and political environments, capital market dynamics, foreign exchange issues, and the degree of governmental support. Ambac Assurance monitors these risks carefully and addresses them through its credit underwriting guidelines, (which include country limits), underwriting procedures and transaction documentation.

Geographically, the international markets that Ambac Assurance focuses on have been the United Kingdom, continental Europe, Australia, Japan and certain emerging market countries. In addition, Ambac Assurance has guaranteed transactions in which the geographic risk is spread over multiple countries. The types of international obligations guaranteed have primarily been pooled debt obligations, utilities, mortgage and asset-backed securities, special revenue and infrastructure obligations, whole business securitizations and future flow transactions. Management believes that the risk associated with its international book of business is similar to its U.S. book of business. In fact, international pooled debt obligations may include significant components of U.S. exposure.

Surveillance and Remediation:

The Surveillance Group is responsible for monitoring outstanding financial guarantee exposures, including credit derivatives. The group’s monitoring activities are designed to detect deterioration in

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credit quality or changes in the economic, regulatory or political environment which could adversely impact the portfolio. Active surveillance enables Ambac Assurance’s Surveillance Group to track single credit migration and industry credit trends. Surveillance analysts also monitor the financial guarantee portfolio for concentrations of risk by (i) specific bond types; (ii) geographic location; and (iii) size of issue.

Surveillance analysts review, on a regular and ad hoc basis, credits in the book of business. Risk-adjusted surveillance strategies have been developed for each transaction type. Review periods and scope of review vary by bond type based upon each bond type’s inherent risk profile. The focus of the surveillance review is to assess performance, identify credit trends and recommend appropriate classifications, ratings and review periods. If a problem is detected, the group focuses on loss mitigation by recommending appropriate action and working with the issuer, trustee, bond counsel, servicer and other interested parties in an attempt to remediate the problem and minimize Ambac Assurance’s exposure to potential loss. In some cases, the Surveillance Group will engage attorneys and other outside consultants with appropriate expertise in the targeted loss mitigation strategy to assist management in examining the underlying collateral or providing industry specific advice. Those credits that are either in default or have developed problems that eventually may lead to a claim or loss are tracked closely by the appropriate surveillance team and reported to management and Ambac’s Board of Directors by preparation of an adversely classified credit listing. Relevant information, along with the plan for corrective actions and a reassessment of the credit’s rating and credit classification, is reviewed with senior management in regular adversely classified credit meetings. Internal and/or external counsel generally reviews the documents underlying any problem credit and if applicable, an analysis is prepared outlining Ambac Assurance’s rights and potential remedies, the duties of all parties involved and recommendations for corrective actions. Ambac Assurance also meets with relevant parties to the transaction as necessary. In many instances, Ambac Assurance, under the terms of the documents governing the underlying obligation, has the ability, among other things, to direct that audits be performed with respect to servicer and trustee contractual responsibilities.

The rating agencies also review the credits underlying Ambac Assurance’s financial guarantees and, in most cases, advise Ambac Assurance of the credit rating each transaction would receive if it were not insured.

Surveillance for collateral dependent transactions focuses on review of the asset and servicer performance as well as transaction cash flows. In connection with our financial guarantee, Ambac will receive periodic reporting from the issuer, servicer (if applicable) and the trustee to assist in this review.

Ambac Assurance manages servicer execution risk for its structured finance exposures in several ways. In connection with the initial decision to guarantee, Ambac Assurance analyzes the capitalization and credit quality, the experience and financial strength of the servicer of the underlying assets. Thereafter, Ambac Assurance monitors the performance of transaction servicers through a combination of (i) on-site servicer reviews; (ii) annual compliance certificates received from servicer management; (iii) independent rating agency information and (iv) a review of servicer financial information. On-site servicer reviews typically include a review of the collection, default management and quality control processes. Where appropriate, a third-party, such as an independent audit firm, may perform the review. In addition, Ambac Assurance may require a back-up servicer or require “term-to-term” servicing which provides for limited, renewable servicing terms in order to provide greater flexibility regarding the servicing arrangements of a particular transaction.

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A significant portion of Ambac Assurance’s structured finance exposures relates to the mortgage-backed and home equity loan market and as such, Ambac Assurance seeks to work with high quality, well-capitalized issuers and servicers. The issuers typically originate or purchase residential mortgages, home equity loans or home equity lines of credit, which are in turn bundled into pools which are sold by the issuers in the form of asset-backed securities. The servicer administers the underlying loans in the pools and may or may not be affiliated with the loans’ originators or the issuer.

The following table presents the top five servicers by net par outstanding, for global structured finance exposures:

($ in Millions)	Asset Class	Net Par Outstanding
Servicer:
Countrywide Home Loans.	Mortgage-backed	$	16,184
Nelnet	Student loans		4,588
PHEAA	Student loans		4,386
RFC—Homecomings Financial	Mortgage-backed		4,355
Chevy Chase Bank, F.S.B.	Mortgage-backed		3,439

Financial Guarantees in Force

Ambac Assurance underwrites and prices financial guarantees on the assumption that the guarantee will remain in force until maturity of the underlying bonds. Ambac Assurance estimated that the average life of its guarantees on par in force at December 31, 2006 is 13 years. The 13 year average life is determined by applying a weighted average calculation, using the remaining years to expected maturity of each guaranteed bond, and weighting them on the basis of the remaining net par guaranteed. No assumptions are made for future refundings of guaranteed issues.

Ambac Assurance seeks to maintain a diversified financial guarantee portfolio designed to spread its risk based on a variety of criteria, including issue size, type of bond, geographic area and issuer.

As of December 31, 2006, the total net par amount of guaranteed bonds outstanding was $519.0 billion. See Note 16 of Notes to Consolidated Financial Statements, located in Part II, Item 8 for further information.

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Types of Bonds

The table below shows the distribution by bond type of Ambac Assurance’s guaranteed portfolio as of December 31, 2006.

Guaranteed Portfolio by Bond Type

as of December 31, 2006 ⁽¹⁾

Bond Type	Net Par Amount Outstanding		% of Total Net Par Amount Outstanding
($ In Millions)
Public Finance:
Lease and tax-backed revenue	$	89,042	17	%
General obligation		62,834	12
Utility revenue		38,313	8
Health care revenue		27,849	6
Transportation revenue		24,979	5
Higher education		22,068	4
Housing revenue		10,996	2
Other		6,181	1
Total Public Finance		282,262	55
Structured Finance:
Mortgage-backed and home equity		46,239	9
Pooled debt obligations		40,568	8
Asset-backed and conduits		34,815	7
Student loan		18,404	3
Investor-owned utilities		17,345	3
Other		5,212	1
Total Structured Finance		162,583	31
Total Domestic		444,845	86
International Finance (2):
Pooled debt obligations		19,978	4
Asset-backed and conduits		17,863	4
Mortgage-backed and home equity		11,951	2
Investor-owned and public utilities		10,531	2
Sovereign/sub-sovereign		6,344	1
Transportation		6,303	1
Other		1,228	—
Total International Finance		74,198	14
Grand Total	$	519,043	100	%

(1) Includes $55,460 of credit derivatives.

(2) International Finance transactions includes significant components of domestic exposure.

Issue Size

Ambac Assurance seeks a broad coverage of the market by guaranteeing small and large issues alike. Ambac Assurance’s financial guarantee exposure in the U.S. public finance market reflects the

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historical emphasis on issues guaranteed with an original par amount of less than $25 million. However, U.S. structured finance and international finance transactions generally involve larger deals. The following table sets forth the distribution of Ambac Assurance’s guaranteed portfolio as of December 31, 2006, with respect to the original size of each guaranteed issue:

Par Amount Per Issue

as of December 31, 2006

Original Par Amount	Number of Issues	% of Total Number of Issues		Net Par Amount Outstanding		% of Total Net Par Amount Outstanding
				($ in Millions	)
Less than $10 million	8,590	52	%	$31,033		6	%
$10-25 million	3,332	20		41,124		8
$25-50 million	1,723	11		48,744		9
Greater than $50 million	2,777	17		398,142		77
	16,422	100	%	$519,043		100	%

Geographic Area

Ambac Assurance and its subsidiary, Ambac UK, are licensed to write business in the U.S. and abroad. The following table sets forth the geographic distribution of Ambac Assurance’s insured exposure as of December 31, 2006:

Geographic Area	Net Par Amount Outstanding		% of Total Net Par Amount Outstanding
($ In Millions)
Domestic:
California	$	54,829	11	%
New York		34,232	6
Florida		24,225	5
Texas		18,837	4
Pennsylvania		13,973	3
New Jersey		13,445	2
Illinois		12,898	2
Massachusetts		10,231	2
Ohio		8,630	2
Colorado		7,635	1
Mortgage and asset-backed		81,054	16
Other states		164,856	32
Total Domestic		444,845	86
International:
United Kingdom		27,253	5
Australia		6,126	1
Germany		5,852	1
Japan		4,391	1
Italy		2,167	—
Internationally diversified		19,180	4
Other international		9,229	2
Total International		74,198	14
Grand Total	$	519,043	100	%

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Mortgage and asset-backed obligations include guarantees with multiple locations of risk within the United States. Internationally diversified is primarily made up of pooled debt obligations which include significant components of domestic exposure.

The table below shows the distribution by currency of Ambac Assurance’s guaranteed portfolio as of December 31, 2006:

Currency	Net Par Amount Outstanding in Base Currency	Net Par Amount Outstanding in U.S. Dollars
(Amounts in Millions)
U.S. Dollars	463,172	$	463,172
British Pounds	12,558		24,583
Euros	17,298		22,826
Australian Dollars	7,266		5,732
Japanese Yen	187,145		1,572
Other	1,863		1,158
Total		$	519,043

Single Risk

Ambac Assurance has adopted underwriting and exposure management policies designed to limit the net guarantees in force for any one credit. In addition, Ambac Assurance uses reinsurance to limit net exposure to any one credit. The highest single insured risk represented 0.5% of the aggregate net par outstanding at December 31, 2006. Ambac Assurance is also subject to certain regulatory limits and rating agency guidelines on exposure to a single credit. See “Insurance Regulatory Matters” and “Rating Agencies,” sections.

Competition

The financial guarantee business is highly competitive. Ambac Assurance faces competition from both other financial guarantors and alternative forms of credit enhancement. Accordingly, each transaction Ambac proposes to guarantee may compete against an alternative execution, e.g. credit derivatives, letters of credit or structures that do not employ third-party credit enhancement, including senior/subordinated structures. Financial guarantee insurance and other forms of credit enhancement also compete in nearly all instances with the issuer’s alternative of foregoing credit enhancement and paying a higher interest rate. If the interest savings from insurance or another form of credit enhancement are not greater than the cost of such credit enhancement, or if the issuer is unwilling to accept the insurer’s terms and conditions for insurance, the issuer will generally choose to issue bonds without credit enhancement. Credit spreads are a significant factor in the issuer’s determination of whether or not to seek credit enhancement. Credit spreads represent the difference in interest cost for issuers between their projected or actual borrowing rate compared to a benchmark rate (such as U.S. Treasuries). As an issuer’s credit rating rises or as credit spreads become compressed (e.g. due to increased amounts of investment capital in the markets), the likelihood that the issuer will choose to issue bonds without credit enhancement increases.

The overall business environment has become more competitive, with increased competition from bank funding, the uninsured market, senior/subordinated securitizations and other triple-A-rated

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financial guarantors. This increased competition has had an adverse impact on pricing; however this competition and credit trends such as the ones we are currently experiencing are a normal part of Ambac Assurance’s business.

Ambac Assurance’s principal competitors in the market for financial guarantees are three other triple-A financial strength rated monoline insurance companies, Financial Guaranty Insurance Company (“FGIC”), Financial Security Assurance Inc. (“FSA Guarantee”) and MBIA Insurance Corporation (“MBIA”). Security Capital Assurance Ltd (“SCA”), Assured Guaranty and CIFG, are also triple-A financial strength rated insurance companies, and while generally not strong competitors in the broad market, they have been strong in certain sectors of the market. In addition, banks, smaller and lower rated financial guarantee insurance companies, multiline insurers and reinsurers represent additional participants in the market.

The principal competitive factors among the financial guarantors are: (i) premium rates; (ii) conditions precedent to the issuance of a policy related to the structure and security features of a proposed bond issue; (iii) the financial strength of the guarantor; and (iv) the quality of service provided to issuers, investors and other clients of the issuer. With respect to each of these competitive factors, Ambac Assurance believes it is on at least equal footing with each of its principal competitors.

In order to enter the financial guarantee market certain requirements must be met, most restrictive of which is that a significant minimum amount of capital is required of a financial guarantor in order to obtain triple-A financial strength ratings by the rating agencies. These capital requirements may deter other companies from entering the market. However, there can be no assurance that these capital requirements will deter potential competitors from entering the business. In addition to sufficient capital the rating agencies have increasingly focused on the viability of the business model of potential entrants. Additionally, the market may increasingly accept guarantees by double–A or lower rated insurers, who have less stringent capital requirements. Under New York law, a monoline financial guarantee insurer must have at least $75 million of paid-in capital and surplus and maintain thereafter at least $65 million of policyholders’ surplus. A similar law in California imposes a $100 million minimum capital and surplus requirement, with a maintenance requirement thereafter of $75 million.

We also face intense competition in attracting and retaining qualified employees. Our ability to continue to compete effectively in our business will depend upon our ability to attract employees and retain and motivate our existing employees.

Reinsurance

Ambac Assurance uses reinsurance to diversify risk, increase underwriting capacity, manage capital needs, stabilize shareholder returns and strengthen financial ratios. Ambac Assurance has treaty and facultative reinsurance agreements with reinsurers that allow Ambac Assurance to reduce its large risks, to manage its portfolio of insurance by bond type and geographic distribution, and to provide additional capacity for frequent bond issuers. Ambac Assurance’s current reinsurance program includes a surplus share treaty that allows Ambac Assurance to secure reinsurance on most insured transactions. Treaties provide coverage for the full term of the policies reinsured during the annual treaty period. Additionally, Ambac Assurance utilizes facultative reinsurance arrangements, when needed, for large transactions or if reinsurance is needed beyond capacity provided by the surplus share treaty. For both the treaty and facultative reinsurance agreements, upon the financial deterioration of the reinsurer and the occurrence of certain other events, Ambac Assurance has the right to recapture the business

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reinsured. For exposures reinsured, Ambac Assurance withholds a ceding commission to defray its underwriting and operating expenses. The largest reinsurer accounted for 1.8% of gross par outstanding at December 31, 2006.

The following table shows the distribution by bond type of Ambac Assurance’s ceded guaranteed portfolio at December 31, 2006:

Ceded Guaranteed Portfolio by Bond Type

as of December 31, 2006

Bond Type	Ceded Par Amount Outstanding		% of Gross Par Ceded
($ In Millions)
Public Finance:
Lease and tax-backed revenue.	$	6,132	6.4	%
General obligation		2,276	3.5
Utility revenue		2,907	7.1
Health care revenue		6,440	18.8
Transportation revenue		2,846	10.2
Higher education		1,344	5.7
Housing revenue		367	3.2
Other		173	2.7
Total Public Finance		22,485	7.4
Structured Finance:
Mortgage-backed and home equity		2,109	4.4
Pooled debt obligations		518	1.3
Asset-backed and conduits		5,058	12.7
Student loan		990	5.1
Investor-owned utilities		2,846	14.1
Other		1,734	25.0
Total Structured Finance		13,255	7.5
Total Domestic		35,740	7.4
International Finance:
Pooled debt obligations		644	3.1
Asset-backed and conduits		3,090	14.7
Mortgage-backed and home equity		260	2.1
Investor-owned and public utilities		4,856	31.6
Sovereign/sub-sovereign		1,932	23.3
Transportation		1,475	19.0
Other		538	30.5
Total International Finance		12,795	14.7
Grand Total	$	48,535	8.6	%

As a primary financial guarantor, Ambac Assurance is required to honor its obligations to its policyholders whether or not its reinsurers perform their obligations under the various reinsurance agreements with Ambac Assurance. To minimize its exposure to significant losses from reinsurer insolvencies, Ambac Assurance (i) monitors the financial condition of its reinsurers, (ii) is entitled to receive collateral from its reinsurance counterparty in certain reinsurance contracts, and (iii) has certain

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cancellation rights that can be exercised by Ambac Assurance in the event of a rating downgrade of a reinsurer. For the purposes of determining the financial strength of Ambac Assurance, the rating agencies allow Ambac Assurance “credit” for reinsurance based on the reinsurer’s financial strength ratings. For Ambac Assurance, rated AAA by S&P, 100% credit is allowed for AAA reinsurance and 65% to 70% credit is allowed for AA reinsurance. Ambac Assurance’s current primary reinsurers are Assured Guaranty Corporation, Blue Point Re Ltd., FSA Guarantee, MBIA, Radian Asset Assurance Inc., Ram Reinsurance Company, Ltd., Swiss Reinsurance Company and Sompo Japan. See financial strength ratings of reinsurers located in the Risk Management section of Quantitative and Qualitative Disclosures about Market Risk located in Part II, Item 7A.

Rating Agencies

Moody’s, S&P, and Fitch periodically review Ambac Assurance’s business and financial condition, focusing on underwriting policies and procedures and the quality of the obligations insured. The rating agencies generally publish their ratings and supporting analyses. Each rating agency performs periodic assessments of the credits insured by Ambac Assurance, as well as the reinsurers and other providers of capital support to Ambac Assurance, to confirm that Ambac Assurance continues to satisfy such rating agency’s capital adequacy criteria necessary to maintain Ambac Assurance’s triple-A rating. Ambac Assurance’s ability to compete with other triple-A rated financial guarantors, and its results of operations and financial condition, would be materially adversely affected by any reduction in its ratings.

Financial factors considered by the rating agencies in assessing capital adequacy include:

· capital charges or other assessments of credit risks for Ambac Assurance’s insured portfolio;

· the quality of Ambac Assurance’s investment portfolio;

· the credit quality of Ambac Assurance’s reinsurers;

· credit lines and other capital support arrangements;

· premium revenues expected to be generated from outstanding policies;

· anticipated future new business originations; and

· future losses under rating agency stress scenarios.

Ambac Assurance’s ratings have been periodically affirmed by each of the rating agencies and have never been revised downward or put on credit watch or review for a possible downgrade. Moody’s, S&P, and Fitch were last reaffirmed in 2006. A rating by Moody’s, S&P, or Fitch is not a “market rating” or a recommendation to buy, hold or sell any security.

Insurance Regulatory Matters

General Law

United States of America:

Ambac Assurance is licensed to transact financial guarantee and surety business as an insurance company in all 50 states, the District of Columbia, the Commonwealth of Puerto Rico, the territory of

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Guam and the U.S. Virgin Islands. Ambac Assurance is subject to the insurance laws and regulations of the State of Wisconsin (the “Wisconsin Insurance Laws”), its state of incorporation, and the insurance laws and regulations of other states in which it is licensed to transact business. These laws and regulations, as well as the level of supervisory authority that may be exercised by the various state insurance departments, vary by jurisdiction. They generally require financial guarantors to maintain minimum standards of business conduct and solvency, meet certain financial tests, and file certain reports with regulatory authorities, including information concerning their capital structure, ownership and financial condition. They generally require prior approval of certain changes in control of domestic financial guarantors and their direct and indirect parents and the payment of certain dividends and distributions. In addition, these laws and regulations require approval of certain inter-corporate transfers of assets and certain transactions between financial guarantors and their direct and indirect parents and affiliates. They generally require that all such transactions have terms no less favorable than terms that would result from transactions between parties negotiating at arm’s length. Ambac Assurance is required to file quarterly and annual statutory financial statements with the National Association of Insurance Commissioners (“NAIC”), and if required, each jurisdiction in which it is licensed. It is subject to single and aggregate risk limits and other statutory restrictions concerning the types and quality of investments and the filing and use of policy forms and premium rates. Additionally, Ambac Assurance’s accounts and operations are subject to periodic examination by the Office of the Commissioner of Insurance of the State of Wisconsin (the “Wisconsin Commissioner”) and other state insurance regulatory authorities. See Note 18 of Notes to Consolidated Financial Statements located in Part II, Item 8 for further information.

United Kingdom:

Ambac UK is licensed to transact credit, suretyship and financial guarantee insurance in the United Kingdom and to offer those services in fifteen other European Union (“EU”) countries. EU legislation allows Ambac UK to conduct business pursuant to its license in EU states other than the United Kingdom through a “passporting” arrangement, which eliminates the necessity of additional licensing or authorization in those other EU jurisdictions.

Ambac Credit Products Limited, also an Ambac Assurance wholly-owned subsidiary, is licensed in the United Kingdom to transact credit derivatives, as well as act as agent for Ambac Credit Products LLP and Ambac Capital Funding. Ambac Credit Products Limited is currently able to offer services via EU “passporting” in a number of other EU countries.

Ambac UK and Ambac Credit Products Limited are each subject to regulation by the FSA in the conduct of their business. The FSA is the single statutory regulator responsible for regulating the financial services industry in the U.K., having the authority to oversee the carrying on of “regulated activities” (including deposit taking, insurance and reinsurance, investment management and most other financial services), with the purpose of maintaining confidence in the U.K. financial system, providing public understanding of the system, securing the proper degree of protection for consumers and helping to reduce financial crime. In addition, the regulatory regime in the United Kingdom must comply with certain EU legislation binding on all EU member states.

The FSA requires that non-life insurance companies such as Ambac UK maintain a margin of solvency at all times in respect of the liabilities of the insurance company, the calculation of which depends on the type and amount of insurance business a company writes. In addition, the FSA has established a capital monitoring level for Ambac UK. Breach of the monitoring level requires that

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Ambac UK inform the FSA and enter into discussions as to the reasons for the breach, and ultimately with a view to a remedy that could include additional capital being required. The monitoring level is fixed for the year 2007, and the FSA has indicated it intends to introduce a revised basis for calculating regulatory capital in respect of Ambac UK at the end of 2007. In addition, an insurer is required to perform and submit to the FSA a solvency margin calculation return in respect of its ultimate parent. Ambac believes that Ambac Assurance and Ambac UK are in compliance with all applicable insurance laws and regulations.

Insurance Holding Company Laws

Under the Wisconsin Insurance Holding Company laws, any acquisition of control of Ambac and thereby indirect control of Ambac Assurance requires the prior approval of the Wisconsin Commissioner. “Control” is defined as the direct or indirect power to direct or cause the direction of the management and policies of a person. Any purchaser of 10% or more of the outstanding voting stock of a corporation is presumed to have acquired control of that corporation and its subsidiaries unless the Wisconsin Commissioner, upon application, determines otherwise. For purposes of this test, Ambac believes that a holder of common stock having the right to cast 10% of the votes which may be cast by the holders of all shares of common stock of Ambac would be deemed to have control of Ambac Assurance within the meaning of the Wisconsin Insurance Laws. At December 31, 2006, no stockholder owned 10% or more of Ambac common stock.

The Wisconsin insurance holding company laws also require prior approval by the Wisconsin Commissioner of certain transactions between Ambac Assurance and companies affiliated with Ambac Assurance.

Dividend Restrictions

Wisconsin:

Pursuant to the Wisconsin Insurance Laws, Ambac Assurance may declare dividends, subject to restrictions in its articles of incorporation, provided that, after giving effect to the distribution, it would not violate certain statutory equity, solvency, income and asset tests. Distributions to Ambac (other than stock dividends) must be reported to the Wisconsin Commissioner. Additionally, no quarterly dividend may exceed the dividend paid in the corresponding quarter of the preceding year by more than 15% without notifying the Wisconsin Insurance Commissioner 30 days in advance of payment. Extraordinary dividends must be reported prior to payment and are subject to disapproval by the Wisconsin Commissioner. An extraordinary dividend is defined as a dividend or distribution, the fair market value of which, together with all dividends from the preceding 12 months, exceeds the lesser of: (a) 10% of policyholders’ surplus as of the preceding December 31 or (b) the greater of: (i) statutory net income for the calendar year preceding the date of the dividend or distribution, minus realized capital gains for that calendar year; or (ii) the aggregate of statutory net income for the three calendar years preceding the date of the dividend or distribution, minus realized capital gains for those calendar years and minus dividends paid or credited and distributions made within the first two of the preceding three calendar years.

During 2006, 2005 and 2004, Ambac Assurance paid to Ambac cash dividends on its common stock totaling $136.0 million, $353.4 million and $103.0 million, respectively. See Note 18 of Notes to Consolidated Financial Statements located in Part II, Item 8 for further information.

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United Kingdom:

U.K. law prohibits Ambac UK from declaring a dividend to its shareholders unless it has “profits available for distribution.” The determination of whether a company has profits available for distribution is based on its accumulated realized profits less its accumulated realized losses. While the U.K. insurance regulatory laws impose no statutory restrictions on a general insurer’s ability to declare a dividend, the FSA’s capital requirements may in practice act as a restriction on dividends.

Statutory Contingency Reserve

Ambac Assurance is required to establish a mandatory contingency reserve in accordance with the NAIC Accounting Practices and Procedures manual (“NAIC SAP”) and the Wisconsin Administrative Code. The mandatory contingency reserve is an additional liability established to protect policyholders against the effect of adverse economic developments or cycles or other unforeseen circumstances. Under NAIC SAP, financial guarantors are required to establish a contingency reserve equal to the greater of 50% of premiums written or a stated percentage of the principal guaranteed depending on the category of obligation insured. However, under the Wisconsin Administrative Code, a municipal bond insurer is required to establish a contingency reserve consisting of 50% of earned premiums on policies of municipal bond insurance. The only exemption is when another jurisdiction in which the insurer is licensed requires a larger contingency reserve than required by the Wisconsin Administrative Code. Ambac Assurance calculates contributions using both methodologies and records the higher contribution amount. Contributions are required to be made in equal quarterly installments over a period of 20 years for municipal bonds and 15 years for all other obligations. Under NAIC SAP, contributions may be discontinued if the total reserve established for all categories exceeds the sum of the stated percentages contained therein multiplied by the unpaid principal balance. This reserve must be maintained for the periods specified above, except that the guarantor may be permitted to release reserves under specified circumstances in the event that actual loss experience exceeds certain thresholds or if the reserve accumulated is deemed excessive in relation to the guarantor’s outstanding guaranteed obligations, with notice to or approval by the insurance commissioner.

New York Financial Guarantee Insurance Law

New York’s comprehensive financial guarantee insurance law governs the conduct of business of all financial guarantors licensed to do business in New York, including Ambac Assurance. Financial guarantors are also required to maintain case basis credit loss and loss expense reserves and unearned premium reserves on a basis established by the statute.

The New York financial guarantee insurance law establishes single risk limits with respect to obligations insured by financial guaranty insurers. Such limits are specific to the type of insured obligation (for example, municipal or asset-backed). The limits generally compare the insured principal amount outstanding and/or average annual debt service on the insured obligations, net of reinsurance and collateral, for a single risk to the insurer’s qualified statutory capital, which is defined as the sum of the insurer’s policyholders’ surplus and contingency reserves. As of December 31, 2006 and 2005, Ambac Assurance and its subsidiaries were in compliance with these regulatory requirements.

Aggregate risk limits are also established on the basis of aggregate net liability and policyholders’ surplus requirements. “Aggregate net liability” is defined as the aggregate of the outstanding insured principal, interest and other payments of guaranteed obligations, net of reinsurance and collateral.

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Under these limits, policyholders’ surplus and contingency reserves must at least equal a percentage of aggregate net liability that is equal to the sum of various percentages of aggregate net liability for various categories of specified obligations. The percentage varies from 0.33% for municipal bonds to 4.00% for certain non-investment grade obligations. As of December 31, 2006 and 2005, Ambac Assurance and its subsidiaries were in compliance with these regulatory requirements.

Financial Guarantee Insurance Regulation in Other States

The Wisconsin insurance laws and regulations governing municipal bond guarantors are similar to those in New York. The Wisconsin regulations also include certain single and aggregate risk limitations. The average annual debt service for any single issue of municipal bonds may not exceed 10% of Ambac Assurance’s policyholders’ surplus. In addition, Ambac Assurance’s cumulative net liability, defined as one-third of one percent of the guaranteed unpaid principal and interest covered by current municipal bond insurance policies, may not exceed its qualified statutory capital. As of December 31, 2006 and 2005, Ambac Assurance and its subsidiaries were in compliance with these regulatory requirements.

California has financial guarantee insurance laws similar in structure to those of New York. None of the risk limits established in California’s legislation with respect to business transacted by Ambac Assurance are more stringent in any material respect than the corresponding provisions in the New York financial guarantee insurance statute.

In addition to the laws and regulations of New York, Wisconsin and California, Ambac Assurance is subject to laws and regulations of other states concerning the transaction of financial guarantees, none of which is more stringent in any material respect than the New York financial guarantee insurance statute.

Financial Services

Financial Services represented 25%, 21% and 17% of total revenues for 2006, 2005 and 2004, respectively. Ambac’s Financial Services segment provides financial and investment products including investment agreements, funding conduits, interest rate, currency and total return swaps principally to clients of the financial guarantee business.

Financial services revenues are primarily derived from: (i) gross investment income; (ii) net derivative product revenues; and (iii) net realized gains and losses on sales of securities.

The principal competitive factors among providers of financial service products that Ambac offers are: (1) pricing of contracts; (2) investment returns; (3) the financial strength of the provider (including credit enhancements); (4) the ability to provide services tailored to customers’ needs; and (5) the quality of service provided to customers. With respect to each of these competitive factors, Ambac believes that it is on equal footing with its principal competitors.

Investment Agreements

The principal purpose of Ambac Capital Funding is to provide investment agreements, including repurchase agreements, primarily to issuers of asset-backed and structured finance debt and, to a lesser

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extent, to municipal issuers. Investment agreements used in structured financings provide a guaranteed investment return customized to meet expected cash flow requirements. Investment agreements are used by bond issuers to invest bond proceeds until such proceeds can be used for their intended purpose, such as financing construction. The investment agreement provides for the guaranteed return of principal invested, as well as the payment of interest thereon at a guaranteed rate and is rated triple-A by virtue of Ambac Assurance’s financial guarantee policy, which guarantees its payment obligations.

Ambac Capital Funding manages its balance sheet to protect against a number of risks inherent in its business including liquidity, market (principally interest rate), credit, operational and legal risk. See “Management’s Discussion and Analysis—Risk Management” located in Part II, Item 7 for further information. Ambac Capital Funding is managed with the goal of closely matching the cash flows of the investment agreement liabilities with the cash flows of the related investment portfolio. To achieve this goal, derivative contracts are used.

A source of liquidity risk is the ability of some counterparties to withdraw moneys on dates other than those specified in the draw down schedule. Liquidity risk is mitigated by provisions in certain of the investment agreements that limit a counterparty’s ability to draw on the funds and provide notice periods prior to the draw of funds. See “Liquidity and Capital Resources” section located in Part II, Item 7 for a discussion on the impact of a ratings downgrade on Ambac Assurance. Investments are restricted to fixed income securities with a credit quality such that the overall minimum average portfolio credit quality is maintained at Aa/AA. Based upon management’s projections, Ambac Capital Funding maintains funds invested in cash and cash equivalents to meet short-term liquidity needs.

Ambac Capital Funding may use interest rate and currency swap contracts as part of its overall cash flow risk management. Interest rate swap contracts are agreements where Ambac Capital Funding agrees with other parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts or the difference between different interest rate indices calculated by reference to an agreed upon notional amount. Currency swap contracts are agreements where Ambac Capital Funding agrees with other parties to exchange foreign currency denominated cash flows for USD denominated cash flows calculated by reference to an agreed upon notional amount.

See Note 9 of Notes to Consolidated Financial Statements located in Part II, Item 8 for further information on investment agreements.

Ambac Securities’ principal business is to serve as the placement agent and dealer for securities issued by Ambac Capital Funding in private placement transactions. Ambac Securities is registered as a broker-dealer with the SEC and in 42 states and the District of Columbia. Self regulatory organizations such as the National Association of Securities Dealers regulate broker-dealers such as Ambac Securities. In addition, state securities and other regulators also have oversight authority over Ambac Securities. As a registered broker-dealer, Ambac Securities is subject to the net capital requirements of Rule 15c3-1 of the Securities Exchange Act of 1934, as amended, which is designed to measure the general financial condition and liquidity of a broker-dealer. In accordance with this rule, the ratio of aggregate indebtedness to net capital (“net capital ratio”) shall not exceed 15 to 1. At December 31, 2006, Ambac Securities had net capital, as adjusted, of approximately $0.6 million, which was $0.5 million in excess of its required net capital of $100 thousand. The net capital ratio was 0.01 to 1.

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Derivative Products

The primary activities in the derivative products business are intermediation of interest rate and currency swap transactions (through Ambac Financial Services) and taking total return swap positions on certain fixed income obligations. Most of the swap intermediation is done on a fully hedged basis with the exception of certain municipal interest rate swaps that are not hedged for the basis difference between taxable and tax-exempt interest rates. As such, changes in the relationship between taxable and tax-exempt interest rates will result in mark-to-market gains or losses. A portion of these municipal interest rate swaps transacted by Ambac Financial Services contain provisions that are designed to protect against certain forms of tax reform, thus mitigating its basis risk. The interest rate swaps provided by Ambac Financial Services are guaranteed by Ambac Assurance through policies that guarantee the obligations of Ambac Financial Services and its counterparties. Total return swaps, which are entered into by Ambac Capital Services, are only used for fixed income obligations that meet Ambac Assurance’s credit underwriting criteria.

Ambac Financial Services and Ambac Capital Services manage a variety of risks inherent in their businesses, including credit, market, liquidity, operational and legal. These risks are identified, measured, and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization. See “Management’s Discussion and Analysis—Risk Management” located in Part II, Item 7 for further information.

Funding Conduits

Ambac has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. The activities of the special purpose entities are contractually limited to purchasing assets from a subsidiary of Ambac, issuing medium-term notes (“MTNs”) to fund such purchases, executing derivative hedges and related administrative services. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued or both. As of December 31, 2006, Ambac Assurance had financial guarantee insurance policies issued for all assets and MTNs owned and outstanding by the special purpose entities. Ambac does not consolidate these special purpose entities under Statement of Financial Accounting Standards 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. See Notes 2 and 11 of Notes to Consolidated Financial Statements located in Part II, Item 8 for further information.

Investments and Investment Policy

As of December 31, 2006, the consolidated investments of Ambac had an aggregate fair value of approximately $17.4 billion and an aggregate amortized cost of approximately $17.1 billion. These investments are managed internally by officers of Ambac, who are experienced investment managers. All investments are effected in accordance with the general objectives and guidelines for investments established by Ambac’s Board of Directors. These guidelines encompass credit quality, risk concentration and duration, and are periodically reviewed and revised as appropriate.

As of December 31, 2006, the Financial Guarantee investment portfolio had an aggregate fair value of approximately $9.9 billion and an aggregate amortized cost of approximately $9.7 billion. Ambac Assurance’s investment policy is designed to achieve diversification of its portfolio and only permits investment in fixed income securities, consistent with its goal to achieve the highest after-tax,

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long-term return while preserving capital. Ambac Assurance is subject to limits on types and quality of investments imposed by the insurance laws and regulations of the States of Wisconsin and New York. In compliance with these laws, Ambac Assurance’s Board of Directors approves each specific investment transaction of Ambac Assurance. See “Insurance Regulatory Matters—General Law,” section above.

As of December 31, 2006, the Financial Services investment portfolio had an aggregate fair value of approximately $7.5 billion and an aggregate amortized cost of approximately $7.4 billion. Ambac Capital Funding’s investment policy is designed to achieve the highest after-tax return, subject to minimum average quality rating of AA on invested assets, and to maintain cash flow that closely matches invested assets to funded liabilities to minimize interest rate and liquidity risk. For further discussion, see “Investment Agreements,” section above.

The following tables provide certain information concerning the investments of Ambac:

Summary of Investments

As of December 31,

	2006				2005				2004
Investment Category	Carrying Value		Weighted Average Yield (1)		Carrying Value		Weighted Average Yield (1)		Carrying Value		Weighted Average Yield (1)
($ In Thousands)
Long-term investments:
Taxable bonds	$	9,323,979	5.52	%	$	8,447,332	4.86	%	$	7,768,196	3.89	%
Tax-exempt bonds		7,783,460	4.53			6,658,322	4.61			6,128,653	4.75
Total long-term investments		17,107,439	5.07			15,105,654	4.75			13,896,849	4.26
Short-term investments (2)		311,759	4.50			472,034	3.74			521,226	2.16
Other		14,391	—			14,173	—			4,234	—
Total	$	17,433,589	5.06	%	$	15,591,861	4.72	%	$	14,422,309	4.18	%

(1) Yields are stated on a pre-tax basis, based on average amortized cost.

(2) Includes taxable and tax-exempt investments.

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Investments by Security Type

As of December 31,

	2006				2005				2004
Investment Category	Carrying Value		Weighted Average Yield (1)		Carrying Value		Weighted Average Yield (1)		Carrying Value		Weighted Average Yield (1)
($ In Thousands)
Municipal obligations (2)	$	8,126,831	4.60	%	$	6,896,354	4.67	%	$	6,352,190	4.81	%
Corporate securities		719,625	6.20			556,239	6.08			673,783	5.55
Foreign obligations		276,830	4.65			181,744	4.56			211,266	4.71
U.S. government obligations		174,022	4.42			184,465	4.21			125,321	4.18
U.S. agency obligations		789,394	5.20			946,430	5.06			876,242	4.76
Mortgage and asset-backed securities		7,020,737	5.51			6,340,422	4.71			5,658,047	3.44
Total long-term investments		17,107,439	5.07			15,105,654	4.75			13,896,849	4.26
Short-term investments (2)		311,759	4.50			472,034	3.74			521,226	2.16
Other		14,391	—			14,173	—			4,234	—
Total	$	17,433,589	5.06	%	$	15,591,861	4.72	%	$	14,422,309	4.18	%

(1) Yields are stated on a pre-tax basis, based on average amortized cost.

(2) Includes taxable and tax-exempt investments.

See Note 2 and 4 of Notes to Consolidated Financial Statements located in Part II, Item 8 for further information.

EMPLOYEES

As of December 31, 2006, Ambac and its subsidiaries had 359 employees. None of the employees are covered by collective bargaining agreements. Ambac considers its employee relations to be satisfactory.

CORPORATE GOVERNANCE

The Sarbanes-Oxley Act of 2002 requires Chief Executive Officers and Chief Financial Officers to make certain certifications with respect to this report and to Ambac’s disclosure control and procedures and internal control over financial reporting.

Ambac’s Disclosure Committee has the responsibility for ensuring that there is an adequate and effective process for establishing, maintaining and evaluating disclosure controls and procedures for Ambac in connection with its external disclosures. Ambac has a Code of Business Conduct that expresses the values that drive employee behavior and maintains Ambac’s commitment to the highest standards of conduct. This code can be found on Ambac’s website at www.ambac.com by clicking on the “Investor Relations” page followed by “Corporate Governance”. Ambac’s corporate governance guidelines and the charters for the audit and risk assessment committee, governance committee and compensation committee are also available on our website under the “Corporate Governance” page.

Item 1A. Risk Factors.

In addition to the other information contained in this Form 10-K and the exhibits hereto, the following risk factors should be considered carefully in evaluating our business. A discussion of the

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policies and procedures used to identify, assess and manage certain risks is set forth under Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in this Report. Our business, financial condition, or results of operations could be materially adversely affected by any of these risks. Additional risks not presently known to us or that we currently deem immaterial individually may also adversely affect our business, financial condition, or results of operations.

A downgrade of the financial strength rating of Ambac Assurance and/or Ambac Assurance UK Limited would adversely affect our business and prospects and, consequently, our results of operations and financial condition.

Our insurance companies currently have triple A financial strength ratings from Moody’s Investors Service, Inc., Standard & Poor’s Rating Services and Fitch Inc. The objective of these ratings is to provide an opinion on an insurer’s financial strength and its ability and intent to pay under its insurance policies and contracts in accordance with their terms. The rating is not specific to any particular policy or contract. Financial strength ratings do not refer to an insurer’s ability to meet non-insurance obligations and are not a “market rating” or a recommendation to buy, hold or sell any security.

The ratings assigned by Moody’s, S&P, and Fitch to us are subject to periodic review and may be downgraded by one or more rating agencies as a result of: changes in the views of the rating agencies, adverse developments in our financial condition or results of operations due to underwriting or investment losses. Moody’s, S&P and Fitch ratings were reaffirmed in 2006.

Any downgrade in our financial strength rating, or the placement of our financial strength rating on negative credit watch, would have a material adverse effect on our competitive position and our prospects for future business opportunities. In addition, a downgrade of our financial strength ratings below specified levels would allow investment agreement and derivative counterparties to terminate certain agreements, resulting in a possible payment of a settlement amount or we would have to pledge collateral for the benefit of the counterparty, introducing liquidity risk. In addition, most investment agreements provide certain remedies for the investment agreement purchaser in the event of a downgrade of Ambac Assurance’s credit rating, typically to A1 by Moody’s or A+ by S&P. In most cases, we are permitted to post collateral or otherwise enhance our credit, prior to an actual draw on the investment agreement. Our results of operations and financial condition would be materially adversely affected by any reduction in its ratings. See Item 1 “Business—Rating Agencies” and Item 7 “Management’s Discussion and Analysis-Credit Ratings and Collateral” for further information.

A downgrade of our long term credit ratings would adversely affect our liquidity and increase our borrowing costs.

Ambac’s long term senior debt is rated “AA” by S&P and Fitch and “Aa2” by Moody’s. Our access to external sources of financing, as well as the cost of financing, is dependent on various factors and could be adversely affected by a deterioration of our long-term debt ratings. Long-term debt ratings are influenced by a number of factors. These include, but are not limited to: financial leverage on an absolute basis or relative to peers, the composition of the balance sheet and/or capital structure, material changes in earning trends and volatility, inability to dividend monies from Ambac Assurance and our competitive position. Material deterioration in any one or a combination of these factors could result in a downgrade of our credit ratings, thus increasing the cost of and/or limiting the availability of unsecured financing. Moreover, if our need for capital arises because of significant sudden losses, the

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occurrence of these losses may make it more difficult for us to raise the necessary capital. If we cannot obtain adequate capital on favorable terms or at all, our business, operating results and financial condition would be adversely affected.

We are subject to credit risk throughout our businesses, including large single risks and correlated risks.

We are exposed to the risk that issuers of debt which we have insured (or with respect to which we have written credit derivatives), issuers of debt which we hold in our investment portfolio, reinsurers and other contract counterparties (including derivative counterparties) may default in their financial obligations, whether as the result of insolvency, lack of liquidity, operational failure or other reasons. These credit risks could cause increased losses and loss reserves and mark-to-market losses with respect to credit derivatives in our financial guarantee business; we could be required by the rating agencies to hold additional capital against insured exposures which have been downgraded by the rating agencies; and we could experience losses and decreases in the value of our investment portfolio and, therefore, our financial strength. Such credit risks may be in the form of large single risk exposures to particular issuers, reinsurers or counterparties; losses caused by catastrophic events (including terrorist acts and natural disasters); or losses in respect of different, but correlated, credit exposures.

General economic conditions can adversely affect our business results and prospects.

Changes in general economic conditions can impact our business. Recessions; increases in corporate, municipal and/or consumer bankruptcies; changes in interest rate levels; changes in domestic and international law, including tax laws; wars; and terrorist acts could adversely affect the performance of our insured portfolio and our investment portfolio, e.g. leading to increases in losses and loss reserves in our insured portfolio and decreases in the value of our investment portfolio and, therefore, our financial strength. Furthermore, reduction in the volume of capital markets transactions; levels of competition; and changes in investor perception of credit risk could adversely impact the volume and pricing of financial guarantee insurance transactions and therefore adversely impact our business prospects.

Changes in prevailing interest rate levels could adversely impact our business results and prospects.

Increases in prevailing interest rate levels can adversely affect the value of our investment portfolio and, therefore, our financial strength. In the event that investments must be sold in order to pay claims, such investments would likely be sold at discounted prices. Additionally, increasing interest rates could lead to increased credit stress on consumer asset-backed transactions in our insured portfolio (as the securitized assets supporting a portion of these exposures are floating rate consumer obligations); slower prepayment speeds and resulting “extension risk” relative to such consumer asset-backed transactions in our insured portfolio and in our investment portfolio; decreased volume of capital markets activity and, correspondingly, decreased volume of insured transactions.

Decreases in prevailing interest rate levels can adversely affect the demand for, and pricing of, financial guarantee insurance, since lower absolute interest rates reduce credit spreads and, therefore, the savings realized by issuers by using our core product. Additionally, decreasing interest rates could result in early terminations of financial guarantee insurance policies in respect of which we are paid on

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an installment basis, thus reducing premium earned in respect of these transactions. Decreases in prevailing interest rates would also reduce investment income.

The financial guarantee business is highly competitive.

The financial guarantee business is highly competitive and we expect it to remain so in the near future. We face competition from both other financial guarantors and alternatives to third-party credit enhancement. Such alternatives include bank financing, senior/subordinated securitization structures, letters of credit, guarantees and credit derivatives provided primarily by foreign and domestic banks. See Item 1 “Business—Competition” for further information.

In addition, our performance is largely dependent on the talents and efforts of highly skilled individuals. Over the past few years, there has been increased competition in the financial guarantee business for qualified employees. Our business could be adversely affected if we are unable to attract new employees and retain and motivate our existing employees.

Adequate capital support and liquidity may not be available.

Financial guarantee insurers, including Ambac Assurance, typically rely on providers of lines of credit, reinsurers, contingent capital facilities and similar support mechanisms (often referred to as “soft capital”) to supplement their “hard capital”. The ratings of soft capital providers directly affect the level of capital credit which the rating agencies attribute to the financial guarantee insurer when rating its financial strength. We intend to maintain soft capital facilities with providers having ratings adequate to provide the desired capital credit, although no assurance can be given that one or more of the rating agencies will not downgrade or withdraw the applicable ratings of such providers in the future. In addition, we cannot assure that an acceptable replacement provider would be available in that event. Reductions by the rating agencies in the amount of capital credit that we receive in respect of soft capital facilities would require us to procure additional soft capital.

Our holding company structure and certain regulatory and other constraints could affect our ability to pay dividends and make other payments.

We are a holding company and have no substantial operations of our own or assets other than our ownership of Ambac Assurance, our principal operating subsidiary, and certain other smaller subsidiaries. As such, we are largely dependent on dividends from Ambac Assurance to pay dividends on our capital stock, to pay principal and interest on our indebtedness, to pay our operating expenses, to purchase our common stock in the open market and to make capital investment in our subsidiaries. Wisconsin insurance regulations restrict the declaration and payment of dividends and the making of distributions by Ambac Assurance, unless certain regulatory requirements are met. The inability of Ambac Assurance to pay dividends in an amount sufficient to enable us to meet our cash requirements at the holding company level could affect our ability to repay our debt or have a material adverse effect on our operations. See Item 1 “Business—Wisconsin Dividend Restrictions” for further information.

Loss Reserves May Not Be Adequate to Cover Potential Losses

Loss reserves established with respect to our financial guarantee insurance business are based upon estimates and judgments by management, including estimates and judgments with respect to the probability of default and the severity of loss upon default. As such, there can be no assurance that the actual losses in our financial guarantee insurance portfolio will not exceed its loss reserves. A further

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description of Ambac’s accounting for loss and loss expenses can be found in Note 2 of Notes to Consolidated Financial Statements located in Part II, Item 8.

Our risk management policies and practices may not anticipate unforeseen risks and/or the magnitude of potential for loss as the result of foreseen risks.

As described in “Item 1 Business—Risk Management”, we have established underwriting policies and practices which seek to mitigate our exposure to credit risk in our insured portfolio. These policies and practices are based in part on models reflecting historical factors, e.g. default rates and severity of loss experience. These policies and practices may not insulate us from risks that are unforeseen and which have unanticipated loss severity.

Our net income and earnings could become more volatile due to the application of fair value accounting (FAS 133) to the portion of our credit enhancement business which is executed in credit derivative form.

FAS 133 requires that credit derivative transactions be recorded at fair value. Since quoted market prices for the contracts that we execute are not available, Ambac estimates fair value by using modeling methodologies which are less precise than using quoted market prices. Changes in estimated fair values relative to our credit derivative book can cause increases or decreases in the value of such credit derivative transactions; those changes in value are reported in our financial statements and will therefore affect our reported earnings. Changes in estimated fair values can be caused by general market conditions, perception of credit risk generally and events affecting particular credit derivative transactions (e.g. impairment or improvement of specific reference entities or reference obligations).

Changes to accounting rules relating to the financial guarantee industry could have a material adverse affect on us and our industry.

In January and February of 2005, the Securities and Exchange Commission, or the SEC, discussed with financial guarantee industry participants the diversity in practice with respect to their accounting policies for loss reserves. In June 2005, the Financial Accounting Standards Board, or the FASB, added a project to its agenda to consider the accounting by financial guarantee insurers for claims liability recognition, premium recognition and deferred acquisition costs. The proposed and final documents are expected to be issued in 2007. When the FASB reaches a conclusion on this issue, we and the rest of the financial guarantee industry may be required to change some aspects of our loss reserving policies and premium and expense recognition policies, which in turn could have a material effect on us and the financial guarantee industry.

We are subject to the compliance requirements of the federal securities laws.

We are subject to extensive regulation under the federal securities laws, both as a registrant under the 1934 Act and in the conduct of our financial guarantee insurance business. In the event that we were unable to comply with the federal securities laws, we would likely be unable to access the public capital markets, which would make it more difficult for us to raise the necessary capital and/or increase the cost of capital. If we cannot obtain adequate capital on favorable terms or at all, our business, operating results and financial condition would be adversely affected. Additionally, if we are unable to comply with the securities laws, Ambac Assurance would likely be unable to insure transactions in the public capital markets, which would have an adverse impact on our business and operating results.

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We are subject to extensive regulation in the conduct of our financial guarantee insurance business.

Our principal subsidiary, Ambac Assurance, is subject to the insurance laws and regulations of each jurisdiction in which it is licensed. Ambac UK, the subsidiary through which we write financial guarantee insurance in the United Kingdom and in the European Union, is regulated by the Financial Services Authority. Failure to comply with applicable insurance laws and regulations could expose us to fines, the loss of insurance licenses in certain jurisdictions and/or the inability to dividend monies to Ambac from Ambac Assurance, all of which could have an adverse impact on our business results and prospects. Additionally, if the cost of complying with these insurance laws and regulations increases materially, this could impact our business results.

We are subject to a variety of operational risks which could have a material adverse impact on our business results.

We depend on internal processes, risk models, various systems and our employees in the conduct of our business. Any failure of such processes, models and systems and/or employee misconduct or fraud could have an adverse impact on our business results. We are also subject to external operational risks, including fraud, settlement risk and the failure of risk models or other analytical tools provided by third parties. Any such external fraud or failure could have an adverse impact on our business results.

Changes in the rating agencies’ capital models and rating methodology with respect to financial guarantee insurers may adversely affect our business results and prospects.

Changes in the rating agencies’ capital models and rating methodology could require us to hold more capital against specified credit risks in our insured portfolio. These requirements could place stress on our ratings and force us to raise additional capital, which could in turn result in lower returns on equity.

Changes in tax laws impacting marginal tax rates and/or the preferred tax treatment of municipal obligations could adversely impact our business.

Tax legislation which imposes a “flat tax” or otherwise changes the tax preference of municipal obligations under current law could adversely affect the market value of municipal obligations. In large part, our investment portfolio is invested in tax-exempt municipal obligations; as such, the value of our investment portfolio could be adversely affected by any such legislation. Additionally, any such changes in tax law could reduce the difference between tax-exempt interest rates and taxable rates. This reduction could adversely impact the financial performance of our interest rate swap business, since, in certain interest swap transactions, we have assumed the “basis risk” between tax-exempt and taxable interest rates in that business. See Item 1 Business – Derivative Products” for further information.

Item 1B. Unresolved Staff Comments.

There are no material unresolved written comments that we received from the SEC staff 180 days or more before the end of our fiscal year relating to our periodic or current reports under the Securities Exchange Act of 1934.

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Item 2. Properties.

The executive office of Ambac is located at One State Street Plaza, New York, New York 10004, which consists of approximately 145,000 square feet of office space, under an agreement that expires in September 2019. This office houses operations for all reportable business segments.

Ambac’s financial guarantee business segment also maintains offices internationally, with the principal office located at 6 Broadgate, London EC2, which consists of approximately 12,600 square feet of office space under an agreement that expires in September 2013. International operations are also conducted in three offices located in Australia (Sydney), Italy (Milan) and Japan (Tokyo).

Ambac maintains a disaster recovery site in upstate New York as part of its Disaster Recovery Plan. This remote hot-site facility is complete with user work stations, phone system, data center, internet connectivity and a power generator, capable of serving the needs of the disaster recovery team to support all business segment operations. The plan, facility and systems are revised and upgraded where necessary, and user tested annually to confirm their readiness.

Item 3. Legal Proceedings.

There are no material lawsuits pending, or to the knowledge of Ambac threatened, to which Ambac or any of its majority-owned subsidiaries is a party.

Item 4. Submission of Matters to a Vote of Security-Holders.

There were no matters submitted to a vote of security holders during the fourth quarter of 2006.

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Part II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

As of February 22, 2007, there were 55 stockholders of record of Ambac’s Common Stock, which is listed on the New York Stock Exchange under the symbol “ABK”.

The table below sets forth, for the quarters indicated, the high and low sales prices per share of Ambac’s Common Stock and the amount of cash dividends declared per common share.

	High		Low		Dividends
2006:
Fourth Quarter	$	90.75	$	81.56	$	0.180
Third Quarter	$	87.50	$	80.64	$	0.180
Second Quarter	$	85.00	$	76.79	$	0.150
First Quarter	$	82.00	$	73.74	$	0.150
2005:
Fourth Quarter	$	79.20	$	67.57	$	0.150
Third Quarter	$	73.25	$	65.98	$	0.150
Second Quarter	$	78.83	$	62.20	$	0.125
First Quarter	$	82.92	$	74.30	$	0.125

The Board of Directors of Ambac has authorized the establishment of a stock repurchase program that permits the repurchase of up to 24,000,000 shares of Ambac’s Common Stock. Ambac will only repurchase shares of its Common Stock under the repurchase program where it feels that it is economically attractive to do so and is in conformity with regulatory and rating agency guidelines. The following table summarizes Ambac’s repurchase program during the fourth quarter of 2006 and shares available at December 31, 2006:

	Total Shares Purchased (1)	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan (1)	Maximum Number of Shares That May Yet Be Purchased Under the Plan
October 2006	—		—	—	9,689,191
November 2006	520,400	$	84.21	520,400	9,168,791
December 2006	179,699	$	87.04	179,699	8,989,092
Fourth Quarter 2006	700,099	$	84.93	700,099	8,989,092

(1) Shares repurchased during the fourth quarter of 2006 were pursuant to a stock repurchase plan authorized by Ambac’s Board of Directors, for settling awards under Ambac’s long-term incentive plans.

On February 7, 2007, Ambac entered into an agreement to repurchase approximately 4,260,630 shares of its common stock leaving approximately 4,728,462 shares remaining for repurchase under its stock repurchase program. The shares will be repurchased under an accelerated share buyback program (“ASB”) with Goldman, Sachs & Co whereby Goldman Sachs and Co was authorized to repurchase $400 million of Ambac’s common stock. As the term of this program has not been completed as of February 22, 2007, the number of shares included above approximates the minimum number of shares that may be repurchased under the program. The minimum number of shares repurchased under the ASB will be determined by dividing $400 million by 104.5% of the average of the daily volume weighted average share prices of Ambac’s common stock over a period of up to

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approximately one month following execution of the ASB Agreement. Goldman Sachs has delivered 3,682,442 shares to Ambac as of February 22, 2007.

Information concerning restrictions on the payment of dividends is set forth in Item 1 above under the caption “Insurance Regulatory Matters—Wisconsin Dividend Restrictions.”

Item 6. Selected Financial Data.

The following financial information for the five years ended December 31, 2006, has been derived from Ambac’s Consolidated Financial Statements. This information should be read in conjunction with the Consolidated Financial Statements and related notes located in Part II, Item 8.

Financial Data	Years Ended December 31,
(Dollars in millions, except per share amounts)	2006			2005			2004			2003			2002
Statement of Operations Highlights:
Gross premiums written	$	996.7		$	1,096.0		$	1,048.3		$	1,143.7		$	904.0
Net premiums earned and other credit enhancement fees		871.4			866.4			764.5			667.3			500.3
Net investment income		423.9			378.1			355.3			321.1			297.3
Interest income from investment and payment agreements		391.7			270.3			198.8			212.0			255.0
Financial services – other revenue		16.6			15.8			26.4			20.6			17.4
Total revenue		1,832.1			1,614.1			1,401.6			1,272.2			958.6
Losses and loss expenses		20.0			149.9			69.6			53.4			26.7
Financial guarantee underwriting and operating expenses		133.7			117.7			106.6			92.0			76.5
Interest expense from investment and payment agreements		359.9			239.3			168.9			196.3			231.3
Financial services – other expenses		12.4			13.7			14.7			12.1			9.9
Interest expense		75.3			55.9			54.3			54.2			43.7
Net income		875.9			751.0			724.6			618.9			432.6
Net income per share:
Basic		8.22			6.94			6.61			5.81			4.08
Diluted		8.15			6.87			6.53			5.66			3.97
Return on equity		15.1	%		14.4	%		15.6	%		15.7	%		13.0	%
Cash dividends declared per common share		0.660			0.550			0.470			0.420			0.380
Balance Sheet Highlights
Total investments, at fair value	$	17,433.6		$	15,591.9		$	14,422.3		$	13,776.3		$	12,539.3
Prepaid reinsurance		315.5			303.4			297.3			325.5			296.1
Total assets		20,267.8			18,545.9			17,672.5			16,557.1			15,354.9
Unearned premiums		3,037.5			2,941.0			2,765.2			2,531.8			2,115.1
Losses and loss expense reserve		220.1			304.1			254.1			189.4			172.1
Obligations under investment agreements, investment repurchase agreements and payment agreements		8,356.9			7,252.8			7,080.7			7,076.4			7,282.9
Long-term debt		991.8			1,191.7			791.8			791.8			616.7
Total stockholders’ equity		6,184.2			5,382.8			5,035.0			4,265.1			3,635.7

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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

In this discussion, we have included statements that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These statements may relate to our future plans and objectives, among other things. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in Part I, Item 1A of the Annual Report on Form 10-K and “Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995” in Part I, Item 1 of the Annual Report on Form 10-K.

Any or all of management’s forward-looking statements here or in other publications may turn out to be wrong and are based on current expectations and the current economic environment. Ambac’s actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among factors that could cause actual results to differ materially are: (1) changes in the economic, credit, or interest rate environment in the United States and abroad; (2) the level of activity within the national and worldwide debt markets; (3) competitive conditions and pricing levels; (4) legislative and regulatory developments; (5) changes in tax laws; (6) the policies and actions of the United States and other governments; (7) changes in capital requirements or other criteria of rating agencies; (8) changes in accounting principles or practices that may impact Ambac’s reported financial results; (9) the amount of reserves established for losses and loss expenses; (10) default of one or more of Ambac Assurance’s reinsurers; (11) market spreads and pricing on insured pooled debt obligations and other derivative products insured or issued by Ambac; (12) prepayment speeds on insured asset-backed securities and other factors that may influence the amount of installment premiums paid to Ambac Assurance; and (13) other risks and uncertainties that have not been identified at this time. Ambac is not obligated to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in Ambac’s reports to the SEC.

OVERVIEW

Ambac is a holding company whose subsidiaries provide financial guarantees and financial services to clients in both the public and private sectors around the world. Our diluted earnings per share were $8.15, $6.87 and $6.53 for 2006, 2005 and 2004, respectively. The 2006 financial results were positively impacted by (i) net improvements in the adversely classified credit portfolio; (ii) cash recoveries received during the period for a security within the financial services investment portfolio that had been written down in 2002 and 2003; and (iii) the sale of aircraft related to a previously reported defaulted enhanced equipment trust certificate (reported as “Other income” in the accompanying Consolidated Statements of Operations). Both the 2005 and 2006 financial results were

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impacted by Hurricane Katrina loss reserve activity. The 2005 results were negatively impacted by the establishment of $92 million of reserves related to the hurricane. The 2006 results were positively impacted by the release of approximately $41 million of Katrina related reserves. Those increases were partially offset by net mark-to-market gains on non-trading derivatives reported in 2005. Return on average shareholders’ equity was 15.1% and 14.4% for 2006 and 2005, respectively.

Ambac’s principal operating subsidiary, Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch Inc. Ambac Assurance provides financial guarantees for bond issues and other forms of debt financing. Financial guarantee insurance is a promise to pay scheduled interest and principal if the issuer fails to meet its obligations. A bond guaranteed by Ambac receives triple-A ratings, typically resulting in lower financing costs for the issuer and generally makes the issue more marketable, both in the primary and secondary markets.

Ambac reports its financial guarantee business segment broken out by three principal markets: Public Finance, Structured Finance and International Finance. Public Finance includes all U.S. municipal issuance including general obligations, lease and tax-backed obligations, health care, public utilities, transportation and higher education, as well as certain infrastructure privatization transactions, such as toll road and bridge financings, public transportation financings, stadium financings, military housing and student housing. Structured Finance obligations include securitizations of a variety of asset types such as mortgage loans, home equity loans, student loans, credit card receivables, operating assets, leases, pooled debt obligations, investor-owned utilities and asset-backed commercial paper conduits originated in the U.S. Included within the operating asset sector are securitizations including aircraft, rental car fleets, shipping containers and rail cars, as well as film rights, franchise fees, pharmaceutical royalties, and intellectual property. International Finance covers infrastructure transactions, investor-owned utilities, asset securitizations and structured finance transactions including pooled debt obligations involving assets primarily outside of the U.S.

Management believes that the financial guarantee business thrives on economic cycles. For example, a strong economic environment with good or improving credit is beneficial to our financial guarantee portfolio. However, such conditions, if in place for an extended period of time, will reduce credit spreads and result in lower pricing. Conversely, in a deteriorating credit environment, credit spreads widen and pricing for our product improves. However, if the weakening environment is prolonged, the stresses on our portfolio could result in claims payments in excess of normal or historical expectations. Ambac’s management believes that its business is well positioned to withstand, and in fact prosper, within normal economic and business cycles. Further, Ambac’s financial guarantee business today enjoys a strong competitive position in a variety of product segments on a global scale and is positioned for further geographic product expansion. Management believes that geographic product expansion will be driven, over the long term, by critical infrastructure needs worldwide and the expansion of global credit markets.

Ambac’s Financial Services segment provides financial and investment products including investment agreements, interest rate swaps, currency swaps, and funding conduits, principally to clients of the financial guarantee business. Ambac Capital Services enters into total return swaps with professional counterparties. Ambac focuses on these businesses due to the complementary nature of the products to its financial guarantee product.

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CRITICAL ACCOUNTING ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting estimates are defined as those that require management to make significant judgments and could potentially result in materially different results under different assumptions and conditions. Management has identified the accounting for loss and loss expenses and the valuation of financial instruments as critical accounting estimates. This discussion should be read in conjunction with the consolidated financial statements and notes thereon included elsewhere in this report. Management has discussed each of these critical accounting estimates with the Audit and Risk Assessment Committee of the Board of Directors.

Financial Guarantee Insurance Losses and Loss Expenses. The loss reserve for financial guarantee insurance discussed in this critical accounting estimates disclosure relates only to Ambac’s non-derivative insurance business. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative Financial Guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments.

The liability for losses and loss expenses consists of active credit and case basis credit reserves. Ambac establishes an active credit reserve to reflect probable and estimable losses due to credit deterioration on insured credits that have not yet defaulted or been reported as of the reporting date. The active credit reserve is established through a process that begins with estimates of probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac’s internal system of credit ratings, which are analogous to the risk ratings of the major rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) the net par outstanding on the adversely classified credit. The loss severities and default information are based on rating agency information and are specific to each bond type and are established and approved by Ambac’s Portfolio Risk Management Committee. The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac. Our Surveillance group is responsible for designating the classified rating of individual credits and assigning credit ratings, which in turn affect default probabilities used in estimating active credit reserves.

For certain adversely classified credit exposures, Ambac’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities applied to adversely classified credits can include various actions by Ambac. The most common actions include obtaining detailed appraisal information on collateral, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical approach discussed above.

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Case basis credit reserves are established for losses on insured obligations that have already defaulted. We believe our definition of case basis credit reserves differs from other financial guarantee industry participants. Our case reserves represent the present value of anticipated loss and loss expense payments expected over the estimated period of default. Loss and loss expenses consider defaulted debt service payments, estimated expenses associated with settling the claims and estimated recoveries under collateral and subrogation rights.

The primary assumptions impacting the estimate of loss reserves are the probability of default and severity of loss given a default. The probability of default assumption represents the percentage chance that a particular insured obligation will default over its remaining life. Probability of default assumptions are based upon rating agency studies of bond defaults given a particular asset class, rating and remaining tenor of an underlying obligation, modified as appropriate by Ambac’s experience and judgment. Severity of loss represents the amount of loss that would be incurred on a defaulted obligation due to the difference in the amount of net par guaranteed and the value of the related collateral and other subrogation rights. Loss severity estimates are based upon available evidence such as rating agency recovery rates with respect to debt obligations in the particular asset class, review of financial statements, collateral performance, and/or surveillance data such as collateral appraisals. However, when credits are in default or have specific attributes that warrant an adjustment, we typically develop a best estimate of the loss based upon transaction specific elements rather than a statistical loss as our knowledge is greater as to the ultimate outcome of these credits due to our surveillance and remediation activity.

For the active credit reserve component of our total reserves, as the probability of default for an individual credit increases and/or the severity of loss given default increases, our loss reserve for that insured obligation will also increase. Political, economic or other unforeseen events could have an adverse impact on default probabilities and loss severities. Our experience has shown that credit deterioration and related changes in the default probabilities are generally gradual processes that typically occur over a long period of time. Nonetheless, downgrades to the underlying rating of a classified credit, particularly those individual credits with a large net par balance, could have a significant impact on our reserves. Case basis credit reserves are only sensitive to severity assumptions because the underlying financial obligation has already defaulted (that is, a 100% probability of default).

Adjustments to our loss reserves may create volatility in our financial results in any given quarter or year. Loss reserve volatility will be a direct result of the credit performance of our insured portfolio including the number, size, asset classes and quality of credits included on our classified list. The number and severity of adversely classified credits depend to a large extent on transaction specific attributes, but will generally increase during periods of economic stress and decline during periods of economic stability. Due to the small number of credits and size of certain individual adversely classified credits, modest changes in underlying ratings or classifications can have a large impact on any quarter’s provision for losses and loss expenses. Furthermore, external influences on our transactions beyond our control may result in favorable or unfavorable development on our reserves. Historically Ambac has not ceded large percentages of outstanding exposures to our reinsurers, therefore, reinsurance recoveries have not had a significant effect on loss reserve volatility. The table below indicates the number of credits and net par outstanding for case and active credit reserves at December 31, 2006:

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	Number of credits	Net par outstanding
Active credit reserves	55	$	3,831 million
Case reserves	7		668 million
Totals	62	$	4,499 million

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 claims due to underlying defaults and therefore the estimate of loss severity has remained constant. However, for certain bond types, Ambac has loss experience that indicates that factors or events could have a material impact on the original estimate of loss severity. We have observed that, with respect to four bond types in particular, it is reasonably possible that a material change in actual loss severities could occur over time. These four bond types are healthcare institutions, aircraft lease securitizations known as Enhanced Equipment Trust Certificates (“EETC”), collateralized debt obligations (“CDOs”) and mortgage-backed and home equity securitizations. These four bond kinds represent 55% of our ever-to-date claim payments. Typically, bonds insured by Ambac in the healthcare sector are secured by revenues generated by a hospital enterprise. The value of a hospital and its ability to generate revenues are primarily impacted by the essentiality of that hospital enterprise to a particular community. For example, hospitals that do not have significant competition in a community generally have more stable collateral values than facilities in communities with significant competition. Intense competition in the global airline industry and high energy costs could adversely impact our EETC transactions. Increases in mortgage rates, unemployment and/or personal bankruptcies could adversely impact residential real estate values and the probability of default and severity of loss for our transactions. As a result of our experience to date, we note that the mortgage-backed and home equity ultimate severities have been less than or equal to our current severity assumption. However, our past experience has been observed during a period of rising real estate values for much of the United States. When calculating modeled loss estimates for an insured CDO obligation, Ambac considers the unique attributes of the underlying collateral and transaction. It is reasonably possible that loss estimates for CDOs may increase as a result of increased probability of default and severity of loss of the underlying collateral; however Ambac’s exposure to CDOs in its classified portfolio is currently limited.

Currently, the credits that comprise our case basis credit reserves do not include any of the four bond kinds discussed above. As such, we do not have a basis to adjust our severity assumptions to provide a reasonably possible negative loss reserve scenario.

Generally, severity assumptions are established for entire asset classes and therefore represent an average severity of loss given a default. Therefore, we have not provided reasonably possible negative scenarios for the severity assumption. The table below outlines the estimated impact on the December 31, 2006 consolidated loss reserve from reasonably possible increases in the probability of default estimate arising via an assumption of one full letter downgrade for each credit of the appropriate bond type that presently resides within the adversely classified credit listing.

Category (Dollars in millions)	Net Par Outstanding		Increase in Reserve Estimate
Transportation	$	1,007	$	35
Healthcare	$	478	$	23
Mortgage-backed and home equity	$	1,195	$	16
EETC	$	541	$	3

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At December 31, 2006, Ambac’s existing loss and loss expense liability for Hurricane Katrina amount to $50.1 million, down from the original estimate of $92 million established in the third quarter of 2005. Ambac’s exposure to losses as a result of the hurricane is derived primarily from its guarantees of municipal bonds in the greater New Orleans area and the Gulf-front regions that were most seriously impacted by the storm in the third quarter of 2005. In the third quarter of 2006, the state of Louisiana issued $400 million of Gulf Zone bonds backed by the full faith and credit of the state. Funds from that bond issuance went to certain issuers within Orleans parish to assist in debt service payments on their outstanding debt obligations. This liquidity injection is a positive development for our insured credits that has been thoroughly considered in the estimation of reserves and is the primary reason for the decline in the loss reserve estimate at December 31, 2006 from the levels in 2005. In determining our loss estimates, our analysis has considered the unprecedented nature of the disaster, including the displacement of the communities’ residents, and the unique aspects of each insured bond, such as the nature of the revenue source, the level of debt service reserves, if any, and other transaction protections. The severity of loss on these credits will be impacted by the timing and extent of residents’ return to the affected areas as well as further direct and indirect governmental support. Throughout the history of Ambac, there have not been any significant losses resulting from natural disasters.

Ambac’s management believes that the reserves for losses and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.

Valuation of Financial Instruments. The fair market values of financial instruments held are determined by using independent market quotes when available and valuation models when market quotes are not available. Ambac’s financial instruments categorized as assets are mainly comprised of investments in fixed income securities and derivative contracts.

Investments in fixed income securities are accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) 115, “Accounting for Certain Investments in Debt and Equity Securities”. SFAS 115 requires that all debt instruments and certain equity instruments be classified in Ambac’s balance sheet according to their purpose and, depending on that classification, be carried at either cost or fair market value. The fair values of fixed income investments are based primarily on quoted market prices received from a nationally recognized pricing service or dealer quotes. For those fixed income investments where broker quotes were not available, fair values are based on internal valuation models. Key inputs to the internal valuation models include maturity date, coupon and generic yield curves for industry and credit rating characteristics that closely match those characteristics of the specific investment securities being valued. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Approximately 1% of the investment portfolio was valued using internal valuation models at December 31, 2006 and 2005.

Ambac’s exposure to derivative instruments is created through interest rate, currency, total return and credit default swaps. These contracts are accounted for at fair value under SFAS 133 “Accounting for Derivative Instruments and Certain Hedging Activities,” as amended (“SFAS 133”). Fair value is determined based upon market quotes from independent sources, when available. When independent quotes are not available, fair value is determined using valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. The net fair value of derivative contracts at December 31, 2006 and 2005 was $352 million and $174 million, respectively, of which

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$254 million and $73 million at December 31, 2006 and December 31, 2005, respectively, were related to derivative contracts used for hedging purposes. In accordance with SFAS 133, as amended, the change in fair value of the hedged items will offset these amounts in the Statement of Operations. See “Derivative Contracts Used for Non-Trading and Hedging Purposes” located in Part II, Item 8 under Note 2 for further discussion. Ambac uses both vendor-developed and proprietary models, based on the complexity of transactions. The selection of a model to value a derivative depends on the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. For derivatives that trade in liquid markets, such as interest rate and currency swaps, we utilize vendor-developed models. For derivatives that trade in less liquid markets, such as credit derivatives on synthetic collateralized debt obligations and total return swaps, a proprietary model is used because such instruments tend to be more complex and pricing information is not readily available in the market. These models and the related assumptions are continuously re-evaluated by management and enhanced, as appropriate, based on improvements in modeling techniques.

In accordance with the Emerging Issues Task Force (“EITF”) Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (“EITF 02-3”), recognition of a trading profit or loss at inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating observable market data. Ambac defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. Management’s judgment is applied in recording adjustments to fair value that take into account various factors, including but not limited to, credit risk, future administration costs, the bid offer spread and illiquidity due to lack of market depth. The FASB issued SFAS 157, “Fair Value Measurements” in September 2006 which is effective for financial statements issued for fiscal years beginning after November 15, 2007 and will supersede the guidance in EITF 02-3. Please refer to Note 2 of the Consolidated Financial Statements located in Part II, Item 8 for further discussion on how SFAS 157 will impact derivative transaction gains and losses. For additional information regarding the sensitivity of these instruments, see “Risk Management—Market Risk” located in Part II, Item 7a below.

RESULTS OF OPERATIONS

The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for 2006, 2005 and 2004 and its financial condition as of December 31, 2006 and 2005. These results are presented for Ambac’s two reportable segments: Financial Guarantee and Financial Services.

Income From Continuing Operations. Ambac’s income from continuing operations in 2006 was $875.9 million or $8.15 per diluted share, an increase of $124.9 million, compared to $751.0 million or $6.87 per diluted share in 2005. Ambac’s income before income taxes was $1,210.2 million in 2006, an increase of 18% from income before income taxes of $1,022.8 million in 2005. Of the $1,210.2 million of income (loss) before income taxes in 2006, $1,197.2 million was from Financial Guarantee, $96.4 million from Financial Services and $(83.4) million from Corporate. Corporate consists primarily of Ambac’s interest expense on debentures outstanding, partially offset by interest income on investments held at the parent company. That compares to income (loss) before income taxes in 2005 of $1,009.3 million, $81.0 million and $(67.5) million from Financial Guarantee, Financial Services and Corporate,

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respectively. Financial Guarantee income before income taxes increased primarily as a result of (i) a lower provision for loss and loss expenses, (ii) higher investment income, and (iii) higher other income resulting from the sale of three aircraft from a previously reported defaulted enhanced equipment trust certificate, partially offset by higher underwriting expenses. The Financial Services increase is primarily attributable to (i) higher net realized investment gains, primarily from cash recoveries on a security that had been written down in 2002 and 2003 and (ii) higher net investment income (after interest expense) in the investment agreement business, partially offset by changes in net mark-to-market gains/losses on non-trading derivatives.

Included in the year ended December 31, 2006 pre-tax income from continuing operations in the Financial Guarantee segment, is the impact from cancellations of the remaining reinsurance contracts with AXA Re Finance S.A. (“AXA Re”) and American Re-Insurance Company (“American Re”). The insured par that was recaptured as a result of the cancellation totaled approximately $3.9 billion. Included in ceded premiums written in Ambac’s Consolidated Statement of Operations is $37.0 million in returned premiums from the cancellation, of which $29.3 million was deferred. The difference, $7.7 million, included in net earned premiums, results from the difference between the negotiated amount of returned premiums and the associated unearned premium remaining on the previously ceded portion of the underlying guarantees. The net impact of this cancellation to the Consolidated Statement of Operations amounted to approximately $3.1 million, $2.0 million after-tax.

Included in the year ended December 31, 2005 pre-tax income from continuing operations in the Financial Guarantee segment, is the impact of a cancellation of a reinsurance contract with Radian Asset Assurance Inc. (“Radian”) during the first quarter of 2005. The insured par that was recaptured as a result of the cancellation totaled approximately $7.5 billion. Included in ceded premiums written in Ambac’s Consolidated Statement of Operations is $55.8 million in returned premiums from the cancellation, of which $51.3 million was deferred. The difference, $4.5 million, included in net earned premiums, results from the difference between the negotiated amount of returned premiums and the associated unearned premium remaining on the underlying guarantees. The net impact of this cancellation to the Consolidated Statement of Operations amounted to approximately $2.7 million, $1.8 million after-tax.

Ambac’s income from continuing operations in 2005 increased $25.2 million compared to $725.8 million or $6.54 per diluted share, in 2004. Ambac’s income before income taxes in 2005 was up 5% from income before income taxes of $976.8 million in 2004. This increase was attributable to growth in both the Financial Guarantee and Financial Services segments. Income (loss) before income taxes in 2004 consisted of $987.4 million from Financial Guarantee, $52.7 million from Financial Services and $(63.3) million from Corporate.

Included in the 2004 pre-tax income from continuing operations in the Financial Guarantee segment, is the impact of cancellations of certain reinsurance contracts with two reinsurers, AXA Re Finance S.A. and American Re-Insurance Company, both of which had been downgraded by the rating agencies in 2003. The insured par that was recaptured as a result of the cancellation totaled approximately $8.5 billion. Included in ceded premiums written in Ambac’s Consolidated Statement of Operations is $64.8 million in returned premiums from the cancellation, of which $54.4 million was deferred. The difference, $10.4 million, included in net earned premiums, results from the difference between the negotiated amount of returned premiums and the associated unearned premium remaining on the underlying guarantees. The net impact of these cancellations to the Consolidated Statements of Operations in 2004 amounted to approximately $7.0 million, $4.5 million after-tax.

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Net Loss From Discontinued Operations. In November 2003, Ambac announced that it had entered into an agreement to sell the operations of Cadre Financial Services, Inc., its investment advisory and cash management business. The transaction closed during the first quarter of 2004, with proceeds of $3.7 million in cash and $4.3 million in a note. This business had been part of the Financial Services segment. There was no net loss from discontinued operations for the years 2006 and 2005 and a $1.3 million loss for 2004. The primary reason for the 2004 loss was a purchase price adjustment due to lower than anticipated revenues.

Financial Guarantee

Ambac provides financial guarantees in respect of debt obligations through its principal operating subsidiary, Ambac Assurance Corporation, as well as credit protection in the form of credit derivatives through Ambac Credit Products LLC, a wholly owned subsidiary of Ambac Assurance. Ambac provides these services in three principal markets: public finance, structured finance and international finance.

Ambac guaranteed $124.5 billion of gross par value bonds during 2006, a decrease of 1% from $125.3 billion in 2005. Par value written during 2005 increased 6% compared to $118.1 billion written during 2004.

The following table provides a breakdown of guaranteed net par outstanding by market sector at December 31, 2006 and 2005:

	December 31,		December 31,
(Dollars in billions)	2006		2005
Public Finance	$	282.2	$	264.1
Structured Finance.		162.6		144.3
International Finance.		74.2		70.7
Total net par outstanding	$	519.0	$	479.1

The following tables provide a rating distribution of guaranteed net par outstanding based upon internal Ambac Assurance credit ratings at December 31, 2006 and 2005 and a distribution by bond type of Ambac Assurance’s below investment grade exposures at December 31, 2006 and 2005. Below investment grade is defined as those exposures with a credit rating below BBB-:

	Percentage of Guaranteed Portfolio(1)
	December 31, 2006		December 31, 2005
AAA	16	%	13	%
AA	20	%	20	%
A	43	%	46	%
BBB	20	%	20	%
Below investment grade	1	%	1	%
Total	100	%	100	%

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Summary of Below Investment Grade Exposure ⁽¹⁾

Bond Type
(Dollars in millions)	2006		2005
Public Finance:
Transportation	$	1,264	$	653
Health care		404		584
General obligation		292		387
Tax-backed		134		135
University		69		70
Other		120		146
Total Public Finance		2,283		1,975
Structured Finance:
Enhanced equipment trust certificates		950		927
Mortgage-backed and home equity		848		507
Investor-owned utilities		509		575
Pooled debt obligations		90		384
Asset-backed		—		188
Total Structured Finance		2,397		2,581
International Finance:
Transportation revenue		397		219
Public finance infrastructure		149		—
Investor-owned utilities		—		52
Sovereign/sub-sovereign		—		38
Other		40		203
Total International Finance		586		512
Grand Total	$	5,266	$	5,068

(1) Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. 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. Ambac Assurance, or one of its affiliates, has insured the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.

The total number of credits with Ambac Assurance ratings below investment grade were 65 and 75 at December 31, 2006 and 2005, respectively. The increase in 2006 for below investment grade exposures is due to the deterioration in three U.S. Transportation credits offset by credit improvements and exposure paydowns, primarily in the U.S. Health care and pooled debt obligations.

Public Finance:

Public finance obligations are bonds issued by states, municipalities and other governmental or not-for-profit entities located in the United States (“Public Finance”). Bond proceeds are used to finance or refinance a broad spectrum of public purpose initiatives, including education, utility, transportation, health care and other general purpose projects. Public Finance bond obligations par value written was $43.1 billion, $53.8 billion and $44.6 billion for 2006, 2005 and 2004, respectively. Ambac’s market share for 2006, based upon par insured, was down from approximately 25% in 2005

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to 23% in 2006. Ambac’s market share for 2004 was approximately 23%. Insured market penetration dipped to below 50% for the first time since 2001, while market penetration was the highest in 10 years in 2005 at 57%. Please refer to the “U.S. Public Finance Market” section, located in Item 1., Business, for further background information.

The table below shows the percentage, by bond type, of new Public Finance business gross par guaranteed by Ambac Assurance during each of the last three years.

New Business Guaranteed by Bond Type

Bond Type	2006		2005		2004
U.S. Public Finance:
Lease and tax-backed revenue	34	%	34	%	34	%
General obligation	24	%	28	%	26	%
Utility revenue	11	%	8	%	14	%
Health care revenue	10	%	11	%	9	%
Higher education	9	%	7	%	8	%
Transportation revenue	6	%	8	%	7	%
Housing revenue	4	%	3	%	2	%
Other	2	%	1	%	0	%
Total U.S. Public Finance	100	%	100	%	100	%

Structured Finance:

Structured finance obligations include securitizations of a variety of asset types such as mortgages, home equity loans, student loans and credit card receivables; commercial asset-backed securities; leases; pooled debt obligations; investor-owned utilities and asset-backed commercial paper conduits originated in the United States (“Structured Finance”). Structured Finance obligations par value written was $62.4 billion, $58.8 billion and $53.4 billion in 2006, 2005 and 2004, respectively. The increase in Structured Finance obligations guaranteed for 2006 as compared to 2005 and 2005 compared to 2004 resulted primarily from higher par written in pooled debt obligations, partially offset by a decline in the consumer asset-backed sector of the market (including mortgage-backed securities).

The table below shows the percentage, by bond type, of new Structured Finance business gross par guaranteed by Ambac Assurance during each of the last three years.

New Business Guaranteed by Bond Type

Bond Type	2006		2005		2004
U.S. Structured Finance:
Pooled debt obligations	33	%	23	%	6	%
Mortgage-backed and home equity	30	%	36	%	50	%
Asset-backed and conduits	25	%	29	%	28	%
Student loan	5	%	7	%	8	%
Investor-owned utilities	4	%	4	%	2	%
Other	3	%	1	%	6	%
Total U.S. Structured Finance	100	%	100	%	100	%

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International Finance:

International finance obligations include public purpose infrastructure projects, utilities and various types of structured financings originated outside the United States (“International Finance”), including asset-backed securities, whole business and future flow securitizations. International structured financings also encompass pooled debt obligations that may include significant components of domestic exposures.

International Finance bond obligations par value written was $19.0 billion, $12.7 billion and $20.1 billion for 2006, 2005 and 2004, respectively. International Finance obligations guaranteed during 2006 are higher than 2005 primarily due to increases in pooled debt obligations, asset-backed and conduits, sovereign/sub-sovereign (primarily PFI), and transportation revenue obligations, partially offset by lower investor-owned and public utility obligations par written. International Finance obligations guaranteed during 2005 are lower than 2004 primarily due to decreases in mortgage-backed obligations, pooled debt obligations (although higher as a percentage of total new business generated), transportation revenue obligations, asset-backed and conduits (although higher as a percentage of total business generated) and sovereign/sub-sovereign obligations guaranteed, which were partially offset by higher investor-owned and public utility obligations.

The table below shows the percentage, by bond type, of new International Finance business gross par guaranteed by Ambac Assurance during each of the last three years.

New Business Guaranteed by Bond Type

Bond Type	2006		2005		2004
International Finance:
Pooled debt obligations	36	%	24	%	19	%
Asset-backed and conduits	25	%	36	%	29	%
Sovereign/sub-sovereign	15	%	1	%	12	%
Investor-owned and public utilities	12	%	30	%	5	%
Transportation	6	%	3	%	5	%
Mortgage-backed and home equity	3	%	6	%	30	%
Other	3	%	0	%	0	%
Total International Finance	100	%	100	%	100	%

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Gross Premiums Written. Gross premiums written in 2006 were $996.7 million, a decrease of 9% from $1,096.0 million in 2005. Up-front premiums written decreased from $575.4 million in 2005, to $459.2 million in 2006. Up-front premiums written by market sector saw a decrease in Public Finance, which were partially offset by increases in both Structured and International Finance. Installment premiums written in 2006 were $537.5 million, an increase of 3% from $520.6 million in 2005. The growth in installment premiums is due to the growing book of business in all three market sectors, Public, Structured and International Finance installment premiums written. Gross premiums written in 2005 increased 5% from $1,048.3 million in 2004. This is a result of increased business activity in all three market sectors. The following table sets forth the amounts of gross premiums written by type:

	2006		2005		2004
Public Finance:
Up-front	$	346.0	$	528.1	$	513.4
Installment		29.7		24.1		24.2
Total Public Finance		375.7		552.2		537.6
Structured Finance:
Up-front		30.0		15.0		20.0
Installment		303.6		299.5		261.7
Total Structured Finance		333.6		314.5		281.7
International Finance:
Up-front		83.2		32.3		41.2
Installment		204.2		197.0		187.8
Total International Finance		287.4		229.3		229.0
Total	$	996.7	$	1,096.0	$	1,048.3
Total up-front	$	459.2	$	575.4	$	574.6
Total installment		537.5		520.6		473.7
Total	$	996.7	$	1,096.0	$	1,048.3

Reinsurance. Ambac Assurance’s reinsurance program is principally comprised of a surplus share treaty and facultative reinsurance. The surplus share treaty requires Ambac Assurance to cede covered transactions while affording Ambac Assurance the flexibility to cede par amounts of such transactions within a predefined range. Management uses facultative reinsurance to cede risks in amounts greater than the maximums that can be ceded under the surplus share treaty and risks which are excluded from the surplus share treaty. Ceded premiums written in 2006 were $103.5 million, up 4% from 99.7 million in 2005. Ceded premiums written in 2005 were up 41% from $70.9 million in 2004.

Included in ceded premiums written in 2006, 2005 and 2004 is $37.0 million, $55.8 million, and $64.8 million, respectively, in return premiums from reinsurance contracts that were cancelled. Excluding the return premiums, ceded premiums written were $140.5 million and $155.5 million for 2006 and 2005, respectively, a decrease of 10%. Excluding the return premiums, ceded premiums written increased 15% in 2005 from $135.7 million in 2004. Ceded premiums written (exclusive of the return premiums) as a percentage of gross premiums written were 14.1%, 14.2% and 13.0% for 2006, 2005 and 2004, respectively.

Net Premiums Earned and Other Credit Enhancement Fees. Net premiums earned and other credit enhancement fees during 2006 were $871.4 million, an increase of 1% from $866.4 million in 2005.

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The increase was primarily the result of higher normal earned premiums (which is defined as net premiums earned less accelerated earnings and reconciled to total net premiums earned in the table below) and higher other credit enhancement fees, partially offset by lower refundings and calls of previously insured obligations and other accelerations, such as reinsurance cancellations, (collectively referred to as “accelerated earnings”).

Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. However, given the same underlying attributes of an insured obligation such as tenor, gross premium amount, and amortization schedule, the timing of revenue recognition may differ for premiums collected upfront versus premiums collected in installments. When an issue insured by Ambac Assurance has been refunded or called, any remaining unearned premium (net of refunding credits, if any) is earned at that time. The level of refundings or calls vary, depending upon a number of conditions, primarily the relationship between current interest rates and interest rates on outstanding debt. Earnings on refundings relate to transactions where the premium was paid up-front at the inception of the policy. Accelerated earnings also include the difference between negotiated return premiums and the associated unearned premium on reinsurance cancellations. Net premiums earned included accelerated earnings of $118.2 million and $141.5 million during 2006 and 2005, respectively. Included in 2006 and 2005 accelerated earnings amounts were approximately $7.7 million and $4.5 million, respectively, from the cancellation of reinsurance contracts previously mentioned.

Normal net premiums earned increased 3% from $674.8 million in 2005 to $693.4 million in 2006. Normal net premiums earned for 2006 increased 3% and 5% for Public and Structured Finance, respectively, and decreased 1% for International Finance from 2005. Public Finance normal earned premium growth has been negatively impacted by the high level of refunding activity over the past two years, increasingly competitive pricing and the mix of business underwritten in recent periods. The growth in normal earned premiums in Structured Finance has improved as the recent level of writings in asset classes such as commercial asset-backed securities, auto securitizations and pooled debt obligations has increased. The decline in International normal earned premiums was driven by significant paydowns and calls in 2005 and the first half of 2006 and the recent business mix which has trended towards long-dated infrastructure transactions that earn premiums over a longer period of time than typical structured finance exposures.

Other credit enhancement fees in 2006, which is primarily comprised of fees received from the credit derivatives product, were $59.8 million, an increase of 19% from $50.1 million in 2005. Included in 2006 was $0.8 million of accelerated other credit enhancement fees, compared to $1.8 million in 2005. Excluding these accelerations, other credit enhancement fees increased 22% for 2006. This increase is primarily due to higher domestic credit derivative writings of collateralized debt obligations. This increase has been driven by investor demand for credit enhancement in the form of credit derivatives, rather than insurance. The increase is primarily due to higher domestic credit derivative writings, partially offset by lower writings in International.

Net premiums earned and other credit enhancement fees during 2005 increased 13% from $764.5 million in 2004. This increase was primarily the result of the higher accelerated earnings and the larger Financial Guarantee book of business.

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The following table provides a breakdown of net premiums earned by market sector and other credit enhancement fees:

(Dollars in millions)	2006		2005		2004
Public Finance	$	231.0	$	223.6	$	207.4
Structured Finance		283.4		269.9		263.7
International Finance		179.0		181.3		164.2
Total normal premiums earned		693.4		674.8		635.3
Accelerated earnings		118.2		141.5		81.9
Total net premiums earned		811.6		816.3		717.2
Other credit enhancement fees		59.8		50.1		47.3
Total net premiums earned and other credit enhancement fees	$	871.4	$	866.4	$	764.5

Net Investment Income. Net investment income in 2006 was $423.9 million, an increase of 12% from $378.1 million in 2005. The increase was primarily attributable to (i) the growth of the investment portfolio resulting from the positive operating cash flows of the Financial Guarantee book of business, including cash received related to the previously mentioned reinsurance cancellations and (ii) an approximately $200 million capital contribution from the parent company in late December 2005. Investments in tax-exempt securities amounted to 76%, 72% and 71% of the total fair value of the portfolio as of December 31, 2006, 2005 and 2004, respectively. The average pre-tax yield-to-maturity on the investment portfolio was 4.61% as of December 31, 2006 and 2005 and 4.64% at December 31, 2004. Net investment income in 2005 increased 6% from $355.3 million in 2004. The increase was primarily attributable to (i) the growth of the investment portfolio resulting from the positive operating cash flows of the Financial Guarantee book of business, and (ii) a net positive adjustment of $5.9 million for certain municipal securities within the investment portfolio that have been pre-refunded. These positive impacts in investment income were partially offset by (i) the repurchase of Ambac stock totaling approximately $298.2 million in 2005 and (ii) net loss payments of $86.7 million in 2005.

Net Realized Investment Gains. Net realized investment gains in 2006 were $7.1 million, compared to net realized gains of $6.3 million and $30.0 million in 2005 and 2004, respectively. The following table details amounts included in net realized gains:

(Dollars in millions)	2006			2005			2004
Net gains (losses) on securities sold	$	1.0		($	0.8	)	$	24.3
Other than temporary impairment on securities		(0.1	)		(0.3	)		—
Net foreign exchange gains on investments		6.2			7.4			5.7
Net realized gains	$	7.1		$	6.3		$	30.0

Net gains (losses) on securities sold are generated as a result of the ongoing management of the investment portfolio. Foreign exchange gains and losses primarily resulted from sales and maturities of long-term foreign currency denominated securities in 2006, 2005 and 2004.

Net Mark-to-Market Gains on Credit Derivative Contracts. Net mark-to-market gains on credit derivative contracts in 2006 were $9.1 million, compared to net mark-to-market gains of $13.6 million and $17.7 million in 2005 and 2004, respectively. The change in estimated fair value of credit derivatives reflects tightening of credit spreads on the underlying obligations. There were no realized net losses paid on structured credit derivatives for the years ended December 31, 2006, 2005 and 2004.

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Other Income (Loss). Other income (loss) in 2006 was $39.6 million, as compared to $12.5 million in 2005. Included in other income are deal structuring fees, commitment fees, aircraft revenues and income from Ambac’s Qualifying Special Purpose Entities (“QSPEs”). During the first quarter of 2006, Ambac Assurance sold the three remaining aircraft from a previously reported defaulted enhanced equipment trust certificate. The gain on the sale amounted to $25.0 million. Also included within other income are structuring fee revenues for 2006 and 2005 of approximately $2.1 million and $0.7 million, respectively. Structuring fees are negotiated for certain domestic and international structured finance transactions, typically collected at inception of the transactions, and are earned ratably over the life of the transactions. Ambac has approximately $14.8 million and $11.0 million of deferred structuring fees included in “Other liabilities” on the Consolidated Balance Sheets as of December 31, 2006 and 2005, respectively. Other income increased $16.4 million in 2005 from ($3.9) million in 2004, primarily due to a $13.6 million mark-to-market loss in 2004 on interest rate derivative contracts relating to Ambac’s medium-term funding conduit.

Losses and Loss Expenses. Losses and loss expenses are based upon estimates of the aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. Losses and loss expenses in 2006 were $20.0 million, versus $149.9 million in 2005 and $69.6 million in 2004.

The following table summarizes the changes in the total net loss reserves for 2006 and 2005:

(Dollars in millions)	December 31, 2006			December 31, 2005
Beginning balance of net loss reserves	$	300.6		$	237.5
Provision for losses and loss expenses		20.0			149.9
Losses paid		(126.2	)		(119.1	)
Recoveries of losses paid from reinsurers		3.9			22.9
Other recoveries, net of reinsurance		16.7			9.4
Ending balance of net loss reserves	$	215.0		$	300.6

The following tables provide details of net losses paid, net of recoveries received for the years ended December 31, 2006, 2005 and 2004 and gross case reserves and total gross loss reserves at December 31, 2006 and 2005:

(Dollars in millions)	2006			2005		2004
Net losses paid (recovered):
Public Finance	$	76.2		$	11.3	$	19.9
Structured Finance		30.6			72.5		(5.0	)
International Finance		(1.2	)		2.9		4.0
Total	$	105.6		$	86.7	$	18.9

	2006					2005
(Dollars in millions)	Gross Case Basis Reserves(1)(2)			Total Loss Reserves		Gross Case Basis Reserves(1)(2)		Total Loss Reserves
Public Finance	$	45.7		$	195.0	$	97.0	$	215.5
Structured Finance		(0.2	)		21.6		9.5		86.6
International Finance		2.0			3.5		—		2.0
Total	$	47.5		$	220.1	$	106.5	$	304.1

⁽¹⁾ Ambac discounts estimated net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio. Discount rates applied to case basis credit reserves were 4.5% and 4.75% at December 31, 2006 and 2005, respectively.

⁽²⁾ Reinsurance recoverables on case basis credit reserves were $5.0 million and $3.5 million at December 31, 2006 and 2005, respectively.

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Active credit reserves were $172.6 million and $197.6 million at December 31, 2006 and 2005. Included in the calculation of active credit reserves at December 31, 2006 and 2005 was the consideration of $6.9 million and $17.5 million, respectively, of reinsurance which would be due to Ambac from the reinsurers, upon default of the insured obligations. The active credit reserve at December 31, 2006 and 2005 was comprised of 55 and 88 credits with net par outstanding of $3,831 million and $6,319 million, respectively. The decrease in net par outstanding of credits within the active credit reserve was driven primarily by credit improvements, redemption of insured credits, and transfers to case basis credit reserves.

Case basis credit reserves at December 31, 2006 and 2005 were comprised of 7 and 10 credits, respectively, with net par outstanding of $668.4 million and $839.0 million, respectively. The decrease to the case basis credit reserves is primarily due to (i) the settlement of an impaired healthcare transaction, and (ii) the settlement of two mortgage-backed securities transactions as a result of loss payments during 2006 and prepayments of the underlying insured par. Offsetting the decrease in case reserves was additional reserves established for a public finance transportation issue.

Net loss reserves as of December 31, 2006 include $50.1 million for Hurricane Katrina credits, down from $91.5 million at December 31, 2005. The decrease is primarily due to significant state and federal support recently provided to the region, particularly the greater New Orleans area. Approximately $730 million of Katrina impacted credits remain in Ambac’s adversely classified credit portfolio. Ambac did not pay any Katrina related claims during 2006.

At December 31, 2006, expected future claim payments on credits that have already defaulted totaled $39.8 million. Related future payments are $0.5 million, $0.3 million, $0.3 million, $1.5 million and $1.6 million for 2007, 2008, 2009, 2010, and 2011, respectively.

Please refer to the “Critical Accounting Estimates” section of this Management’s Discussion and Analysis and to Note 2 of the Consolidated Financial Statements located in Part II, Item 8 for further background information on loss reserves, our policy and for further explanation of potential changes.

Underwriting and Operating Expenses. Underwriting and operating expenses of $133.7 million in 2006 increased by 14% from $117.7 million in 2005. Underwriting and operating expenses in 2005 increased 10% from $106.6 million in 2004. Underwriting and operating expenses consist of gross underwriting and operating expenses, less the deferral to future periods of expenses and reinsurance commissions related to the acquisition of new insurance contracts, plus the amortization of previously deferred expenses and net reinsurance commissions. The following table provides details of underwriting and operating expenses for 2006, 2005 and 2004:

										% Change
(Dollars in millions)	2006			2005			2004			2006 vs. 2005		2005 vs. 2004
Gross underwriting and operating expenses	$	191.2		$	167.4		$	144.8		+14	%	+16	%
Net reinsurance commissions received (1)		(26.1	)		(21.3	)		(15.9	)
Operating expenses and reinsurance commissions deferred		(69.6	)		(59.0	)		(47.6	)
Amortization of previously deferred expenses (1)		38.2			30.6			25.3
Underwriting and operating expenses	$	133.7		$	117.7		$	106.6		+14	%	+10	%

(1) The 2006, 2005 and 2004 cancellations of reinsurance contracts disclosed above impacted net reinsurance commissions received by ($10.3) million, ($17.4) million and ($19.8) million, respectively and the amortization of previously deferred expenses by $8.1 million, $15.9 million and $16.3 million, respectively.

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The increases in gross underwriting and operating expenses in 2006 and 2005 reflect the overall increased business activity in those years and are primarily attributable to higher compensation costs. Ambac’s 2006 expenses include the impact of implementation of Statement of Financial Accounting Standards (“SFAS”) No.123-R “Share-Based Payment”. Under provisions of SFAS 123-R, Ambac will accrue the estimated cost of future stock compensation grants to retirement-eligible employees over the service period; the year preceding the grant date ($8.4 million was recognized in 2006). Previously, such awards were recognized on the date of grant. Compensation expenses in 2006, 2005 and 2004 were $142.5 million, $113.4 million and $103.5 million, respectively.

Financial Services

Through its Financial Services subsidiaries, Ambac provides financial and investment products including investment agreements, funding conduits, interest rate swaps, currency swaps and total return swaps. The investment agreement business is managed with the goal of closely matching the cash flows of the investment agreement liabilities with the cash flows of the related investment portfolio. To achieve this goal in the investment agreement business, derivative contracts are used for hedging purposes. The primary activities in the derivative products business are intermediation of interest rate and currency swap transactions and taking total return swap positions on certain fixed income obligations. Most of the swap intermediation is done on a fully hedged basis with the exception of certain municipal interest rate swaps that are not hedged for the basis difference between taxable and tax-exempt interest rates. As such, changes in the relationship between taxable and tax-exempt interest rates will result in mark-to-market gains or losses.

Revenues. Revenues in 2006 increased 40% to $468.7 million from $333.9 million in 2005. The increased revenues in 2006 are primarily due to (i) higher investment income and (ii) higher net realized investment gains due to the recoveries received related to a previously impaired security noted below, partially offset by higher (i) net mark-to-market gains on non-trading derivatives in 2005.

The following table provides a breakdown of Financial Services revenues for 2006, 2005 and 2004:

									% Change
(Dollars in millions)	2006			2005		2004			2006 vs. 2005		2005 vs. 2004
Investment income	$	391.7		$	270.3	$	198.8		+45	%	+36	%
Derivative products		16.6			15.8		26.4		+5	%	-40	%
Net realized investment gains		59.3			2.3		5.1		+2478	%	-55	%
Net mark-to-market gains on total return swaps		2.5			1.3		9.4		+92	%	-86	%
Net mark-to-market (losses) gains on non-trading derivative contracts		(1.4	)		44.2		(3.4	)	-103	%	+1400	%
Total Financial Services revenue	$	468.7		$	333.9	$	236.3		+40	%	+41	%

The increases in investment income in both 2005 and 2006 were driven by higher interest rates on floating rate investments and the issuance of investment agreements during the period. Derivative product revenues decreased in 2005 primarily due to lower new business revenues on interest rate swap contracts amounting to $5.8 million and $19.8 million in 2005 and 2004, respectively. The total return swap portfolio has experienced a spread narrowing resulting in an increase in net mark-to-market gains. The mark-to-market gains on the non-trading derivative contracts in 2005 relate almost entirely to interest rate hedge contracts in Ambac’s investment agreement business. The non-trading derivative

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contracts were highly effective economic hedges, but did not meet the technical requirements for hedge accounting under SFAS Statement No. 133 “Accounting for Derivative Instruments and Hedging Activities”. These derivatives were redesignated to meet the technical requirements of SFAS No. 133 in 2005.

During 2002 and 2003 realized losses included an impairment write-down of $139.7 million and $10.5 million, respectively, related to asset-backed notes issued by National Century Financial Enterprises, Inc (“NCFE”). These notes, which were backed by health care receivables and rated triple-A until October 25, 2002, defaulted and NCFE filed for protection under Chapter 11 of the U.S. Bankruptcy Code in November 2002. The loss was specific to the NCFE notes and had no impact on other investments held. In 2006, 2005 and 2004, Ambac has received cash recoveries of $55.5 million, $10.8 million and $17.9 million, respectively, resulting from distributions under the NCFE Bankruptcy Plan, payments made by a trust created under the Plan and litigation settlements.

Expenses. Financial Services expenses were $372.3 million, $252.9 million and $183.6 million for 2006, 2005 and 2004, respectively. Included in the above are expenses related to investment and payment agreements of $359.9 million, $239.2 million and $168.9 million for 2006, 2005 and 2004, respectively. The increases are primarily related to higher rates on floating rate investment agreements.

Corporate Items

Interest Expense. Interest expense was $75.3 million, $55.9 million and $54.3 million in 2006, 2005 and 2004, respectively. The increases are primarily attributable to Ambac’s issuance of $400 million, 5.95% debt, due December 5, 2035 in December 2005. This was partially offset, in October 2006, when Ambac redeemed all of its outstanding $200 million 7% debentures at par plus accrued interest. For additional information, please refer to “Liquidity and Capital Resources – Ambac Financial Group, Inc. Liquidity” section.

Corporate Expenses. Corporate expenses include the operating expenses of Ambac Financial Group. Corporate expenses were $20.6 million, $15.0 million, and $10.7 million in 2006, 2005 and 2004, respectively. The increased expenses in 2006 are primarily related to the write-off of approximately $6.0 million of fees and expenses related to the redemption of Ambac’s $200 million 7% debentures mentioned above. The increased expenses in 2005 are primarily related to Ambac’s contingent capital facility of $5.0 million. Prior period amounts were recorded directly in shareholders’ equity in the Consolidated Balance Sheet rather than in corporate operating expenses.

Provision for Income Taxes. Income taxes for continuing operations for 2006 were at an effective rate of 27.6%, compared to 26.6% and 25.7% for 2005 and 2004, respectively. The increase in the effective tax rates for 2006 is primarily due to higher taxable income resulting from improved financial guarantee underwriting results relative to the comparable prior period and a net release of tax reserves in 2005 as a result of the expiration of the statute of limitations on a prior tax year. The increase in the effective rate for 2005 compared to 2004 related predominantly to a 2005 increase in state income taxes due to mark-to-market adjustments in the Financial Services segment, and non-deductible expense associated with the contingent capital facility.

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LIQUIDITY AND CAPITAL RESOURCES

Ambac Financial Group, Inc. Liquidity. Ambac’s liquidity, both on a short-term basis (for the next twelve months) and a long-term basis (beyond the next twelve months), is largely dependent upon: (i) Ambac Assurance’s ability to pay dividends or make other payments to Ambac; and (ii) external financing. Pursuant to Wisconsin insurance laws, Ambac Assurance may pay dividends, provided that, after giving effect to the distribution, it would not violate certain statutory surplus, solvency and asset tests. Additionally, no quarterly dividend may exceed the dividend paid in the corresponding quarter of the preceding year by more than 15% without notifying the Wisconsin Insurance Commissioner 30 days in advance of payment. Based upon these tests and with notice as described above, the maximum amount that will be available during 2007 for payment of dividends without regulatory approval by Ambac Assurance is $370.0 million. Ambac Assurance paid dividends of $136.0 million in 2006.

Ambac’s principal uses of liquidity are for the payment of its operating expenses, income taxes, interest on its debt, dividends on its shares of common stock, purchases of its common stock in the open market and capital investments in its subsidiaries.

The following table includes aggregated information about contractual obligations for Ambac. These contractual obligations impact Ambac’s and its subsidiaries short-and long-term liquidity and capital resource needs. The table includes information about payments due under specified contractual obligations, aggregated by type of contractual obligation, including claim payments, principal and interest payments of Ambac’s long-term debt obligations, investment agreement obligations, payment agreement obligations and payments due under operating leases.

	Contractual Obligations by Year
(Dollars in millions)	2007		2008		2009		2010		2011		Thereafter
Long-term debt obligations (1)	$	65.0	$	65.0	$	65.0	$	65.0	$	207.5	$	3,508.0
Investment agreement obligations (2)		3,114.6		1,301.3		1,076.9		1,022.9		200.4		2,873.9
Payment agreement obligations (3)		320.3		68.3		56.7		55.2		55.6		728.2
Operating lease obligations		9.3		9.3		9.5		9.9		10.0		72.5
Purchase obligations (4)		6.6		3.1		0.1		—		—		—
Pension and post retirement benefits (5)		1.0		1.0		1.0		1.1		1.1		6.0
Other long-term liabilities (6)		0.5		0.3		0.3		1.5		1.6		189.5
Total.	$	3,517.3	$	1,448.3	$	1,209.5	$	1,155.6	$	476.2	$	7,378.1

(1) Includes principal of and interest on obligations using current rates for floating rate obligations.

(2) Includes principal of and interest on obligations using current rates for floating rate obligations. Certain investment agreements have contractual provisions that allow our counterparty the flexibility to withdraw funds prior to legal maturity date. Amounts included in the table are based on the earliest optional draw date.

(3) Certain payment agreements have contractual provisions that allow investors the right to redeem their investment at any time prior to legal maturity date. Amounts included in the table are based on this right being exercised in 2007.

(4) Purchase obligations include various technology related maintenance agreements, rating agency fees and other outside services.

(5) Amount primarily represents future benefit payments on the non-qualified pension and postretirement benefit plans for the next 10 years (unfunded). Contributions to the funded pension plan are not included as Ambac’s Board of Directors has terminated the plan on December 31, 2006.

(6) Amount represents expected claim payments on financial guarantee insurance contracts that have already defaulted. Expected claim payments on financial guarantee insurance contracts that have not yet defaulted are not included.

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Based on the amount of dividends that it expects to receive from Ambac Assurance and other subsidiaries during 2006, management believes that Ambac will have sufficient liquidity to satisfy its needs over the next twelve months, including the ability to pay dividends on its common stock in accordance with its dividend policy. Beyond the next twelve months, Ambac Assurance’s ability to declare and pay dividends to Ambac may be influenced by a variety of factors including adverse market changes, insurance regulatory changes and changes in general economic conditions. Consequently, although management believes that Ambac will continue to have sufficient liquidity to meet its debt service and other obligations over the long term, no guarantee can be given that Ambac Assurance will be able to dividend amounts sufficient to pay all of Ambac’s operating expenses, debt service obligations and dividends on its common stock.

A subsidiary of Ambac provides a $360 million liquidity facility to a reinsurance company which acts as reinsurer with respect to a portfolio of life insurance policies. The liquidity facility, which is guaranteed by Ambac Assurance, provides temporary funding in the event that the reinsurance company’s capital is insufficient to make payments under the reinsurance agreement. The reinsurance company is required to repay all amounts drawn under the liquidity facility. No amounts have been drawn under this facility at December 31, 2006.

Ambac Assurance Liquidity. The principal uses of Ambac Assurance’s liquidity are the payment of operating expenses, claim payments, reinsurance premiums, taxes, dividends to Ambac and capital investments in its subsidiaries. Management believes that Ambac Assurance’s operating liquidity needs can be funded exclusively from its operating cash flow. The principal sources of Ambac Assurance’s liquidity are gross premiums written, scheduled investment maturities, net investment income and receipts from credit derivatives.

Financial Services Liquidity. The principal uses of liquidity by Financial Services subsidiaries are payment of investment and payment agreement obligations pursuant to defined terms, net obligations under interest rate, total return and currency swaps, operating expenses and income taxes. Management believes that its Financial Services liquidity needs can be funded from its operating cash flow, the maturity of its invested assets and from time to time, by short-term inter-company loans and repurchase agreement transactions. The principal sources of this segment’s liquidity are proceeds from issuance of investment agreements, net investment income, maturities of securities from its investment portfolio (which are invested with the objective of closely matching the cash flows of its obligations under the investment agreements) and net receipts from interest rate, currency and total return swaps. The investment objectives with respect to investment agreements are to achieve the highest after-tax total return, subject to a minimum average quality rating of AA on invested assets, and to maintain a liquid floating rate investment portfolio, which includes short-term investments, to minimize interest rate and liquidity risk. As of December 31, 2006, the investment agreement business floating rate investment portfolio approximates $6.0 billion or 83% of the investment portfolio related to the investment agreement business.

Investment agreements subject Ambac to liquidity risk associated with unscheduled withdrawals of principal allowed by the terms of the investment agreements. Ambac manages liquidity risk by characterizing our investment agreements into two broad categories, contingent and fixed. Contingent draw transactions include contractual provisions that allow the investor to withdraw principal under limited, defined circumstances and require minimal notice to Ambac. The vast majority of these investment agreements can only be drawn in the event that well-defined, observable events have occurred, primarily credit events. In addition, many of these contracts contain lock-out periods where

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unscheduled withdrawals are restricted and compensate Ambac for break-costs resulting from early withdrawal. As of December 31, 2006, approximately $4.9 billion relates to contingent draw investment agreements, of which $0.8 billion include provisions where our counterparty has the ability to withdraw funds prior to maturity during 2007. Fixed draw investment agreements have few provisions for unscheduled withdrawals, however, if permitted, the events triggering the withdrawal are deemed to be remote, require advance notification to Ambac and most often include provisions that compensate Ambac for break costs. At December 31, 2006, approximately $2.6 billion relates to fixed draw investment agreements, of which $1.2 billion include provisions where our counterparty has the ability to withdraw funds during 2007.

Credit Ratings and Collateral. Downgrades in Ambac Assurance’s triple-A financial strength rating would adversely affect Ambac’s ability to compete for business. Credit ratings are an important component of a financial institutions’ ability to compete in the financial guarantee, derivative, investment agreement and structured transaction markets. In the event that Ambac Assurance is downgraded, Ambac may be required to post incremental collateral to its investment agreement and derivative counterparties, introducing liquidity risk. In addition, most investment agreements provide certain remedies, including a termination of the investment agreement contract, for the investment agreement purchaser in the event of a downgrade of Ambac Assurance’s credit rating, typically to A1 by Moody’s or A+ by S&P. In most cases Ambac is permitted to post collateral or otherwise enhance its credit, prior to an actual draw on the investment agreement.

The financial services business executes a range of interest rate and cross-currency swaps to reduce the market risk on investment agreements with Ambac’s derivatives subsidiary, Ambac Financial Services, LLC. In addition, Ambac Financial Services provides interest rate and currency swap transactions for states, municipalities, asset-backed issuers and other entities in connection with their financings. Ambac Financial Services offsets most of the interest rate and currency risks in these instruments and incorporates these transactions under standardized derivative documents including collateral support agreements. Under these agreements, Ambac could be required to post collateral to a swap dealer in the event unrealized losses exceed a predetermined threshold amount. Ambac has posted collateral of $15.7 million under these contracts at December 31, 2006. Conversely, Ambac could receive collateral from the counterparty in the event unrealized gains exceed a predetermined threshold. Ambac has received collateral of $189.2 million under these contracts at December 31, 2006. The thresholds afforded Ambac by the swap dealer would be reduced in the event of a downgrade of Ambac’s credit rating. The reduction in the threshold could result in Ambac posting additional amounts of collateral to the counterparty.

Ambac Capital Services enters into total return swaps and Ambac Credit Products enters into credit derivative contracts. All of our total return swaps and a portion of our credit derivatives have collateral support agreements. In addition, a downgrade of our financial strength rating below specified levels would allow credit derivative counterparties to terminate certain agreements, resulting in a possible payment of a settlement amount or we would have to pledge collateral for the benefit of the counterparty. At December 31, 2006, Ambac has not pledged collateral under any of its credit derivative or total return swap contracts.

Ambac manages this liquidity risk through the maintenance of liquid collateral and bank liquidity facilities. Additionally, Ambac generally has the right to re-hypothecate collateral that it receives under derivative contracts to counterparties.

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Credit Facilities. On July 28, 2005, Ambac and Ambac Assurance, as borrowers, entered into a $400 million five year unsecured, committed revolving credit facility (the “Credit Facility”) with a group of highly rated banks (the “Banks”). The Credit Facility was amended on July 28, 2006 to extend the expiration date from July 28, 2010 to July 28, 2011. The Credit Facility provides for borrowings by Ambac and Ambac Assurance on a revolving basis up to an aggregate of $400 million at any one time outstanding, which maximum amount may, at Ambac’s and Ambac Assurance’s request and subject to the terms and conditions of the facility, be increased up to $500 million.

Ambac and/or Ambac Assurance may borrow under the Credit Facility for general corporate purposes, including the payment of claims. Subject to the terms and conditions thereof, Ambac and/or Ambac Assurance may borrow under the Credit Facility until the final maturity date. Loans may be denominated in U. S. Dollars or certain other currencies at the option of Ambac and/or Ambac Assurance. Ambac and/or Ambac Assurance has the option of selecting either (i) a Base Rate, a fluctuating rate equal to the higher of Citibank’s Base Rate and the Federal Funds Rate plus 0.5%, plus the Applicable Margin (as defined in the Credit Facility) or (ii) a Eurocurrency Rate, a periodic fixed rate equal to LIBOR plus the Applicable Margin. There are no outstanding loans under the Credit Facility. Neither Ambac nor Ambac Assurance have previously incurred any borrowing under this or prior similar facilities.

The Credit Facility contains customary representations, warranties and covenants for this type of financing, including two financial covenants requiring Ambac to: (i) maintain as of the end of each fiscal quarter a debt-to-capital ratio, excluding debt consolidated under FIN 46, of not more than 30%, and (ii) maintain at all times total stockholders’ equity equal to or greater than $2.8 billion. The stockholders’ equity financial covenant will increase annually, in an amount equal to 15% of the prior fiscal year’s net income and 15% of the net proceeds of any future equity issuances. As a result, the stockholders’ equity financial covenant will increase to $2.93 billion for 2007. The Credit Facility also provides for certain events of default with corresponding grace periods, including failure to pay any principal or interest when due, failure to comply with covenants, any material representation or warranty made by Ambac or Ambac Assurance proving to be false in any material respect, certain bankruptcy, insolvency or receivership events affecting Ambac or Ambac Assurance, defaults relating to other indebtedness, imposition of certain judgments and a change in ownership of Ambac and/or Ambac Assurance. Ambac and Ambac Assurance are in full compliance with the terms and conditions of the Credit Facility.

Capital Support. Ambac Assurance has a series of perpetual put options on its own preferred stock. The counterparty to these put options are trusts established by a major investment bank. The trusts were created as a vehicle for providing capital support to Ambac Assurance by allowing it to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put option were exercised, Ambac Assurance would receive up to $800 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose, including the payment of claims. The preferred stock would give investors the rights of an equity investor in Ambac Assurance. Such rights are subordinate to insurance claims, as well as to the general unsecured creditors of Ambac Assurance. Dividend payments on the preferred stock are cumulative, subject to certain limited exceptions, only if Ambac Assurance pays dividends on its common stock. Each trust is restricted to holding high-quality short-term commercial paper investments to ensure that it can meet its obligations under the put option. To fund these investments, each trust has issued its own auction market perpetual securities. Each trust is rated AA/Aa2 by Standard & Poor’s and Moody’s, respectively. During 2006 and 2005, Ambac Assurance incurred fees related to these

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perpetual put options of $3.5 million and $5.0 million, respectively. These fees are included as Corporate expenses on the Consolidated Statements of Operations.

From time to time, Ambac accesses the capital markets to support the growth of its businesses. In February 2006, Ambac filed a Form S-3 with the SEC utilizing a “shelf” registration process for well known seasoned issuers. Under this process, Ambac may issue through February 2009 an unlimited amount of the securities described in the prospectus filed as part of the registration, namely, common stock, preferred stock, debt securities, and warrants of Ambac.

On February 12, 2007, Ambac Financial Group completed the public offering of $400 million aggregate principal amount of Directly Issued Subordinated Capital Securities due 2087 (the “DISCs”). The proceeds from the sale of the DISCs will be used to repurchase $400 million of Ambac’s common stock pursuant to an accelerated share repurchase program.

In connection with the completion of the DISCs Offering, Ambac entered into a replacement capital covenant for the benefit of persons that buy, hold or sell a specified series of long-term indebtedness of Ambac (“DISCs Covered Debt”).

The DISCs replacement capital covenant provides that Ambac will not repay, redeem or purchase, and will cause its subsidiaries not to repay, redeem or purchase, all or any part of the DISCs on or before February 7, 2067, except, with certain limited exceptions, to the extent that, during a specified period prior to the date of that repayment, redemption or purchase, Ambac has received proceeds from the sale of replacement capital securities.

As of the date of this 10-K, the Ambac 5.95% Debentures due 2035, CUSIP No. 023139AE8, constitutes DISCs Covered Debt whose holders are entitled to the benefits of the DISCS Replacement Capital Covenant.

Balance Sheet. Total assets as of December 31, 2006 were $20.27 billion, up 9% compared to total assets of $18.55 billion at December 31, 2005. The increase was primarily due to cash generated from operations during the period. As of December 31, 2006, stockholders’ equity was $6.18 billion, a 15% increase from year-end 2005 stockholders’ equity of $5.38 billion. The increase stemmed primarily from net income during the period. As outlined in the Notes to Consolidated Financial Statements (Note 11) included in Part II, Item 8, Ambac de-consolidated three transactions where it previously concluded it was the primary beneficiary as a result of retrospectively applying FASB Staff Position (FSP) FIN 46(R)-6 as of December 31, 2006.

Ambac Assurance’s investment objectives for the Financial Guarantee portfolio are to maintain an investment duration that closely approximates the expected duration of related financial guarantee liabilities and achieve the highest after-tax net investment income. The Financial Guarantee investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits.

The Financial Services investment portfolio consists primarily of assets funded with proceeds from the issuance of investment agreement liabilities. The investment objectives with respect to investment agreements are to achieve the highest after-tax total return, subject to a minimum average credit quality rating of Aa/AA on invested assets, and to maintain cash flow matching of invested assets to funded liabilities to minimize interest rate and liquidity exposure. The investment portfolio is subject to

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

The following table summarizes the composition of the fair value of Ambac’s investment portfolio by segment at December 31, 2006 and 2005:

(Dollars in millions)	Financial Guarantee			Financial Services			Corporate			Total
2006:
Fixed income securities:
Municipal obligations	$	7,667.4		$	459.4		$	—		$	8,126.8
Corporate obligations		208.2			511.4			—			719.6
Foreign obligations		276.8			—			—			276.8
U.S. government obligations		160.2			13.9			—			174.1
U.S. agency obligations		400.4			389.0			—			789.4
Mortgage and asset-backed securities		905.9			5,807.7			—			6,713.6
Other		13.4			—			1.0			14.4
		9,632.3			7,181.4			1.0			16,814.7
Short-term		229.1			17.1			65.6			311.8
		9,861.4			7,198.5			66.6			17,126.5
Fixed income securities pledged as collateral:
Mortgage and asset-backed securities		—			307.1			—			307.1
Total investments	$	9,861.4		$	7,505.6		$	66.6		$	17,433.6
Percent total		56.6	%		43.0	%		0.4	%		100	%
2005:
Fixed income securities:
Municipal obligations	$	6,434.4		$	462.0		$	—		$	6,896.4
Corporate obligations		90.1			466.1			—			556.2
Foreign obligations		181.7			—			—			181.7
U.S. government obligations		170.4			14.1			—			184.5
U.S. agency obligations		555.6			390.8			—			946.4
Mortgage and asset-backed securities		1,072.9			4,896.4			—			5,969.3
Other		13.3			—			0.9			14.2
		8,518.4			6,229.4			0.9			14,748.7
Short-term		392.1			14.4			65.5			472.0
		8,910.5			6,243.8			66.4			15,220.7
Fixed income securities pledged as collateral:
Mortgage and asset-backed securities		—			371.2			—			371.2
Total investments	$	8,910.5		$	6,615.0		$	66.4		$	15,591.9
Percent total		57.2	%		42.4	%		0.4	%		100	%

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The following table represents mortgage-backed securities guaranteed by either a U.S. government agency or U.S. government sponsored enterprise at December 31, 2006 and 2005 by segment:

(Dollars in millions)	Financial Guarantee		Financial Services		Corporate		Total
2006:
Government National Mortgage Association	$	8.1	$	1.3	$	—	$	9.4
Federal National Mortgage Association		638.9		185.2		—		824.1
Federal Home Loan Mortgage Corporation		253.7		233.8		—		487.5
Vendee Mortgage Trust		—		—		—		—
Total	$	900.7	$	420.3	$	—	$	1,321.0
2005:
Government National Mortgage Association	$	11.1	$	5.0	$	—	$	16.1
Federal National Mortgage Association		758.2		290.3		—		1,048.5
Federal Home Loan Mortgage Corporation		299.0		309.7		—		608.7
Vendee Mortgage Trust		—		2.0		—		2.0
Total .	$	1,068.3	$	607.0	$	—	$	1,675.3

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The following table summarizes, for all securities in an unrealized loss position as of December 31, 2006 and 2005, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position:

	2006				2005
	Estimated		Gross		Estimated		Gross
	Fair		Unrealized		Fair		Unrealized
(Dollars in millions)	Value		Losses		Value		Losses
Municipal obligations in continuous unrealized loss for:
0 – 6 months	$	658.5	$	3.4	$	1,123.4	$	9.8
7 - 12 months		69.9		0.6		212.5		4.0
Greater than 12 months		1,129.3		16.7		278.7		7.7
		1,857.7		20.7		1,614.6		21.5
Corporate obligations in continuous unrealized loss for:
0 – 6 months		34.6		0.1		23.2		1.0
7 - 12 months		33.2		0.2		1.5		—
Greater than 12 months		50.9		0.8		51.1		0.7
		118.7		1.1		75.8		1.7
Foreign obligations in continuous unrealized loss for:
0 – 6 months		78.8		0.9		46.7		0.9
7 - 12 months		26.5		0.3		5.5		0.3
Greater than 12 months		13.1		0.2		14.2		1.6
		118.4		1.4		66.4		2.8
U.S. government obligations in continuous unrealized loss for:
0 – 6 months		28.1		0.1		131.8		0.9
7 – 12 months		—		—		7.4		0.1
Greater than 12 months		123.4		3.1		17.4		0.1
		151.5		3.2		156.6		1.1
U.S. agency obligations in continuous unrealized loss for:
0 – 6 months		351.6		3.6		296.5		4.5
7 – 12 months		—		—		16.6		0.3
Greater than 12 months		121.6		2.8		23.0		1.0
		473.2		6.4		336.1		5.8
Mortgage and asset-backed securities in continuous unrealized loss for:
0 – 6 months		450.5		2.4		1,091.1		9.6
7 - 12 months		75.5		0.6		411.6		3.4
Greater than 12 months		1,153.8		24.0		885.8		19.1
		1,679.8		27.0		2,388.5		32.1
Other in continuous unrealized loss for:
0 – 6 months		0.3		—		0.3		—
7 – 12 months		0.2		—		—		—
Greater than 12 months		—		—		0.5		0.1
		0.5		—		0.8		0.1
Total	$	4,399.8	$	59.8	$	4,638.8	$	65.1

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Management has determined that the unrealized losses in fixed income securities at December 31, 2006 are primarily attributable to the current interest rate environment and that these unrealized losses are temporary in nature based upon (a) no principal and interest payment defaults on these securities; (b) analysis of the creditworthiness of the issuer; and (c) Ambac’s ability and current intent to hold these securities until a recovery in fair value or maturity. Of the $4,399.8 million that were in a gross unrealized loss position at December 31, 2006, below investment grade securities and non-rated securities had a fair value of $0.5 million and unrealized loss of less than $0.1 million, which represented less than 0.1% of the total fair value and total pre-tax unrealized losses shown in the above table. Of the $4,638.8 million that were in a gross unrealized loss position at December 31, 2005, below investment grade securities and non-rated securities had a fair value of $19.8 million and an unrealized loss of $1.0 million, which represented 0.4% of the total fair value and 1.5% of total pre-tax unrealized losses as shown in the above table.

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The following table summarizes amortized cost and fair value for all securities in an unrealized loss position as of December 31, 2006 and 2005, by contractual maturity date:

	2006				2005
(Dollars in millions)	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Municipal obligations:
Due in one year or less	$	—	$	—	$	—	$	—
Due after one year through five years		365.6		361.9		206.9		205.1
Due after five years through ten years		1,095.9		1,082.7		1,066.8		1,052.3
Due after ten years		416.9		413.1		362.4		357.2
		1,878.4		1,857.7		1,636.1		1,614.6
Corporate obligations:
Due in one year or less		—		—		—		—
Due after one year through five years		—		—		17.2		16.3
Due after five years through ten years		25.0		25.0		—		—
Due after ten years		94.8		93.7		60.3		59.5
		119.8		118.7		77.5		75.8
Foreign obligations:
Due in one year or less		22.2		22.1		3.7		3.5
Due after one year through five years		81.4		80.2		58.9		56.3
Due after five years through ten years		16.2		16.1		6.6		6.6
Due after ten years		—		—		—		—
		119.8		118.4		69.2		66.4
U.S. government obligations:
Due in one year or less		49.9		49.6		17.7		17.5
Due after one year through five years		11.2		11.2		57.0		56.7
Due after five years through ten years		37.9		36.8		37.8		37.4
Due after ten years		55.7		53.9		45.2		45.0
		154.7		151.5		157.7		156.6
U.S. agency obligations:
Due in one year or less		56.6		56.1		—		—
Due after one year through five years		256.7		253.3		146.2		143.6
Due after five years through ten years		102.7		100.6		195.7		192.5
Due after ten years		63.6		63.2		—		—
		479.6		473.2		341.9		336.1
Mortgage and asset-backed securities		1,706.8		1,679.8		2,420.6		2,388.5
Other:
Due in one year or less		0.5		0.5		0.9		0.8
Due after one year through five years		—		—		—		—
Due after five years through ten years		—		—		—		—
Due after ten years		—		—		—		—
		0.5		0.5		0.9		0.8
Total	$	4,459.6	$	4,399.8	$	4,703.9	$	4,638.8

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The following table summarizes, for all securities sold at a loss during 2006 and 2005, the aggregate fair value and realized loss by length of time those securities were continuously in an unrealized loss position prior to the sale date:

	2006				2005
			Gross				Gross
	Fair		Realized		Fair		Realized
(Dollars in millions)	Value		Losses		Value		Losses
Municipal obligations in continuous unrealized loss for:
0 – 6 months	$	2.1	$	0.1	$	132.7	$	1.1
7 – 12 months		—		—		—		—
Greater than 12 months		0.4		—		0.4		—
		2.5		0.1		133.1		1.1
Corporate obligations in continuous unrealized loss for:
0 – 6 months		19.0		—		10.6		1.4
7 – 12 months		—		—		—		—
Greater than 12 months		1.5		—		24.6		12.2
		20.5		—		35.2		13.6
U.S. government obligations in continuous unrealized loss for:
0 – 6 months		4.0		—		193.2		1.0
7 – 12 months		—		—		—		—
Greater than 12 months		—		—		—		—
		4.0		—		193.2		1.0
U.S. agency obligations in continuous unrealized loss for:
0 – 6 months		139.0		2.7		272.0		3.6
7 – 12 months		0.1		—		29.6		0.4
Greater than 12 months		—		—		144.8		5.0
		139.1		2.7		446.4		9.0
Mortgage and asset-backed securities in continuous unrealized loss for:
0 – 6 months		48.2		—		313.2		2.1
7 – 12 months		—		—		71.2		0.8
Greater than 12 months		—		—		106.6		2.5
		48.2		—		491.0		5.4
Other securities in continuous unrealized loss for:
0 – 6 months		31.1		0.6		48.2		0.9
7 – 12 months		—		—		—		—
Greater than 12 months		—		—		0.3		0.1
		31.1		0.6		48.5		1.0
Total	$	245.4	$	3.4	$	1,347.4	$	31.1

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Excluded from 2006 and 2005, gross realized losses in the above table were impairment write-downs of $0.1 million and $0.7 million, respectively. The following table provides the ratings distribution of the fixed income investment portfolio at December 31, 2006 and 2005 by segment:

Rating (1):
2006:
	Financial Guarantee		Financial Services		Combined
AAA	87	%	91	%	89	%
AA	11		3		8
A	1		5		3
BBB	<1		1		<1
Below investment grade	0		<1		<1
Not rated	<1		0		<1
	100	%	100	%	100	%
2005:
AAA	88	%	91	%	89	%
AA	11		3		7
A	1		4		2
BBB	<1		2		1
Below investment grade	0		<1		<1
Not rated	<1		<1		<1
	100	%	100	%	100	%

(1) Ratings represent Standard & Poor’s classifications. If unavailable, Moody’s rating is used.

Short-term investments in the Financial Guarantee portfolio consisted primarily of domestic and foreign currency denominated money market funds. Short-term investments in the Financial Services portfolio consisted of domestic money market funds.

Ambac’s fixed income portfolio includes securities covered by guarantees issued by Ambac Assurance (“insured securities”). The published ratings on these securities are triple-A by the major rating agencies as a result of the Ambac Assurance insurance policy and are reflected in the above table as AAA. Rating agencies generally do not publish separate underlying ratings (those ratings excluding the Ambac Assurance insurance) because the insurance cannot be legally separated from the underlying security by the insurer. Ambac obtains underlying ratings through ongoing dialog with rating agencies. In the event these underlying ratings are not available from the rating agencies, Ambac will assign an internal rating. At December 31, 2006, securities with a total carrying value of $748.6 million representing 4% of the investment portfolio with a weighted-average underlying rating of BBB- was insured by Ambac. In determining this BBB- rating, approximately $131.1 million of the securities were assigned internal ratings by Ambac.

Cash Flows. Net cash provided by operating activities was $903.1 million, $1,002.3 million and $950.1 million during 2006, 2005 and 2004, respectively. These cash flows were primarily provided by net insurance premium receipts of $893.2 million, $996.4 million, and $977.4 million in 2006, 2005 and 2004, respectively, partially offset by net claim payments of $105.6 million, $86.7 million and $18.9 million in 2006, 2005 and 2004, respectively. Future net cash provided by operating activities will be impacted by the level of claim payments. 2007 claim payments are estimated to be approximately $0.5 million for credits that are in default at December 31, 2006. Net cash provided by

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(used in) financing activities was $613.2 million, $420.0 million and ($229.9) million during 2006, 2005 and 2004, respectively. Financing activities for the years ended 2006 and 2005 included $932.3 million and $347.6 million, respectively, in net investment and payment agreements issued (net of investment and payment agreement draws), which were provided primarily by the investment agreement business. Financing activities for 2006 included a $200.0 million payment for the redemption of long-term debt, while 2005 included $396.3 million in proceeds from the issuance of long-term debt by Ambac. Financing activities also included net purchases of common stock held in treasury of $65.7 million, $279.1 million and $21.7 million in 2006, 2005 and 2004, respectively. Net cash used in fixed income investing activities in 2006, 2005 and 2004 were $1,933.9 million, $1,347.0 million and $312.3 million, respectively. These investing activities were primarily net purchases of fixed income investment securities. Total cash provided by (used in) operating, investing and financing activities was $4.2 million, $8.4 million and ($5.2) million during 2006, 2005 and 2004, respectively.

SPECIAL PURPOSE and VARIABLE INTEREST ENTITIES

Please refer to Note 2, Significant Accounting Policies” and Note 11, “Special Purpose Entities and Variable Interest Entities” of the Consolidated Financial Statements, located in Part II, Item 8, for information regarding special purpose and variable interest entities.

ACCOUNTING STANDARDS

Please refer to Note 2, “Significant Accounting Policies” of the consolidated Financial Statements, located in Part II, Item 8, for a discussion of the impact of recent accounting pronouncements on Ambac’s financial condition and results of operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

RISK MANAGEMENT

In the ordinary course of business, Ambac manages a variety of risks, principally credit, market, liquidity, operational and legal. These risks are identified, measured and monitored through a variety of control mechanisms, which are in place at different levels throughout the organization.

Credit Risk. Ambac is exposed to credit risk in various capacities including as an issuer of financial guarantees, as counterparty to reinsurers and derivative and other financial contracts and as a holder of investment securities. Ambac’s Portfolio Risk Management Committee (“PRMC”) employs various procedures and controls to monitor and manage credit risk. The PRMC is comprised of senior risk professionals and senior management of Ambac. Its purview is enterprise-wide and its focus is on risk limits and measurement, concentration and correlation of risk, and the attribution of economic and regulatory capital in a portfolio context.

All financial guarantees and credit derivatives issued are subject to a formal credit underwriting process. Various factors affecting the creditworthiness of the underlying obligation are evaluated during the underwriting process. Senior credit personnel approve all transactions prior to issuing a financial guarantee. Subsequent to the issuance of a financial guarantee, credit personnel perform periodic reviews of exposures according to a schedule based on the risk profile of the guaranteed obligations or

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as necessitated by specific credit events or other macro-economic variables. Proactive credit remediation can help secure rights and remedies which mitigate losses in the event of default.

Ambac manages credit risk associated with its investment portfolio through adherence to specific investment guidelines. These guidelines establish limits based upon single risk concentration and minimum credit rating standards. Additionally, senior credit personnel monitor the portfolio on a continuous basis. Credit risk relating to derivative positions (other than credit derivatives) primarily concern counterparty default. The majority of these counterparties are clients of the financial guarantee business which have been subject to our formal underwriting process upon the issuance of a financial guarantee. The counterparty creditworthiness of new clients is separately evaluated by senior credit personnel upon entering these contracts. Counterparty default exposure is mitigated through the use of industry standard collateral posting agreements. For counterparties subject to such collateral posting agreements, collateral is posted when a derivative counterparty’s credit exposure exceeds contractual limits. Please refer to Note 4 “Investments”, located in Part II, Item 8, for disclosures of collateral posted to Ambac under derivative contracts.

To minimize exposure to significant losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of a rating downgrade of a reinsurer. Ambac Assurance held letters of credit and collateral amounting to approximately $366.4 million from its reinsurers as of December 31, 2006. The rating agencies continually review reinsurers providing coverage to the financial guarantee industry. The following table provides ceded par outstanding by financial strength rating of Ambac Assurance’s reinsurers, on a Standard and Poor’s (“S&P”) basis:

(Dollars in billions)	December 31, 2006		December 31, 2005
AAA	$	20.7	$	19.2
AA		27.7		21.1
A		—		2.3
Not rated		—		1.6
Total	$	48.4	$	44.2

Market Risk. Market risk represents the potential for losses that may result from changes in the value of a financial instrument as a result of changes in market conditions. The primary market risks that would impact the value of Ambac’s financial instruments are interest rate risk, basis risk (e.g., taxable interest rates relative to tax-exempt interest rates, discussed below) and credit spread risk. Below we discuss each of these risks and the specific types of financial instruments impacted. Senior managers in Ambac’s Risk Analysis and Reporting group are responsible for monitoring risk limits and applying risk measurement methodologies. The results of this effort are reported to the PRMC. The estimation of potential losses arising from adverse changes in market conditions is a key element in managing market risk. Ambac utilizes various systems, models and stress test scenarios to monitor and manage market risk. This process includes frequent analyses of both parallel and non-parallel shifts in the yield curve, “Value-at-Risk” (“VaR”) and changes in credit spreads. These models include estimates, made by management, which utilize current and historical market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market.

Financial instruments that may be adversely affected by changes in interest rates consist primarily of investment securities, loans, investment agreement liabilities, obligations under payment agreements, long-term debt, and derivative contracts used for hedging purposes. The following table summarizes

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the estimated change in fair value (based primarily on the valuation models discussed above) on these financial instruments, assuming immediate changes in interest rates at specified levels at December 31, 2006 and 2005:

(Dollars in millions)
Change in Interest Rates	Estimated Net Fair Value		Estimated Change in Net Fair Value
2006:
300 basis point rise	$	7,529	$	(1,552	)
200 basis point rise		8,111		(970	)
100 basis point rise		8,627		(454	)
Base scenario		9,081		—
100 basis point decline		9,470		389
200 basis point decline		9,794		713
300 basis point decline		10,055		974
2005:
300 basis point rise	$	6,845	$	(1,294	)
200 basis point rise		7,361		(778	)
100 basis point rise		7,793		(346	)
Base scenario		8,139		—
100 basis point decline		8,398		259
200 basis point decline		8,573		434
300 basis point decline		8,661		522

Ambac, through its subsidiary Ambac Financial Services, is a provider of interest rate swaps to states, municipalities and their authorities and other entities in connection with their financings. Ambac Financial Services manages its municipal interest rate swaps business with the goal of being market neutral to changes in overall rates while retaining some basis risk. Ambac’s municipal interest rate swap portfolio may be adversely affected by changes in basis. If actual or projected tax-exempt interest rates increase or decrease in a parallel shift by 1% in relation to taxable interest rates, Ambac will experience a market-to-market gain or loss of $0.04 million and $0.7 million at December 31, 2006 and 2005, respectively.

A portion of the municipal interest rate swaps transacted by Ambac Financial Services contain provisions that are designed to protect Ambac against certain forms of tax reform, thus mitigating its basis risk. The estimation of potential losses arising from adverse changes in market relationships, known as VaR, is a key element in management’s monitoring of basis risk for the municipal interest rate swap portfolio. Ambac has developed a VaR methodology to estimate potential losses using a one day time horizon and a 99% confidence level. This means that Ambac would expect to incur losses greater than that predicted by VaR estimates only once in every 100 trading days, or about 2.5 times a year. Ambac’s methodology estimates VaR using a 300-day historical “look back” period. This means that changes in market values are simulated using market inputs from the past 300 days. For the years ended December 31, 2006 and 2005, Ambac’s VaR, for its interest rate swap portfolio averaged approximately $1.3 million and $3.3 million, respectively. Ambac’s VaR ranged from a high of $2.3 million to a low of $0.3 million in 2006 and from a high of $7.0 million to a low of $2.5 million in 2005. Ambac supplements its VaR methodology, which is a good risk management tool in normal markets, by performing rigorous stress testing to measure the potential for losses in abnormally volatile markets. These stress tests include (i) parallel and non-parallel shifts in the yield curve and (ii) immediate changes in normal basis relationships, such as those between taxable and tax-exempt markets.

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Financial instruments that may be adversely affected by changes in credit spreads include Ambac’s outstanding credit derivative and total return contracts. Ambac, through its subsidiary Ambac Credit Products, enters into credit derivative contracts. These contracts require Ambac Credit Products to make payments upon the occurrence of certain defined credit events relating to an underlying obligation (generally a fixed income obligation). If credit spreads of the underlying obligations change, the market value of the related credit derivative changes. As such, Ambac Credit Products could experience mark-to-market gains or losses. Market liquidity could also impact valuations. Changes in credit spreads are generally caused by changes in the market’s perception of the credit quality of the underlying obligations. Ambac offers credit derivatives to provide credit protection enabling financial institutions to hedge portfolios of credit risk achieving either economic or regulatory relief. Ambac Credit Products structures its contracts with partial hedges from various financial institutions or with first loss protection. Such structuring mitigates Ambac Credit Products’ risk of loss and reduces the price volatility of these financial instruments. Management models the potential impact of credit spread changes on the value of its contracts.

Ambac, through its subsidiary Ambac Capital Services, enters into total return swap contracts. These contracts require Ambac Capital Services to pay a specified spread in excess of LIBOR in exchange for receiving the total return of an underlying fixed income obligation over a specified period of time. If credit spreads of the underlying obligations change, the market value of the related total return swaps changes and Ambac Capital Services could experience mark-to-market gains or losses.

The following table summarizes the estimated change in fair values (based primarily on the valuation models discussed above) on the net balance of Ambac’s net structured credit and total return swap derivative positions assuming immediate increases in credit spreads at December 31, 2006 and 2005:

(Dollars in millions)
Change in Credit Spreads	Estimated Net Fair Value			Estimated Unrealized Gain/(Loss)
2006:
30 basis point widening	$	(198	)	$	(218	)
20 basis point widening		(126	)		(146	)
10 basis point widening		(53	)		(73	)
Base scenario		20			—
10 basis point narrowing		92			72
20 basis point narrowing		160			140
30 basis point narrowing		173			153
2005:
30 basis point widening	$	(136	)	$	(150	)
20 basis point widening		(86	)		(100	)
10 basis point widening		(36	)		(50	)
Base scenario		15			—
10 basis point narrowing		61			47
20 basis point narrowing		102			87
30 basis point narrowing		123			108

The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates, and other market conditions at the time these fair values are determined. The increase in sensitivities to changes in credit spreads is primarily due to the average tenor of the portfolio.

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Liquidity Risk. Liquidity risk relates to the possible inability to satisfy contractual obligations when due. This risk is present in financial guarantee contracts, derivative contracts and investment agreements. Ambac Assurance manages its liquidity risk by maintaining a comprehensive analysis of projected cash flows. Additionally, the financial guarantee business maintains a minimum level of cash and short-term investments at all times. The investment agreement business manages liquidity risk by closely matching the maturity schedules of its invested assets, including hedges, with the maturity schedules of its investment agreement liabilities. Ambac Financial Services maintains cash and short-term investments and closely matches the date swap payments are made and received. See additional discussion in “Liquidity and Capital Resources” section.

Operational Risk. Operational risk relates to the potential for loss caused by a breakdown in information, communication and settlement systems. Ambac mitigates operational risk by maintaining and testing critical systems (and their system backup) and performing ongoing control procedures to monitor transactions and positions, maintain documentation, confirm transactions and ensure compliance with regulations.

Ambac maintains a disaster recovery site in upstate New York as part of its Disaster Recovery Plan. This remote hot-site facility is complete with user work stations, phone system, data center, internet connectivity and a power generator, capable of serving the needs of the disaster recovery team to support all business segment operations. The plan, facility and systems are revised and upgraded where necessary, and user tested annually to confirm their readiness.

Legal Risk. Legal risks attendant to Ambac’s businesses include uncertainty with respect to the enforceability of the obligations insured by Ambac Assurance and the security for such obligations, as well as uncertainty with respect to the enforceability of the obligations of Ambac’s counterparties, including contractual provisions intended to reduce exposure by providing for the offsetting or netting of mutual obligations. Ambac seeks to remove or minimize such uncertainties through continuous consultation with internal and external legal advisers to analyze and understand the nature of legal risk, to improve documentation and to strengthen transaction structure.

Item 8. Financial Statements and Supplementary Data.

Management’s Responsibility for Financial Information

The management of Ambac Financial Group, Inc. (“Ambac”) is responsible for the integrity and objectivity of the Consolidated Financial Statements and all other financial information presented in this Form 10-K and for assuring that such information fairly presents the consolidated financial position and operating results of Ambac. The accompanying Consolidated Financial Statements have been prepared in conformity with U.S. generally accepted accounting principles using management’s best estimates and judgment. The financial information presented elsewhere in this Form 10-K is consistent with that in the Consolidated Financial Statements.

The independent registered public accounting firm audits Ambac’s Consolidated Financial Statements in accordance with the standards of the Public Company Accounting Oversight Board.

The Audit and Risk Assessment Committee of the Board of Directors, comprised solely of independent directors, meets regularly with financial and risk management, the internal auditors and the independent registered public accounting firm to review the work and procedures of each. The

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independent registered public accounting firm and the internal auditors have free access to the Audit and Risk Assessment Committee, without the presence of management, to discuss the results of their work and their considerations of Ambac and its subsidiaries and the quality of Ambac’s financial reporting. The Audit and Risk Assessment Committee appoints the independent registered public accounting firm, subject to stockholder approval.

Management’s Report on Internal Control Over Financial Reporting

The management of Ambac is responsible for establishing and maintaining adequate internal control over financial reporting. Ambac’s internal control over financial reporting is a process designed under the supervision of the chief executive officer and chief financial officer and effected by Ambac’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of Ambac’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. Ambac’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of Ambac; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of Ambac; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of Ambac’s assets that could have a material effect on the financial statements.

As of December 31, 2006, management conducted an assessment of the effectiveness of Ambac’s internal control over financial reporting based on the framework established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation in relation to the criteria established in Internal Control —Integrated Framework, management concluded that Ambac’s internal control over financial reporting is effective as of December 31, 2006.

Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report which is included herein, which expresses unqualified opinions on management’s assessment and on the effectiveness of Ambac’s internal control over financial reporting as of December 31, 2006.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Ambac Financial Group, Inc.:

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Ambac Financial Group, Inc. and subsidiaries (the “Company” or “Ambac”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that Ambac maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Ambac maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

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We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Ambac as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006, and our report dated February 28, 2007, expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

New York, New York

February 28, 2007

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Ambac Financial Group, Inc.:

We have audited the accompanying consolidated balance sheets of Ambac Financial Group, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of Ambac Financial Group, Inc.’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ambac Financial Group, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, in 2006 Ambac Financial Group, Inc. changed its methods of accounting for variable interest entities and stock-based compensation.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Ambac Financial Group, Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 28, 2007, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

/s/ KPMG LLP

New York, New York

February 28, 2007

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

	December 31,
(Dollars in Thousands, Except per Share Data)	2006			2005
Assets:
Investments:
Fixed income securities, at fair value (amortized cost of $16,484,257 in 2006 and $14,391,506 in 2005)	$	16,800,338		$	14,734,494
Fixed income securities pledged as collateral, at fair value (amortized cost of $311,546 in 2006 and $378,480 in 2005)		307,101			371,160
Short-term investments, at cost (approximates fair value)		311,759			472,034
Other (cost of $13,427 in 2006 and $13,537 in 2005)		14,391			14,173
Total investments		17,433,589			15,591,861
Cash		31,868			27,619
Securities purchased under agreements to resell		273,000			419,000
Receivable for securities sold		12,857			2,161
Investment income due and accrued		193,199			171,331
Reinsurance recoverable on paid and unpaid losses		3,921			3,730
Prepaid reinsurance		315,498			303,383
Deferred acquisition costs		252,115			201,518
Loans		625,422			684,762
Derivative assets		1,019,339			981,068
Other assets		107,005			159,425
Total assets	$	20,267,813		$	18,545,858
Liabilities and Stockholders’ Equity:
Liabilities:
Unearned premiums	$	3,037,544		$	2,940,988
Losses and loss expense reserve		220,074			304,139
Ceded reinsurance balances payable		20,084			23,746
Obligations under investment and payment agreements		8,202,590			7,056,222
Obligations under investment repurchase agreements		154,287			196,568
Deferred income taxes		263,483			263,671
Current income taxes		49,920			16,726
Long-term debt		991,804			1,191,735
Accrued interest payable		105,129			99,892
Derivative liabilities		667,066			807,527
Other liabilities		275,670			250,241
Payable for securities purchased		95,973			11,641
Total liabilities		14,083,624			13,163,096
Stockholders’ equity:
Preferred stock, par value $0.01 per share; authorized shares — 4,000,000; issued and outstanding shares — none		—			—
Common stock, par value $0.01 per share; authorized shares — 350,000,000; issued and outstanding shares — 109,193,096 at December 31, 2006 and at December 31, 2005		1,092			1,092
Additional paid-in capital		790,168			723,680
Accumulated other comprehensive income		197,576			202,312
Retained earnings		5,454,575			4,703,256
Common stock held in treasury at cost, 3,462,543 at December 31, 2006 and 3,553,650 shares at December 31, 2005		(259,222	)		(247,578	)
Total stockholders’ equity		6,184,189			5,382,762
Total liabilities and stockholders’ equity	$	20,267,813		$	18,545,858

See accompanying Notes to Consolidated Financial Statements.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(Dollars in Thousands, Except Share Data)	Years Ended December 31,
	2006		2005		2004
Revenues:
Financial Guarantee:
Gross premiums written	$996,669		$1,096,023		$1,048,336
Ceded premiums written	(103,496	)	(99,673	)	(70,946	)
Net premiums written	$893,173		$996,350		$977,390
Net premiums earned	$811,623		$816,324		$717,184
Other credit enhancement fees	59,760		50,091		47,326
Net premiums earned and other credit enhancement fees	871,383		866,415		764,510
Net investment income	423,885		378,096		355,262
Net realized investment gains	7,085		6,307		30,004
Net mark-to-market gains on credit derivative contracts	9,068		13,618		17,734
Other income (loss)	39,559		12,467		(3,947	)
Financial Services:
Investment income	391,732		270,299		198,800
Derivative products	16,638		15,757		26,399
Net realized investment gains	59,255		2,314		5,099
Net mark-to-market gains on total return swap contracts	2,508		1,330		9,376
Net mark-to-market (losses) gains on non-trading derivative contracts	(1,414	)	44,201		(3,329	)
Corporate:
Net investment income	11,614		3,345		1,674
Net realized investment gains (losses)	791		—		(18	)
Total revenues	1,832,104		1,614,149		1,401,564
Expenses:
Financial Guarantee:
Losses and loss expenses	20,004		149,856		69,600
Underwriting and operating expenses	133,740		117,701		106,563
Financial Services:
Interest from investment and payment agreements	359,904		239,255		168,943
Other expenses	12,389		13,683		14,671
Interest	75,294		55,896		54,322
Corporate	20,560		14,994		10,683
Total expenses	621,891		591,385		424,782
Pre-tax income from continuing operations	1,210,213		1,022,764		976,782
Provision for income taxes	334,302		271,754		250,942
Net income from continuing operations	875,911		751,010		725,840
Discontinued Operations:
Pre-tax loss from discontinued operations	—		—		(1,349	)
Income tax benefit	—		—		(60	)
Net loss from discontinued operations	—		—		(1,289	)
Net income	$875,911		$751,010		$724,551
Earnings per share:
Income from continuing operations	$8.22		$6.94		$6.62
Discontinued operations	$0.00		$0.00		$(0.01	)
Net income	$8.22		$6.94		$6.61
Earnings per diluted share:
Income from continuing operations	$8.15		$6.87		$6.54
Discontinued operations	$0.00		$0.00		$(0.01	)
Net income	$8.15		$6.87		$6.53
Weighted-average number of common shares outstanding:
Basic	106,593,409		108,280,281		109,602,601
Diluted	107,536,339		109,394,985		110,898,854

See accompanying Notes to Consolidated Financial Statements.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Dollars in Thousands) Years Ended December 31,	2006						2005						2004
Retained Earnings:
Balance at January 1	$	4,703,256					$	4,042,644					$	3,390,653
Net income		875,911		$	875,911			751,010		$	751,010			724,551		$	724,551
Dividends declared – common stock		(69,910	)					(58,805	)					(50,910	)
Dividends on restricted stock units		(636	)					—						—
Exercise of stock options		(54,046	)					(31,593	)					(21,650	)
Balance at December 31	$	5,454,575					$	4,703,256					$	4,042,644
Accumulated Other Comprehensive Income:
Balance at January 1	$	202,312					$	296,814					$	266,919
Unrealized (losses) gains on securities, ($26,882), ($124,780), and $15,131, pre-tax, in 2006, 2005 and 2004, respectively (1)					(15,396	)					(87,280	)					8,368
Gains on derivative hedges, $9,210, $1,205, and $29,725 pre-tax in 2006, 2005 and 2004, respectively					5,149						1,122						17,851
Adjustment to initially apply FASB Statement No. 158, ($3,518) pre-tax in 2006					(2,287	)					—						—
Foreign currency gain (loss)					7,798						(8,344	)					3,676
Other comprehensive (loss) income		(4,736	)		(4,736	)		(94,502	)		(94,502	)		29,895			29,895
Total comprehensive income				$	871,175					$	656,508					$	754,446
Balance at December 31	$	197,576					$	202,312					$	296,814
Preferred Stock:
Balance at January 1 and December 31	$	—					$	—					$	—
Common Stock:
Balance at January 1	$	1,092					$	1,089					$	1,073
Issuance of stock		—						3						16
Balance at December 31	$	1,092					$	1,092					$	1,089
Additional Paid-in Capital:
Balance at January 1	$	723,680					$	694,465					$	606,468
Stock based compensation		48,669						17,986						19,223
Excess tax benefit related to share-based compensation		17,819						9,468						29,499
Issuance of stock		—						1,761						43,973
Capital issuance costs		—						—						(4,698	)
Balance at December 31	$	790,168					$	723,680					$	694,465
Common Stock Held in Treasury at Cost:
Balance at January 1	$	(247,578	)				$	—					$	—
Cost of shares acquired		(126,703	)					(309,670	)					(51,781	)
Shares issued under equity plans		115,059						62,092						51,781
Balance at December 31	$	(259,222	)				$	(247,578	)				$	—
Total Stockholders’ Equity at December 31	$	6,184,189					$	5,382,762					$	5,035,012

(1) Disclosure of reclassification amount:	2006			2005			2004
Unrealized holding (losses) gains arising during period	$	(10,505	)	$	(84,273	)	$	32,062
Less: reclassification adjustment for net gains included in net income		4,891			3,007			23,694
Net unrealized (losses) gains on securities	$	(15,396	)	$	(87,280	)	$	8,368

See accompanying Notes to Consolidated Financial Statements.

78

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

	Years Ended December 31,
(Dollars in Thousands)	2006			2005			2004
Cash flows from operating activities:
Net income	$	875,911		$	751,010		$	724,551
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,865			4,287			2,890
Amortization of bond premium and discount		3,288			(2,736	)		(4,475	)
Share-based compensation		37,199			17,987			19,354
Current income taxes		33,194			16,544			10,412
Deferred income taxes		5,055			71,275			19,990
Deferred acquisition costs		(31,212	)		(17,429	)		(9,470	)
Unearned premiums, net		84,441			169,772			261,534
Losses and loss expenses		(84,256	)		63,119			50,906
Ceded reinsurance balances payable		(3,662	)		5,498			2,865
Investment income due and accrued		(21,868	)		(11,140	)		(752	)
Accrued interest payable		5,237			31,012			(5,061	)
Net realized investment gains		(67,131	)		(8,621	)		(35,085	)
Other, net		64,072			(88,245	)		(87,594	)
Net cash provided by operating activities		903,133			1,002,333			950,065
Cash flows from investing activities:
Proceeds from sales of bonds		850,015			2,189,299			2,941,467
Proceeds from matured bonds		1,954,943			1,469,583			1,381,664
Proceeds from the sales of Cadre Financial Services, Inc.		—			—			3,676
Purchases of bonds		(4,738,905	)		(5,005,902	)		(4,635,443	)
Change in short-term investments		160,275			49,192			(270,844	)
Securities purchased under agreements to resell		146,000			(66,000	)		(298,985	)
Loans, net		59,340			2,131			159,575
Recoveries from impaired investments		55,474			—			—
Other, net		753			(52,298	)		(6,415	)
Net cash used in investing activities		(1,512,105	)		(1,413,995	)		(725,305	)
Cash flows from financing activities:
Dividends paid		(69,910	)		(58,805	)		(50,910	)
Securities sold under agreements to repurchase		—			—			(225,500	)
Proceeds from issuance of investment and payment agreements		2,389,288			1,652,029			2,053,150
Payments for investment and payment draws		(1,456,984	)		(1,304,384	)		(2,040,327	)
Proceeds from issuance of long-term debt		—			396,332			—
Payments for redemption of long-term debt		(200,000	)		—			—
Capital issuance costs		(3,498	)		(5,035	)		(4,698	)
Net cash collateral received		2,196			17,175			16,062
Issuance of common stock		—			1,764			43,989
Purchases of treasury stock		(126,703	)		(309,670	)		(51,781	)
Proceeds from sale of treasury stock		61,013			30,608			30,073
Excess tax benefit related to share-based compensation		17,819			—			—
Net cash provided by (used in) financing activities		613,221			420,014			(229,942	)
Net cash flow		4,249			8,352			(5,182	)
Cash at January 1		27,619			19,267			24,449
Cash at December 31	$	31,868		$	27,619		$	19,267
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes	$	248,186		$	185,927		$	180,333
Interest expense on long-term debt	$	79,860		$	46,120		$	55,166
Interest on investment agreements	$	359,581		$	250,935		$	157,576
Cash received during the year for:
Income taxes	$	—		$	896		$	—

See accompanying Notes to Consolidated Financial Statements.

79

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

1        BACKGROUND

Ambac is a holding company incorporated in the state of Delaware. Ambac through its subsidiaries provides financial guarantees and financial services to clients in both the public and private sectors around the world. Ambac’s principal operating subsidiary, Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch Inc. Ambac’s Financial Services segment provides financial and investment products including investment agreements, funding conduits, interest rate, currency and total return swaps, principally to its insurance clients.

2        SIGNIFICANT ACCOUNTING POLICIES

The accompanying consolidated financial statements of Ambac and subsidiaries have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosures of contingent assets and liabilities. Actual results could differ from those estimates. The significant accounting policies of Ambac are described below:

Consolidation:

The consolidated financial statements include the accounts of Ambac and all other entities in which Ambac has a controlling financial interest. All significant intercompany balances have been eliminated. The usual condition for a controlling financial interest is ownership of a majority of the voting interests of an entity. However, a controlling financial interest may also exist in entities, such as special purpose entities (“SPEs”), through arrangements that do not involve controlling voting interests.

There are two different accounting frameworks applicable to SPEs; the qualifying SPE (“QSPE”) framework under Statement of Financial Accounting Standards (“SFAS”) No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125”); and the variable interest entity (“VIE”) framework under Financial Interpretation Number (“FIN”) 46R “Consolidation of Variable Interest Entities”. The applicable framework depends on the nature of the entity and Ambac’s relation to that entity.

The QSPE framework is applicable when an entity transfers (sells) financial assets to a SPE meeting certain criteria as defined in SFAS 140. These criteria are designed to ensure that the activities of the entity are essentially predetermined in their entirety at the inception of the vehicle; decision making is limited and restricted to certain events, and that the transferor of the financial assets cannot exercise control over the entity and the assets therein. Entities meeting these criteria are not consolidated by the transferor or other counterparties, as long as the entity does not have the unilateral ability to liquidate or to cause it to no longer meet the QSPE criteria. Ambac follows the QSPE model for its medium-term note issuance program and does not consolidate those SPEs.

80

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

When the SPE does not meet the QSPE criteria, consolidation is assessed pursuant to FIN 46(R). Under FIN 46(R), a VIE is defined as an entity that is not assessed for consolidation by determining which party maintains a controlling financial interest. As such, a VIE (i) lacks enough equity investment at risk to permit the entity to finance its activities without additional subordinated financial support from other parties, (ii) equity owners lack the right to make significant decisions affecting the entity’s operations, and (iii) equity owners do not have an obligation to absorb or the right to receive the entity’s losses or returns.

FIN 46(R) requires a variable interest holder (e.g., an investor in the entity or a financial guarantor) to consolidate that VIE if that holder will absorb a majority of the expected losses of the VIE, receive a majority of the residual returns of the VIE, or both. Ambac determines whether it is the primary beneficiary of a VIE by first performing a qualitative analysis of the VIE that includes, among other factors, its capital structure, contractual terms, which variable interests create or absorb variability, related party relationships and the design of the VIE. When qualitative analysis is not conclusive Ambac performs a quantitative analysis.

In April of 2006, the FASB issued FASB Staff Position (FSP) FIN 46(R)-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)”. FSP FIN 46(R)-6 requires that the analysis of VIEs, in accordance with FIN 46(R), be based on the design of the entity (referred to as a “by design” approach). This evaluation requires an analysis of the nature of risks in a VIE, determining the purpose for which the entity was created, and determining the variability the VIE was designed to create and pass along to its interest holders. Accordingly, Ambac elected to consider, in its consolidation evaluation, the facts and circumstances surrounding the design of transactions, including participation of all interested parties. This evaluation considers the nature of all subordinate variable interest holders within the design of the transaction. FSP FIN 46(R)-6 permitted retrospective application to the date of the initial application of FIN 46(R). Under this provision, Ambac elected to retrospectively apply the new guidance as of December 31, 2006. As a result of retrospectively applying FSP FIN 46(R)-6, Ambac de-consolidated three transactions where it previously had concluded it was the primary beneficiary. Previous reporting periods have also been adjusted to reflect the effects of this de-consolidation. All previously consolidated VIEs are bankruptcy remote special purpose financing entities created by the issuer of debt securities to facilitate the sale of notes guaranteed by Ambac Assurance. Ambac is not primarily liable for the debt obligations of these entities. Ambac would only be required to make payments on these debt obligations in the event that the issuer defaults on any principal or interest due. Additionally, Ambac’s creditors do not have rights with regard to the assets of these VIEs.

Investments:

Ambac’s investment portfolio is accounted for on a trade-date basis and consists primarily of investments in fixed income securities that are considered available-for-sale as defined by SFAS 115 “Accounting for Certain Investments in Debt and Equity Securities”. Available-for-sale securities are reported in the financial statements at fair value with unrealized gains and losses, net of deferred taxes, reflected in Accumulated Other Comprehensive Income in Stockholders’ Equity and are computed using amortized cost as the basis. Ambac purchases certain securities which are considered trading

81

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

securities as defined by SFAS 115. These securities are reported in the financial statements at fair value in “Other Investments”. Net gains and losses from sales and changes in fair value are reported in “Derivative Products” revenue in the consolidated Statements of Operations. Fair value is based primarily on quotes obtained from independent market sources. When quotes are not available, valuation models are used to estimate fair value. These models include estimates, made by management, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. For purposes of computing amortized cost, premiums and discounts are accounted for using the effective interest method. For bonds purchased at a price below par value, discounts are accreted over the remaining term of the securities even if they are callable. For bonds purchased at a price above par value that have call features, premiums are amortized to the call date that produces the lowest yield, typically the first call date. For premium bonds that do not have call features, such premiums are amortized over the remaining terms of the securities. Premiums and discounts on mortgage-backed and asset-backed securities are adjusted for the effects of actual and anticipated prepayments on a retrospective basis. Short-term investments are carried at cost, which approximates fair value. Realized gains and losses on the sale of investments are determined on the basis of specific identification.

Ambac has a formal impairment review process for all securities in its investment portfolio. Ambac conducts a review each quarter to identify and evaluate investments that have indications of possible impairment. An investment in a debt security is impaired if its fair value falls below its amortized cost and the decline is considered “other than temporary.” If we believe a decline in the value of a particular investment is temporary, we record the decline as an unrealized loss; net of tax in Accumulated Other Comprehensive Income in Stockholders’ Equity on our Consolidated Balance Sheets. If we believe the decline is “other than temporary”, we write-down the carrying value of the investment and record a loss on our Consolidated Statements of Operations. Factors considered when assessing impairment include: (i) debt securities whose fair values have declined by 20% or more below amortized cost; (ii) debt securities whose market values have declined by 5% or more but less than 20% below amortized cost for a continuous period of at least six months; (iii) recent downgrades by rating agencies; (iv) the financial condition of the issuer; (v) whether scheduled interest payments are past due; and (vi) whether Ambac has the ability and intent to hold the security for a sufficient period of time to allow for anticipated recoveries in fair value. Ambac’s assessment of a decline in value includes management’s current judgment regarding facts and circumstances specific to a security and the factors noted above. If that judgment changes in the future, Ambac may ultimately record a loss after having originally concluded that the decline in value was temporary.

Repurchase Agreements:

Securities purchased under agreements to resell and securities sold under agreements to repurchase, represent short-term collateralized financing transactions and are recorded at their contracted amounts, plus accrued interest. Ambac nets securities purchased under agreements to resell and securities sold under agreements to repurchase that are executed with the same counterparty under legally enforceable netting agreements that meet the applicable netting criteria. Ambac takes possession of securities purchased under agreements to resell, makes delivery of securities sold under agreements to repurchase, monitors the market value of these securities on a daily basis and delivers or obtains

82

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

additional collateral as appropriate. At December 31, 2006 and 2005, collateral underlying securities purchased under agreements to resell had an average credit rating of triple-A and a weighted average maturity of 43 days and 93 days, respectively.

Deferred Acquisition Costs:

Financial guarantee insurance costs that vary with and are primarily related to the production of business, have been deferred. Ambac periodically conducts a study to determine the amount of operating costs that vary with and primarily relate to the acquisition of business and qualify for deferral. These costs include compensation of employees, marketing, and certain other underwriting expenses, net of reinsurance ceding commissions. Premium taxes and reinsurance commissions are deferred in their entirety. Costs associated with credit derivatives are expensed as incurred. The deferred acquisition costs are being amortized over the periods in which the related premiums are earned. Amortization of deferred acquisition costs is adjusted to reflect acceleration of premium revenue due to refundings or calls and to reflect changes in the estimated lives of certain insured obligations amounted to $38,221, $30,582 and $25,260 for 2006, 2005 and 2004, respectively.

Loans:

Loans are reported at their outstanding unpaid principal balances. Interest income is accrued on the unpaid principal balance. A loan is considered impaired when, based on current events and the financial condition of the issuer, it is probable that Ambac will be unable to collect all principal and interest due according to the contractual terms of the loan agreement.

Losses and Loss Expenses:

Ambac’s financial guarantee insurance is a promise to pay scheduled interest and principal if the issuer of the insured obligation fails to meet its obligation. The loss reserve policy for financial guarantee insurance discussed in this footnote relates only to Ambac’s non-derivative insurance business. The policy for derivative contracts is discussed in the section entitled “Derivative Contracts”. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. In most instances, claim payments are forecasted in advance of issuer default as a result of active surveillance of the insured book of business and observation of deterioration in the obligor’s credit standing. Based upon Ambac’s experience, claim payments become probable and estimable once the issuer’s credit profile has migrated to certain impaired credit levels. The trustee, on behalf of the insured party, named beneficiary, or custodian has the right to make a claim under Ambac’s financial guarantee insurance policy at the first scheduled debt service date of the defaulted obligation. As discussed in the last paragraph of this section, the accounting for credit loss reserves is subject to change.

The liability for losses and loss expenses consists of active credit and case basis credit reserves. Active credit reserves are for probable and estimable losses due to credit deterioration on insured credits that have not yet defaulted or been reported and are reflected on an undiscounted basis as of the

83

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

reporting date. The establishment of reserves for exposures that have not yet defaulted is a common practice in the financial guarantee industry. However, Ambac is aware that there are differences in the specific methodologies applied by other financial guarantors in establishing such reserves. Ambac’s active credit reserve is based on management’s on-going review of the non-derivative financial guarantee credit portfolio. Active surveillance of the insured portfolio enables Ambac’s Surveillance Group to track credit migration of insured obligations from period to period and prepare an adversely classified credit listing. The active credit reserve is established only for adversely classified credits. The criteria for an exposure to be included on the adversely classified credit listing includes the deterioration in an issuer’s financial condition, underperformance of the underlying collateral (for collateral dependent transactions such as mortgage-backed securitizations), problems with the servicer of the underlying collateral and other adverse economic events or trends. The servicer of the underlying collateral of an insured securitization transaction is a consideration in assessing credit quality because the servicer’s performance can directly impact the performance of the related issue. For example, a servicer of a mortgage-backed securitization that does not remain current in its collection efforts could cause an increase in the delinquency and potential default of the underlying obligation.

The active credit reserve is established through a process that begins with estimates of probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac’s internal system of credit ratings, which are analogous to the risk ratings of the major rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) the net par outstanding on the adversely classified credit. The loss severities and default information are based on rating agency information and are specific to each bond type and are established and approved by Ambac’s Portfolio Risk Management Committee. The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac. For certain adversely classified credit exposures, Ambac’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities applied to adversely classified credits can include various actions by Ambac. The most common actions include obtaining detailed appraisal information on collateral, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical approach discussed above. Senior management meets at least quarterly with the Surveillance Group to review the status of their work to determine the adequacy of Ambac’s loss reserves and make any necessary adjustments. Active credit reserves were $172,644 and $197,607 at December 31, 2006 and 2005, respectively. The active credit reserves at December 31, 2006 and 2005 were comprised of 55 and 88 credits with net par outstanding of $3,830,759 and $6,319,724, respectively. Included in the calculation of active credit reserves at December 31, 2006 and 2005 was the consideration of $6,859 and $17,479, respectively, of reinsurance which would be due to Ambac from reinsurers, upon default of the insured obligation.

Case basis credit reserves are for losses on insured obligations that have defaulted. We believe our definition of case basis credit reserves differs from other financial guarantee industry participants. Upon the occurrence of a payment default, the related active credit reserve is transferred to case basis credit

84

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

reserve. Additional provision for losses upon further credit deterioration of a case basis exposure are initially recorded through the active credit reserve and subsequently transferred to case basis credit reserves. Our case reserves represent the present value of anticipated loss and loss expense payments expected over the estimated period of default. Loss and loss expenses consider anticipated defaulted debt service payments, estimated expenses associated with settling the claims and estimated recoveries under collateral and subrogation rights. The estimate does not consider future installment premium receipts, as the likelihood of such receipts is remote. Ambac discounts these estimated net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio.

Case basis credit reserves were $47,430 and $106,532 at December 31, 2006 and 2005, respectively. The discount rate applied to case basis credit reserves was 4.50% and 4.75% at December 31, 2006 and 2005, respectively. The case basis credit reserves at December 31, 2006 and 2005 were comprised of 7 and 10 credits, respectively, with net par outstanding of $668,440 and $838,975, respectively. Additionally, we have reinsurance recoverables on case basis credit reserves of $4,972 and $3,468 at December 31, 2006 and 2005, respectively.

Ambac provides information on the classification of its loss reserve between active credit reserve and case basis credit reserve for the purpose of disclosing the components of the total reserve that relate to exposures that have not yet defaulted and those that have defaulted. The total reserve (active credit and case basis) was $220,074 and $304,139 at December 31, 2006 and 2005, respectively. Due to the relatively small number and large size of certain insured obligations comprising the active and case basis credit reserves, improvements or further deterioration in any one credit may significantly impact our loss provision in a given period. The provision for losses and loss expenses in the accompanying Consolidated Statements of Operations represents the expense recorded to bring the total reserve to a level determined by management to be adequate for losses inherent in the non-derivative financial guarantee insurance portfolio. Ambac’s management believes that the reserves for losses and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.

Our liabilities for credit losses are based in part on the short-duration accounting guidance in SFAS No. 60, “Accounting and Reporting by Insurance Enterprises.” The trustee (on behalf of the insured party), named beneficiary or custodian has a right to a claim payment under the financial guarantee insurance policy at the date of the first scheduled debt service payment of a defaulted security in the amount equal to the payment shortfall. We believe a loss event occurs for financial guarantee insurance products at the time the issuers’ financial condition deteriorates to an impaired credit status rather than at the time the insured party has a right to a claim payment. Because of this belief and the ambiguities discussed below in the application of SFAS No. 60 to the financial guarantee industry, Ambac does not believe that SFAS No. 60 alone provides sufficient guidance. As a result, Ambac supplements the guidance in SFAS No. 60 with the guidance in SFAS No. 5, “Accounting for Contingencies,” which calls for a loss to be accrued if it is probable that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. Ambac also relies by analogy on EITF Issue No. 85-20, “Recognition of Fees for Guaranteeing a Loan,” which states that a guarantor should perform an ongoing assessment of the probability of loss to determine if a liability (and a loss) should be recognized under SFAS No. 5.

85

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

In management’s view, the accounting guidance noted above does not comprehensively address the attributes of financial guarantee insurance contracts, primarily due to the fact that SFAS No. 60 was developed prior to the maturity of the financial guarantee industry. Financial guarantee contracts have elements of long-duration insurance contracts in that they are generally irrevocable and extend over a period of time that may be 30 years or more but are considered and reported for regulatory purposes as property and casualty insurance, normally considered short-duration contracts. The short-duration and long-duration classifications have different methods of accounting for premium revenue, deferred acquisition costs and contract liability recognition.

Ambac is aware that there are certain differences regarding the measurement of liabilities for credit losses among participants in the financial guarantee industry. Difficulties applying the existing insurance accounting literature such as the classification of the insurance contracts as either short-duration or long-duration to the attributes of financial guarantee insurance, different measurement models and assumptions utilized, regulatory guidance provided to certain entities, and the existence of accounting literature providing guidance with respect to liability recognition for loan guarantees are the reasons for differences among the industry participants.

In January and February of 2005, the Securities and Exchange Commission staff discussed with the financial guarantee industry participants differences in loss reserve recognition practices among those participants. In June 2005, the Financial Accounting Standards Board (“FASB”) added a project to its agenda to consider the accounting by financial guarantee insurers for claims liability recognition, premium recognition and deferred acquisition costs. The proposed and final guidance are expected to be issued in 2007. When the FASB reaches a final resolution on this issue, Ambac and the rest of the financial guarantee industry may be required to change some aspects of their loss reserving policies and premium and expense recognition. Until a final standard is released, Ambac cannot predict how the FASB will resolve this issue and the resulting impact on our financial statements. Until the issue is resolved, Ambac intends to continue to apply its existing policy with respect to the establishment of both case and active credit reserves.

Obligations under Investment and Payment Agreements and Investment Repurchase Agreements:

Obligations under investment and payment agreements and investment repurchase agreements are recorded as liabilities on the Consolidated Balance Sheets at amortized cost. The carrying value of these obligations is adjusted for principal paid and interest credited to the account as well as any fair value hedge adjustments. These fair value hedge adjustments are discussed further in “Derivative Contracts used for Hedging Purposes” below. Interest expense is computed based upon daily outstanding liability balances at rates and periods specified in the agreements.

Net Premiums Earned:

Gross premiums are received either upfront (typical of public finance obligations), or in installments (typical of structured finance obligations). Up-front insurance premiums written are received for an entire bond issue, which may contain several maturities; and are recorded as unearned premiums. The premium is allocated to each bond maturity proportionately based on total principal

86

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

amount guaranteed and is recognized as premiums on a straight-line basis over the term of each maturity. Installment insurance premiums written are recognized as premiums earned over each installment period, typically one year or less, on a straight-line basis. Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. When an issue insured by Ambac Assurance has been refunded or called, the remaining unrecognized premium (net of refunding credits, if any) is recognized at that time.

Premiums ceded to reinsurers reduce the amount of net premiums earned by Ambac from its financial guarantee insurance policies. For both up-front and installment premiums, ceded premiums written are primarily recognized in earnings in proportion to and at the same time the related gross premium revenue is recognized. Prepaid reinsurance represents the portion of premiums ceded to reinsurers relating to unearned premiums ceded under reinsurance contracts.

Financial Services Revenue:

Ambac’s Financial Services revenues includes the following products:

Investment agreements – Ambac provides investment agreements and investment repurchase agreements principally to asset-backed and structured finance issuers, states, municipalities and municipal authorities, whereby Ambac agrees to pay an agreed-upon return based on funds deposited. Proceeds from these investment agreement and investment repurchase agreement obligations are used to invest in high credit quality fixed income investments. Interest income from these investments is included in Financial Services revenues.

Interest rate, currency swaps and total return swaps – Ambac provides interest rate and currency swaps principally to states, municipalities and their authorities and asset-backed issuers in connection with their financings. Ambac also enters into total return swaps, which contain contractual provisions similar to credit default swaps, with various financial institutions. All interest rate, currency and total return swap revenues are accounted for as “Derivative Contracts Classified as Held for Trading Purposes,” which is discussed in the Derivatives Contracts section below.

Derivative Contracts:

SFAS 133 “Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS 138 and SFAS 149”, establishes accounting and reporting standards for derivative instruments. All derivatives, whether designed for hedging relationships or not, are required to be recorded on the Consolidated Balance Sheets at fair value. When available, quotes are obtained from independent market sources. However, when quotes are not available, Ambac uses internally developed valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. The valuation results from these models could differ materially from amounts that would actually be realized in the market. In accordance with the Emerging Issues Task Force (EITF) Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (EITF 02-3), recognition of a trading

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

profit at inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating observable market data. Ambac defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. The deferral is recognized in income when the market data becomes observable or over the life of the transaction. The fair value includes an adjustment for counterparty credit risk and other adjustments, as appropriate, to reflect liquidity and ongoing servicing costs.

All derivative contracts are recorded on the Consolidated Balance Sheets on a gross basis; assets and liabilities are netted by customer only when a legal right of set-off exists. Gross asset and gross liability balances for all derivatives are recorded as Derivative Assets or Derivative Liabilities on the Consolidated Balance Sheets.

Derivative Contracts Classified as Held for Trading Purposes:

Financial Guarantee Credit Derivatives:

Ambac Assurance Corporation, through its subsidiary Ambac Credit Products, enters into credit derivative transactions with various financial institutions. Management views these credit derivative transactions as an extension of its financial guarantee business, under which Ambac intends to hold its position for the entire term of the related contract. These credit derivative contracts are accounted for at fair value since they do not qualify for the financial guarantee scope exception under SFAS 133, as amended. Changes in fair value are recorded in the Consolidated Statement of Operations. The fee component is reflected in “Other Credit Enhancement Fees”, and the mark-to-market gains or losses associated with fair value changes are reflected in “Net Mark-to-Market Gains on Credit Derivative Contracts”.

Financial Services – Derivative Products:

Ambac, through its subsidiary Ambac Financial Services, provides interest rate and currency swaps to states, municipalities and their authorities, asset-backed issuers and other entities in connection with their financings. Ambac Capital Services enters into total return swaps with professional counterparties. Total return swaps are primarily referenced to fixed income obligations, which meet Ambac Assurance’s financial guarantee credit underwriting criteria. These contracts are recorded on trade date at fair value. Changes in fair value are recorded in the Consolidated Statements of Operations. The entire change in fair value of interest rate and currency swaps and the fee component of total returns swaps are reflected in “Derivative Product Revenues” and the mark-to-market gains or losses associated with the fair value changes on total return swaps are reflected in “Net Mark-to-Market Gains on Total Return Swap Contracts”.

Derivative Contracts used for Non-Trading and Hedging Purposes:

In order to qualify for hedge accounting, a derivative must be considered highly effective at reducing the risk associated with the exposure being hedged. Each derivative must be designated as a

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

hedge, with documentation of the risk management objective and strategy, including identification of the hedging instrument, the hedged item, the risk exposure, and how effectiveness will be assessed prospectively and retrospectively. The extent to which a hedging instrument is effective at achieving offsetting changes in fair values or cash flows must be assessed at least quarterly. Any ineffectiveness must be reported in net income.

Interest rate and currency swaps are utilized to hedge exposure to changes in fair value of assets or liabilities resulting from changes in interest rates and foreign exchange rates, respectively. These interest rate and currency swap hedges are referred to as “fair value” hedges. Gains and losses on derivative hedges are recognized currently in net income. If the provisions of the derivative contract meet the technical requirements for hedge accounting under SFAS 133, the change in fair value (gain or loss) on the hedged asset or liability attributable to the hedged risk (interest rate or foreign exchange risk) adjusts the carrying amount of the hedged item and is recognized currently in net income. The net amount representing hedge ineffectiveness, recorded as a component of “Net mark-to-market (losses) gains on non-trading derivative contracts” in the accompanying Consolidated Statements of Operations, was ($1,313), ($673) and $132 for 2006, 2005 and 2004, respectively.

Interest rate swaps are also utilized to hedge the exposure to changes in cash flows caused by variable interest rates. These interest rate swap hedges are referred to as “cash flow” hedges. Gains and losses on interest rate swaps that meet the technical requirements for cash flow hedge accounting under SFAS 133 are reported in “Accumulated Other Comprehensive Income” in Stockholders’ Equity, until earnings are affected by the variability in cash flows of the designated hedged item. During 2006 and 2005, $362 and $612, respectively, of cash flow hedge ineffectiveness was reported in net income with no cash flow hedge ineffectiveness reported in net income for 2004. As of December 31, 2006, $757 of pre-tax deferred losses on derivative instruments reported in Accumulated Other Comprehensive Income are expected to be reclassified to net income during the next twelve months. Transactions and events expected to occur over the next twelve months that will necessitate reclassifying these derivative losses include the repricing of variable-rate medium-term notes (“MTNs”).

Ambac enters into non-trading derivative contracts for the purpose of economically hedging exposures to fair value or cash flow changes caused by fluctuations in interest rates and foreign currency rates. If the hedging relationship does not meet the technical requirements for hedge accounting under SFAS 133, changes to the fair value of the derivative contract are recorded as a component of “Net mark-to-market (losses) gains on non-trading derivative contracts” in the accompanying Consolidated Statements of Operations. The change in fair value of such derivative contracts was ($101), $44,874 and ($3,461) for 2006, 2005 and 2004, respectively. The mark-to-market gains in 2005 primarily related to highly effective economic hedges that did not meet the technical requirements for hedge accounting under SFAS 133. These derivatives have met the technical requirements of SFAS 133 as of July 1, 2005.

Ambac discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative expires, is sold or terminated. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, Ambac continues to carry the derivative on the balance sheet at its fair value, and no longer adjusts the hedged asset or liability for changes in

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

fair value. The adjustment of the carrying amount of the hedged asset or liability is accounted for in the same manner as other components of the carrying amount of that asset or liability. The net derivative gain or loss related to a discontinued cash flow hedge (recognized during the period of hedge effectiveness) will continue to be reported in Accumulated Other Comprehensive Income and amortized into net income as a yield adjustment to the previously designated asset or liability. If the previously designated asset or liability is sold or matures, the net derivative gain or loss related to a discontinued cash flow hedge reported in Accumulated Other Comprehensive Income will be reclassified into net income immediately. All subsequent changes in fair values of derivatives previously designated as cash flow hedges will be recognized in net income.

Depreciation and Amortization:

Depreciation of furniture and fixtures and electronic data processing equipment is charged over the estimated useful lives of the respective assets, ranging from three to five years, using the straight-line method. Amortization of leasehold improvements is charged over the lesser of ten years or the remaining term of the operating leases using the straight-line method.

Pensions, Postretirement and Postemployment Benefits:

Ambac provides pensions, postretirement and postemployment benefits, including health and life benefits covering substantially all employees who meet certain age and service requirements. Ambac accounts for these benefits under the accrual method of accounting. Amounts related to the defined benefit pension plan and postretirement health benefits liability are established and charged to expense based on actuarial determinations. During 2006, the Compensation Committee of the Board of Directors approved an amendment to the Pension Plan that terminated the Plan effective December 31, 2006. Effective August 1, 2005, new employees were not eligible for postretirement benefits.

Ambac adopted FAS 158, “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans”, on December 31, 2006. FAS 158 requires employers’ to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its Consolidated Balance Sheet and to recognize changes in that funded status in the year in which the changes occur through accumulated other comprehensive income. The table below shows the incremental effect of applying FAS 158 on individual line items in the Consolidated Balance Sheet effective December 31, 2006:

	Before FAS 158		Adjustments			After FAS 158
Deferred income taxes	$	279,853	$	(1,231	)	$	278,622
Other liabilities		272,152		3,518			275,670
Total liabilities		14,081,337		2,287			14,083,624
Accumulated Other Comprehensive Income		199,863		(2,287	)		197,576
Total stockholders’ equity		6,186,476		(2,287	)		6,184,189

Stock Compensation Plans:

The Ambac 1997 Equity Plan (the “Equity Plan”) provides for the granting of stock options, stock appreciation rights, restricted stock units (“RSUs”), performance units and other awards that are

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

valued or determined by reference to the Common Stock. Ambac generally expects to deliver shares to employees under this plan from its treasury stock. Ambac also maintains the Ambac 1997 Non-employee Directors Equity Plan, which provides awards of restricted stock units to non-employee members of Ambac’s Board of Directors. The number of restricted stock units awarded to each non-employee director under the Directors Equity Plan are determined by formula. The fair value of the stock option awards are attributed over the shorter of the derived vesting periods based on the output of the valuation model or the service period. RSU awards are attributed over the shorter of the vesting or service period. As of December 31, 2006, approximately 13,600,000 shares were available for future grant under the Equity Plan and the Directors Equity Plan.

Since January 1, 2003, Ambac accounted for stock-based employee compensation in accordance with the fair-value method prescribed by SFAS No. 123 as amended by SFAS Statement 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” (“SFAS 148”), prospectively to all employee awards granted after January 1, 2003.

Effective January 1, 2006, Ambac adopted SFAS No. 123-R, “Share-Based Payment”, (“SFAS No. 123-R”) by using the modified prospective approach to all employee awards granted after the effective date. Beginning with the effective date, SFAS 123-R requires entities to recognize compensation cost for all equity-classified awards after the effective date and for all awards granted to employees prior to the effective date of SFAS No. 123-R that remain unvested on the effective date using the fair-value measurement method and estimating forfeitures for all unvested awards. Key differences between SFAS No. 123-R and SFAS No. 123 are:

· SFAS No. 123-R provided clarification that the Black-Scholes-Merton model is not appropriate for stock options containing a market condition that affects vesting and the ability to exercise. Stock options granted prior to the adoption of SFAS 123-R were valued using the Black-Scholes-Merton model. Stock options granted in 2006 will vest on the earlier of Ambac’s Common Stock achieving certain price targets (market conditions) or meeting the requisite service requirement, therefore, the fair value of each market condition award was estimated on the date of grant using a Monte Carlo simulation model.

· SFAS 123-R requires compensation expense be recognized for partially vested awards outstanding at its effective date. The expense related to the unvested award will be recognized for the remainder of the requisite service period. Certain market condition stock option grants previously accounted for under APB No. 25 were partially vested as of January 1, 2006. For 2006 approximately $770 of compensation expense is recorded for these partially vested awards.

· SFAS No.123-R requires the grant date expensing of share-based awards granted to retirement-eligible employees. This is consistent with how Ambac recognized such awards under SFAS 123. Based on interpretative guidance under SFAS No. 123-R, Ambac must elect to continue to expense awards to retirement eligible employees on the grant date or accrue in the year prior to the grant date. Ambac elected to accrue the estimated cost of future stock- compensation grants to retirement-eligible employees over the service period. Therefore,

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

Ambac will accrue the estimated cost of such awards over the course of the fiscal year preceding the grant date ($8,392 is recognized in 2006).

For 2006, basic and diluted earnings per share would have increased by $0.03 per share, respectively, if Ambac had not adopted SFAS No. 123-R.

Foreign Currency:

Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with SFAS Statement 52, “Foreign Currency Translation” (“SFAS 52”). Under SFAS 52, functional currency assets and liabilities of Ambac’s foreign subsidiaries are translated into U.S. dollars using exchange rates in effect at the balance sheet dates and the related translation adjustments are included as a component of “Accumulated Other Comprehensive Income,” net of any related taxes in Stockholders’ Equity. Functional currencies are generally the currencies of the local operating environment. Income statement accounts expressed in functional currencies are translated using average exchange rates.

Foreign currency transaction gains and losses of Ambac’s U.S. dollar functional currency subsidiaries’, arising primarily from sales of long-term foreign denominated investment securities, short-term investment securities and cash denominated in foreign currencies, are reflected in net income. The Consolidated Statements of Operations include pre-tax gains from such foreign exchange items of $8,724, $6,270 and $6,600 for 2006, 2005 and 2004, respectively.

Income Taxes:

Ambac files a consolidated Federal income tax return with its subsidiaries. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.

Net Income Per Share:

Basic net income per share is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding during the period. Common shares outstanding includes common stock issued less treasury shares plus restricted stock units for which no future service is required as a condition to the delivery of the underlying common stock. Diluted net income per share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding during the period, plus all dilutive potential common shares outstanding during the period. All dilutive potential common shares outstanding include common stock deliverable pursuant to stock options and nonvested restricted stock units. These dilutive shares totaled 942,929, 1,626,422 and 2,049,728 additional shares from the assumed

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

conversion of dilutive stock options and nonvested restricted stock units at December 31, 2006, 2005 and 2004, respectively. The number of additional shares is calculated by assuming that outstanding stock options were exercised and that the proceeds from such exercises were used to acquire shares of common stock at the average market price during the year.

Future Application of Accounting Standards:

On February 16, 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS 155 amends SFAS 133 and SFAS 140, and addresses issues raised in SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” The primary objectives of SFAS 155 are: (i) with respect to SFAS 133, to address the accounting for beneficial interests in securitized financial assets and (ii) with respect to SFAS 140, eliminate a restriction on the passive derivative instruments that a QSPE may hold. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Ambac will adopt SFAS 155 on January 1, 2007 and is currently evaluating the implications of SFAS 155 on its financial statements.

In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48 “Accounting for Uncertainty in Income Taxes”, an interpretation of SFAS 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109 “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is applicable for fiscal years beginning after December 15, 2006. Ambac will adopt FIN 48 on January 1, 2007 and is currently evaluating the implication of this Interpretation on its financial statements.

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. Ambac is currently evaluating the implications of SFAS 157 on its financial statements. In addition, SFAS 157 supersedes certain accounting guidance, which prohibited the recognition of day one gains on certain derivative transactions. With the adoption of SFAS 157, any remaining reserves for day one gains will be reflected as a cumulative effect adjustment to the opening balance of retained earnings.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS 159 permits reporting entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments and not to portions of instruments. SFAS 159 also establishes presentation

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years that begin after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007 provided the entity also elects to apply the provisions of SFAS 157, which are described in the previous paragraph. This early adoption election must be made within 120 days of the beginning of the fiscal year of adoption provided the entity has not yet issued interim period financial statements. Ambac is currently evaluating the implications of SFAS 159 on its financial statements.

The FASB is currently working on a number of amendments to the existing accounting standards governing financial guarantees and asset transfers. Upon completion of these standards, Ambac will need to reevaluate its accounting and disclosures.

Reclassifications:

Certain reclassifications have been made to prior years’ amounts to conform to the current year’s presentation.

3        CORRECTION OF PREMIUM REVENUE RECOGNITION

For contracts entered into prior to 2004, where installment premiums are billed and collected in arrears, Ambac recognized revenues for these installment paying financial guarantees when received rather than on an accrual basis. Ambac has determined that $10,555 of premium income, net of deferred acquisition costs and tax, should have been recorded as premium revenue in periods prior to 2004. This amount was not material to any of the noted periods and therefore is reported as an adjustment to beginning 2004 retained earnings. The impact of the adjustments decreased total assets by $677 and total liabilities by $11,232 at December 31, 2005. There was no effect on the previously reported liquidity or net operating cash flows for either 2004 or 2005. In 2006, the Company is recording financial guarantee premiums on an accrual basis of accounting.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

4        INVESTMENTS

The amortized cost and estimated fair value of investments at December 31, 2006 and 2005 were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
2006: Fixed income securities:
Municipal obligations	$	7,891,422	$	256,066	$	20,657	$	8,126,831
Corporate obligations		691,993		28,700		1,068		719,625
Foreign obligations		269,834		8,413		1,417		276,830
U.S. government obligations		177,165		99		3,242		174,022
U.S. agency obligations		757,823		38,005		6,434		789,394
Mortgage and asset-backed securities		6,696,020		39,890		22,274		6,713,636
Short-term		311,759		—		—		311,759
Other		13,427		996		32		14,391
		16,809,443		372,169		55,124		17,126,488
Fixed income securities pledged as collateral:
Mortgage and asset-backed securities		311,546		269		4,714		307,101
Total	$	17,120,989	$	372,438	$	59,838	$	17,433,589
2005: Fixed income securities:
Municipal obligations	$	6,649,815	$	268,052	$	21,513	$	6,896,354
Corporate obligations		525,609		32,318		1,688		556,239
Foreign obligations		178,348		6,186		2,790		181,744
U.S. government obligations		184,421		1,149		1,105		184,465
U.S. agency obligations		902,215		50,000		5,785		946,430
Mortgage and asset-backed securities		5,951,098		42,933		24,769		5,969,262
Short-term		472,034		—		—		472,034
Other		13,537		787		151		14,173
		14,877,077		401,425		57,801		15,220,701
Fixed income securities pledged as collateral:
Mortgage and asset-backed securities		378,480		—		7,320		371,160
Total	$	15,255,557	$	401,425	$	65,121	$	15,591,861

Foreign obligations consist primarily of government issued securities which are denominated in either Pounds sterling, Euros or Australian dollars.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The amortized cost and estimated fair value of investments at December 31, 2006, by contractual maturity, were as follows:

	Amortized Cost		Estimated Fair Value
Due in one year or less	$	518,209	$	522,721
Due after one year through five years		1,538,151		1,548,233
Due after five years through ten years		2,826,764		2,863,364
Due after ten years		5,230,299		5,478,534
		10,113,423		10,412,852
Mortgage and asset-backed securities		7,007,566		7,020,737
	$	17,120,989	$	17,433,589

Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

The following table shows gross unrealized losses and fair values of Ambac’s investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2006 and 2005:

	Less Than 12 Months				12 Months or More				Total
	Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss
2006: Fixed income securities:
Municipal obligations.	$	728,470	$	3,981	$	1,129,258	$	16,676	$	1,857,728	$	20,657
Corporate obligations		67,782		268		50,875		800		118,657		1,068
Foreign obligations		105,264		1,258		13,090		159		118,354		1,417
U.S. government obligations		28,132		174		123,418		3,068		151,550		3,242
U.S. agency obligations		351,568		3,605		121,637		2,829		473,205		6,434
Mortgage and asset-backed securities		525,933		2,942		1,153,846		24,046		1,679,779		26,988
Other		516		32		—		—		516		32
Total temporarily impaired securities	$	1,807,665	$	12,260	$	2,592,124	$	47,578	$	4,399,789	$	59,838
2005: Fixed income securities:
Municipal obligations.	$	1,335,894	$	13,839	$	278,752	$	7,674	$	1,614,646	$	21,513
Corporate obligations.		24,688		982		51,063		706		75,751		1,688
Foreign obligations.		52,208		1,194		14,228		1,596		66,436		2,790
U.S. government obligations.		139,244		980		17,372		125		156,616		1,105
U.S. agency obligations		313,102		4,753		23,021		1,032		336,123		5,785
Mortgage and asset-backed securities		1,502,716		13,032		885,768		19,057		2,388,484		32,089
Other		240		3		538		148		778		151
Total temporarily impaired securities	$	3,368,092	$	34,783	$	1,270,742	$	30,338	$	4,638,834	$	65,121

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

At December 31, 2006 and 2005, there were 334 and 345 investments in fixed income securities where the aggregate amortized cost exceeded fair value by $59,838 or 1% and $65,121 or 1%, respectively. Management has determined that the unrealized losses in fixed income securities at December 31, 2006 are primarily attributable to the current interest rate environment and has concluded that these unrealized losses are temporary in nature based upon (a) no principal and interest payment defaults on these securities; (b) analysis of the creditworthiness of the issuer; and (c) Ambac’s ability and current intent to hold these securities until a recovery in fair value or maturity. There were no individual securities with material unrealized losses as of December 31, 2006 and 2005. Of the $12,260 and $34,783 that have been in a gross unrealized loss position for less than a year, 100% and 97% are rated investment grade for 2006 and 2005, respectively. Of the $47,578 and $30,338 that have been in a gross unrealized loss position for a year or more, 100% are rated investment grade for both 2006 and 2005.

Securities carried at $6,389 and $6,583 at December 31, 2006 and 2005, respectively, were deposited by Ambac with governmental authorities or designated custodian banks as required by laws affecting insurance companies.

Ambac’s fixed income portfolio included securities covered by guarantees issued by Ambac Assurance (“insured securities”). The published ratings on these securities are triple-A by the major rating agencies as a result of the Ambac Assurance insurance policy. Rating agencies generally do not publish separate underlying ratings (those ratings excluding the Ambac Assurance insurance) because the insurance cannot be legally separated from the underlying security by the insurer. Ambac obtains underlying ratings through ongoing dialog with rating agencies. In the event these underlying ratings are not updated or simply not available from the rating agencies, Ambac will assign an internal rating. At December 31, 2006, securities with a total carrying value of $748,562 representing 4% of the investment portfolio with a weighted-average underlying rating of BBB- was insured by Ambac. In determining this BBB- rating, approximately $131,137 of the securities were assigned internal ratings by Ambac.

Net investment income from the Financial Guarantee segment was comprised of the following:

	2006			2005			2004
Fixed income securities	$	417,339		$	374,224		$	355,672
Short-term investments		9,358			8,061			2,414
Loans		2,088			1,519			2,057
Total investment income		428,785			383,804			360,143
Investment expense		(4,900	)		(5,708	)		(4,881	)
Net investment income	$	423,885		$	378,096		$	355,262

The Financial Guarantee segment had gross realized gains of $10,654, $20,376 and $46,627 in 2006, 2005 and 2004, respectively, and gross realized losses of $3,569, $14,069 and $16,623 in 2006, 2005 and 2004, respectively. Included in the above are net foreign exchange gains of $6,176, $7,448 and $5,654 in 2006, 2005 and 2004, respectively. Net foreign exchange gains primarily resulted from

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Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

sales and maturities of long-term foreign currency denominated securities in 2006, 2005 and 2004. Included in gross realized losses were impairment write-downs of $119, $340 and $0 in 2006, 2005 and 2004, respectively.

The Financial Services segment had gross realized gains of $59,903, $20,364 and $11,217 in 2006, 2005 and 2004, respectively, and gross realized losses of $648, $18,049 and $4,129 in 2006, 2005 and 2004, respectively. Included in gross realized losses were impairment write-downs of $0, $334, and $0, during 2006, 2005 and 2004 respectively. In 2002 and 2003 realized losses included impairment write-downs of $150,201 related to asset-backed notes issued by National Century Financial Enterprises, Inc. (“NCFE”). These notes, which were backed by health care receivables and rated triple-A until October 25, 2002, defaulted and NCFE filed for protection under Chapter 11 of the U.S. Bankruptcy Code in November 2002. The loss was specific to the NCFE notes and had no impact on other investments held. In 2006, 2005 and 2004, Ambac has received cash recoveries of $55,474, $10,767 and $17,850, respectively, resulting from distributions under the NCFE Bankruptcy Plan, payments made by a Trust created under the Plan and litigation settlements.

Ambac routinely pledges and receives collateral related to certain business lines and/or transactions. The following is a description of those arrangements by collateral source:

(1) Securities purchased under agreements to resell (repurchase agreements)—In the normal course of business, Ambac holds securities under repurchase agreements with various counterparties. A portion of these securities has been pledged to Ambac’s investment agreement counterparties (including counterparties with agreements structured as investment repurchase agreements). Such securities may not then be repledged by the investment agreement counterparty to another entity. Securities purchased under agreements to resell have also been pledged to certain interest rate swap and credit derivative counterparties. Under the terms of these derivative agreements, Ambac and its counterparties may be required to pledge collateral to the other resulting from changes in the estimated fair value of those agreements. Both Ambac and the counterparties have identical rights to pledge or rehypothecate the securities received under these derivative agreements.

(2) Securities held in Ambac’s investment portfolio—Ambac pledges investments it holds in its Financial Services investment portfolio to both investment and payment agreement counterparties in accordance with the terms and conditions described in (1) above. Ambac has also sold securities in its Financial Services investment portfolio under agreements to repurchase (reverse repurchase agreements). Ambac’s counterparties under derivative agreements and reverse repurchase agreements have the right to pledge or rehypothecate the securities, which were pledged or sold, respectively. Consequently, securities held in Ambac’s investment portfolio which are pledged or sold under reverse repurchase agreements, are separately classified on the Consolidated Balance Sheet as “Fixed income securities pledged as collateral, at fair value”.

(3) Cash and Securities pledged to Ambac under derivative agreements—Ambac may repledge securities it holds from certain derivative counterparties as described in (1) above, to other derivative counterparties in accordance with its rights and obligations under those agreements.

98

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The following table presents (i) the sources of collateral either received from various counterparties where Ambac is permitted to sell or re-pledge or directly held in the investment portfolio, and (ii) how that collateral was pledged to various investment and payment agreement, derivative and reverse repurchase agreement counterparties at December 31, 2006 and 2005:

			Collateral Pledged
	Fair Value of Cash and Underlying Securities		Fair Value of Securities Pledged to Investment and Payment Agreement Counterparties		Fair Value of Cash and Securities Pledged to Derivative Counterparties		Fair value of securities sold under agreements to repurchase
2006: Sources of Collateral:
Securities purchased under agreements to resell	$	561,243	$	283,008	$	—	$	—
Securities pledged directly from the investment portfolio		559,563		252,462		—		307,101
Cash and securities pledged from its derivative counterparties		189,292		46,795		15,720		—
2005: Sources of Collateral:
Securities purchased under agreements to resell	$	786,425	$	341,998	$	—	$	—
Securities pledged directly from the investment portfolio		710,039		338,879		—		371,160
Cash and securities pledged from its derivative counterparties		167,640		—		77,154		—

5        LOANS

In the normal course of business, Ambac primarily extended loans for the following purposes:

Structured Municipal Transactions: Loans have been extended to customers participating in certain structured municipal transactions. The loans are collateralized with cash in amounts adequate to repay the loan balance. Equipment and other assets underlying the transactions serve as additional collateral for the loans. Ambac acts as the payment custodian and holds the funds posted as collateral. At December 31, 2006 and 2005, both the loan balances outstanding and collateral held were $609,821 and $631,430, respectively. As of December 31, 2006 and 2005, the interest rates on these loans ranged from 6.25% to 8.06%. The range of expected final maturity dates of these loans is January 2013 to January 2027 as of December 31, 2006.

Investment Partnerships: Ambac has had senior secured short-term loans outstanding to certain investment partnerships which invest in diversified portfolios of assets, primarily high-yield debt obligations and bank loans. The loans were collateralized with a first priority lien and security interest in the invested assets. As of December 31, 2006, Ambac had no outstanding loan balances. As of December 31, 2005, Ambac had outstanding loan balances of $26,773 with interest rates ranging from 4.98% to 5.75%. The range of maturity dates for these loans was January 2006 to June 2006.

99

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

6        REINSURANCE

In the ordinary course of business, Ambac Assurance cedes exposures under various reinsurance contracts primarily designed to minimize losses from large risks and to protect capital and surplus. Ceded premiums are considered prepaid reinsurance premiums and are amortized into income in proportion to the protection received. The effect of reinsurance on premiums written and earned was as follows:

	Years Ended December 31,
	2006						2005						2004
	Written			Earned			Written			Earned			Written			Earned
Direct	$	960,372		$	868,725		$	1,043,576		$	873,466		$	1,011,911		$	778,515
Assumed		36,297			34,279			52,447			36,478			36,425			37,746
Ceded		(103,496	)		(91,381	)		(99,673	)		(93,620	)		(70,946	)		(99,077	)
Net premiums	$	893,173		$	811,623		$	996,350		$	816,324		$	977,390		$	717,184

Ambac Assurance pledged cash and fixed income securities to foreign insurers of $15,331, $13,556 and $15,086 at December 31, 2006, 2005 and 2004, respectively, related to business assumed from those insurers.

The reinsurance of risk does not relieve Ambac Assurance of its original liability to its policyholders. In the event that any of Ambac Assurance’s reinsurers are unable to meet their obligations under reinsurance contracts, Ambac Assurance would, nonetheless, be liable to its policyholders in the full amount of its policy.

To minimize exposure to significant losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of a rating downgrade of a reinsurer. For the years ended December 31, 2006, 2005 and 2004, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $3,904, $22,936 and $2,581, respectively. Reinsurance recoverables (payables) on paid losses and loss expenses as of December 31, 2006, 2005 and 2004 were ($1,051), $263 and $266, respectively.

Ambac Assurance’s reinsurance assets, including prepaid reinsurance and reinsurance recoverables on losses amounted to $319,419 at December 31, 2006. This credit exposure existed at December 31, 2006 with respect to reinsurance recoverables to the extent that any reinsurer may not be able to reimburse Ambac Assurance under the terms of these reinsurance arrangements. Ambac Assurance requires certain reinsurers to maintain bank letter of credits or establish trust accounts to cover liabilities ceded to such reinsurers under reinsurance contracts. The collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis. At December 31, 2006, approximately 60% of the reinsurance assets were collateralized. All of the balances with respect to the remaining reinsurers had financial strength ratings of AA or better as rated by Standard & Poor’s.

100

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

7        LOSSES AND LOSS EXPENSE RESERVE

As discussed in Note 2, Ambac Assurance’s liability for losses and loss expenses consists of case basis and active credit reserves. Following is a summary of the activity in the case basis credit and active credit reserve accounts and the components of the liability for loss and loss expense reserves:

	2006			2005			2004
Case basis loss and loss expense reserves:
Balance at January 1	$	106,532		$	133,254		$	57,233
Less: reinsurance recoverables		3,468			16,499			2,535
Net balance at January 1		103,064			116,755			54,698
Transfers from active reserves:
Current year		34,660			31,274			40,215
Prior years		10,307			41,776			40,765
Total transfers from active reserves		44,967			73,050			80,980
Paid (net of recoveries) related to:
Current year		32,895			2,755			214
Prior years		72,673			83,986			18,709
Total paid		105,568			86,741			18,923
Net balance at December 31		42,463			103,064			116,755
Less impact on foreign exchange gains on loss reserves		5			—			—
Plus reinsurance recoverables		4,972			3,468			16,499
Balance at December 31		47,430			106,532			133,254
Active credit reserve:
Balance at January 1		197,607			120,801			132,181
Provision for losses		20,004			149,856			69,600
Transfers to case reserves		(44,967	)		(73,050	)		(80,980	)
Balance at December 31		172,644			197,607			120,801
Total	$	220,074		$	304,139		$	254,055

During 2006, 2005 and 2004, gross losses paid were $126,183, $119,070 and $55,321, respectively. During 2006, 2005 and 2004, other recoveries (under subrogation rights) of losses were $16,711, $9,394 and $33,628, respectively.

The provision for losses and loss expenses represents the expense recorded to bring the total reserve (active credit and case basis credit) to a level determined by management to be adequate for losses inherent in the non-derivative financial guarantee insurance portfolio as of the reporting date. The provision for losses of $20,004 is the amount recorded as loss and loss expenses in the Consolidated Statements of Operations. The 2006 loss and loss expenses were primarily driven by provisions for losses for deteriorating public finance infrastructure and domestic health care credits, offset by a reduction in provisions of $41,253 for Hurricane Katrina credits. The decrease in the Hurricane Katrina reserves is primarily due to significant state and federal support provided to the region in 2006, particularly the greater New Orleans area. Approximately $730 million of Katrina

101

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

impacted credits remain in Ambac’s adversely classified credit portfolio. Ambac did not pay any Katrina related claims during 2006. Provisions are recognized through the active credit reserve based on the ongoing analysis of the portfolio as discussed in Note 2. Upon default of the underlying credit, the reserve is transferred from active credit reserves to case basis credit reserves. Additional provisions for losses upon further credit deterioration of a defaulted exposure are initially recorded in active credit reserve and subsequently transferred to case basis credit reserve.

Transfers from active credit reserves related to prior years were $10,307 and $41,776 for the years ended December 31, 2006 and 2005, respectively.

Continued deterioration in a previously impaired public finance infrastructure issue was experienced in 2006, offset by favorable development resulting from the final settlement of several credits (including the health care institution discussed below). Ambac believes the primary factor causing the deterioration is the highly competitive economic environment the issuer’s management is operating in. Ambac is closely surveilling the credit and is in frequent communication with the issuer’s management. A domestic health care institution, which defaulted in a year prior to 2005, continued to experience significant financial stress in 2005. An enhanced equipment trust that was impacted by a bankruptcy of a commercial airline in 2004, experienced additional losses in 2005 upon the settlement of the trust. In connection with the settlement of the trust, Ambac purchased three airplanes. In February 2006, Ambac sold these airplanes and recognized a realized gain of approximately $25,000 (included in “Other Income” on our Consolidated Statements of Operations).

8        LONG-TERM DEBT AND LINES OF CREDIT

Long-term Debt:

The carrying value of long-term debt was as follows:

	As of December 31,
	2006		2005
9-3/8% Debentures, due 2011	$	142,304	$	142,261
7-1/2% Debentures, due 2023		74,662		74,641
5.95% Debentures, due 2035		399,838		399,833
7.00% Debentures, due 2051		—		200,000
5.95% Debentures, due 2103		200,000		200,000
5.875% Debentures, due 2103		175,000		175,000
Total long-term debt	$	991,804	$	1,191,735

The debentures due on August 1, 2011 were issued on August 8, 1991 in the principal amount of $150,000 and bear interest of 9-3/8%, payable on February 1 and August 1 of each year and are non-callable. In July 2001, Ambac extinguished $7,500, thereby reducing the principal amount of the debt to $142,500.

102

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The debentures due on May 1, 2023 were issued on May 11, 1993 in the principal amount of $75,000 and bear interest of 7-1/2%, payable on May 1 and November 1 of each year and are non-callable.

The debentures due on December 5, 2035 were issued on December 5, 2005 in the principal amount of $400,000 and bear interest of 5.95%, payable on June 5 and December 5 of each year beginning June 5, 2006. The debentures are redeemable prior to maturity, in whole at any time or in part from time to time, at a redemption price equal to the greater of (i) 100% of the principal amount of the debentures to be redeemed or (ii) the sum of the present values of the remaining scheduled payments of principal and interest thereon (exclusive of interest accrued to the date of redemption) discounted to the redemption date on a semiannual basis (assuming a 360-day year consisting of twelve 30-day months) at the Treasury Rate plus 20 basis points, plus, in each case, accrued interest thereon to the date of redemption.

The debentures due on October 17, 2051 were issued on October 18, 2001 in the principal amount of $200,000 and bear interest of 7.00%, payable on March 31, June 30, September 30 and December 31 of each year. On October 23, 2006 (the “Redemption Date”), Ambac redeemed all of the debentures at par plus accrued interest to the Redemption Date.

The debentures due on February 28, 2103 were issued on February 28, 2003 in the principal amount of $200,000 and bear interest of 5.95%, payable on March 31, June 30, September 30 and December 31 of each year. The debentures may not be redeemed prior to February 28, 2008. On or after February 28, 2008, Ambac may redeem the debentures at 100% of their principal amount, plus accrued interest to the date of redemption. Ambac may also shorten the maturity of the debentures or redeem all of the debentures at 100% of their principal amount, plus accrued interest, in the event of certain changes involving United States federal income taxation.

The debentures due on March 24, 2103 were issued on March 24, 2003 in the principal amount of $175,000 and bear interest of 5.875%, payable on March 31, June 30, September 30 and December 31 of each year beginning June 30, 2003. The debentures may not be redeemed prior to March 24, 2008. On or after March 24, 2008, Ambac may redeem the debentures at 100% of their principal amount, plus accrued interest to the date of redemption. Ambac may also shorten the maturity of the debentures or redeem all of the debentures at 100% of their principal amount, plus accrued interest, in the event of certain changes involving United States federal income taxation.

In February 2007, Ambac issued in a public offering $400,000 of 6.15% Directly-Issued Subordinated Capital Securities due 2087 (the”DISCS^”sm). The DISCS were rated Aa3 by Moody’s Investors Service, Inc. and A+ by Standard & Poor’s Ratings Services. Ambac will use the proceeds from the offering to repurchase $400,000 of its common stock pursuant to an accelerated share repurchase program.

Credit Facilities:

On July 28, 2005, Ambac and Ambac Assurance, as borrowers, entered into a $400,000 five year unsecured, committed revolving credit facility (the “Credit Facility”) with a group of highly rated banks

103

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

(the “Banks”). The Credit Facility was amended on July 28, 2006 to extend the final maturity date from July 28, 2010 to July 28, 2011. The Credit Facility provides for borrowings by Ambac and Ambac Assurance on a revolving basis up to an aggregate of $400,000 at any one time outstanding, which maximum amount may, at Ambac’s and Ambac Assurance’s request and subject to the terms and conditions of the facility, be increased up to $500,000.

Ambac and/or Ambac Assurance may borrow under the Credit Facility for general corporate purposes, including the payment of claims. Subject to the terms and conditions thereof, Ambac and/or Ambac Assurance may borrow under the Credit Facility until the final maturity date. Loans may be denominated in U. S. Dollars or certain other currencies at the option of Ambac and/or Ambac Assurance. Ambac and/or Ambac Assurance has the option of selecting either (i) a Base Rate, a fluctuating rate equal to the higher of Citibank’s Base Rate and the Federal Funds Rate plus 0.5%, plus the Applicable Margin (as defined in the Credit Facility) or (ii) a Eurocurrency Rate, a periodic fixed rate equal to LIBOR plus the Applicable Margin. There are no outstanding loans under the Credit Facility. Neither Ambac nor Ambac Assurance have previously incurred any borrowing under this or prior similar facilities.

The Credit Facility contains customary representations, warranties and covenants for this type of financing, including two financial covenants requiring Ambac to: (i) maintain as of the end of each fiscal quarter a debt-to-capital ratio, excluding debt consolidated under FIN 46, of not more than 30%, and (ii) maintain at all times total stockholders’ equity equal to or greater than $2,800,000. The stockholders’ equity financial covenant will increase annually, in an amount equal to 15% of the prior fiscal year’s net income and 15% of the net proceeds of any future equity issuances. As a result, the stockholders’ equity financial covenant will increase to $2,930,000 for 2007. The Credit Facility also provides for certain events of default with corresponding grace periods, including failure to pay any principal or interest when due, failure to comply with covenants, any material representation or warranty made by Ambac or Ambac Assurance proving to be false in any material respect, certain bankruptcy, insolvency or receivership events affecting Ambac or Ambac Assurance, defaults relating to other indebtedness, imposition of certain judgments and a change in ownership of Ambac and/or Ambac Assurance. Ambac and Ambac Assurance are in full compliance with the terms and conditions of the Credit Facility.

Ambac Assurance has a series of perpetual put options on its own preferred stock. The counterparty to these put options are trusts established by a major investment bank. The trusts were created as a vehicle for providing capital support to Ambac Assurance by allowing it to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put option were exercised, Ambac Assurance would receive up to $800,000 in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose, including the payment of claims. The preferred stock would give investors the rights of an equity investor in Ambac Assurance. Such rights are subordinate to insurance claims, as well as to the general unsecured creditors of Ambac Assurance. Dividend payments on the preferred stock are cumulative, subject to certain limited exceptions, only if Ambac Assurance pays dividends on its common stock. Each trust is restricted to holding high-quality short-term commercial paper investments to ensure that it can meet its obligations under the put option. To fund these investments, each trust has issued its

104

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

own auction market perpetual securities. Each trust is rated AA/Aa2 by Standard & Poor’s and Moody’s, respectively. During 2006 and 2005, Ambac Assurance incurred fees related to these perpetual put options of $3,497 and $5,035, respectively. These fees are included as Corporate expenses on the Consolidated Statements of Operations, except for 2004 where it was recorded in additional paid-in capital.

From time to time, Ambac accesses the capital markets to support the growth of its businesses. In February 2006, Ambac filed a Form S-3 with the SEC utilizing a “shelf” registration process for well known seasoned issuers. Under this process, Ambac may issue through February 2009 an unlimited amount of the securities described in the prospectus filed as part of the registration, namely, common stock, preferred stock, debt securities, and warrants of Ambac.

9        OBLIGATIONS UNDER INVESTMENT AND PAYMENT AGREEMENTS

Obligations under investment agreements, including those structured in the form of repurchase agreements, are recorded on a settlement-date basis. Certain investment agreements have contractual provisions that allow our counterparty the flexibility to withdraw funds prior to the legal maturity date. Amounts included in the table below are based on the earliest optional draw date. As of December 31, 2006 and 2005, the contractual interest rates for these agreements, which include both fixed and variable, ranged from 1.57% to 9.11% and from 1.57% to 8.08% respectively. As of December 31, 2006 and 2005, obligations under investment agreements and investment repurchase agreements, excluding fair value hedge adjustments, were $7,501,729 and $6,424,159, respectively.

Net payments due under investment agreements in each of the next five years ending December 31, and the periods thereafter, are as follows:

	Principal Amount
2007	$	2,808,304
2008		1,075,277
2009		892,311
2010		891,715
2011		95,922
All later years		1,738,200
	$	7,501,729

105

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

Obligations under payment agreements represent funds received by Ambac from certain municipal customers. These funds serve as collateral for loans extended by Ambac in connection with certain structured municipal transactions. In connection with these transactions, Ambac is obligated to make periodic agreed upon payments. As of December 31, 2006 and 2005, the interest rates on these obligations ranged from 6.25% to 8.06%. Net payments due under payment agreements in each of the next five years ending December 31, and the periods thereafter, based on contractual payment dates, are as follows:

	Principal Amount
2007	$	23,427
2008		31,427
2009		21,701
2010		21,477
2011		23,177
All later years		488,611
	$	609,820

10        INCOME TAXES

Ambac’s provision for income taxes charged to income from continuing operations is comprised of the following:

	2006			2005		2004
Current taxes	$	334,639		$	200,480	$	230,952
Deferred taxes		(337	)		71,274		19,990
	$	334,302		$	271,754	$	250,942

The total effect of income taxes on income and stockholders’ equity for the years ended December 31, 2006 and 2005 was as follows:

	2006			2005
Total income taxes charged to income from continuing operations	$	334,302		$	271,754
Income taxes charged (credited) to stockholders’ equity:
Unrealized losses on investment securities		(11,486	)		(37,500	)
Unrealized gains on derivative hedges		4,061			83
Exercise of stock options		(17,819	)		(9,468	)
Other		2,179			—
Total credited to stockholders’ equity		(23,065	)		(46,885	)
Total effect of income taxes	$	311,237		$	224,869

106

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The tax provisions in the accompanying Consolidated Statements of Operations reflect effective tax rates differing from prevailing Federal corporate income tax rates. The following is a reconciliation of these differences:

	2006			%		2005			%		2004			%
Tax on income from continuing operations at statutory rate	$	423,575		35.0	%	$	357,967		35.0	%	$	341,874		35.0	%
Changes in expected tax resulting from:
Tax-exempt interest		(94,044	)	(7.8	)		(84,759	)	(8.3	)		(79,564	)	(8.1	)
Addition to (release of) tax reserves		2,030		0.2			(9,000	)	(0.9	)		(8,250	)	(0.8	)
State income taxes, net of federal tax benefit		1,558		0.1			5,249		0.5			(371	)	(0.1	)
Other, net		1,183		0.1			2,297		0.3			(2,747	)	(0.3	)
Tax expense on income from continuing operations	$	334,302		27.6	%	$	271,754		26.6	%	$	250,942		25.7	%

The addition to tax reserves in 2006 relates to the accrual of interest. The release of tax reserves in 2005 and 2004 relates to the expiration of the statute of limitations of earlier tax years.

The tax effects of temporary differences that give rise to significant portions of the deferred tax liabilities and deferred tax assets at December 31, 2006 and 2005 are presented below:

	2006			2005
Deferred tax liabilities:
Contingency reserve	$	366,957		$	336,957
Unrealized gains on bonds		118,829			126,254
Deferred acquisition costs		91,840			80,120
Unearned premiums and credit fees		139,339			112,740
Investments		9,068			7,900
Mark–to-market gains on non-trading derivatives		19,786			19,987
Other		8,934			3,402
Total deferred tax liabilities		754,753			687,360
Deferred tax assets:
Tax and loss bonds		331,371			301,371
Loss reserves		98,469			69,805
Compensation		46,091			39,375
Investment impairment loss		—			1,302
Other		15,339			11,836
Sub-total deferred tax assets		491,270			423,689
Valuation allowance		—			—
Total deferred tax assets		491,270			423,689
Net deferred tax liabilities	$	(263,483	)	$	(263,671	)

Ambac believes that no valuation allowance is necessary in connection with the deferred tax assets. It is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.

107

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

11        SPECIAL PURPOSE ENTITIES AND VARIABLE INTEREST ENTITIES

Ambac has involvement with special purpose entities, including VIEs in the following ways. First, Ambac is a provider of financial guarantee insurance for various debt obligations. Second, Ambac has sponsored two special purpose entities that issue MTNs to fund the purchase of certain financial assets. As discussed in detail below, these Ambac-sponsored special purpose entities are considered QSPEs. Lastly, Ambac is an investor in asset-backed securities issued by VIEs, and, in one transaction, has a beneficial interest in a VIE that purchases fixed rate municipal bonds with proceeds from the issuance of floating rate short term beneficial interests as discussed in detail below.

Financial Guarantees:

Ambac provides financial guarantees in respect of debt obligations of special purpose entities, including VIEs. Ambac’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structure provides certain financial protection to Ambac. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread. In the case of over-collateralization, (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by Ambac Assurance), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the structured finance obligations that have been guaranteed by Ambac. In the case of first loss, the financial guarantee insurance policy only covers a senior layer of losses on debt issued by special purpose entities, including VIEs. The first loss with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate interest cash flows that are in excess of the interest payments on the related debt; such excess cash flow is applied to redeem debt, thus creating over-collateralization.

Qualified Special Purpose Entities:

Ambac has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with SFAS 140. QSPEs are not subject to the requirements of FIN 46(R) and accordingly are not consolidated in Ambac’s financial statements. The QSPEs are legal entities that are demonstrably distinct from Ambac. Ambac, its affiliates or its agents cannot unilaterally dissolve the QSPEs. The QSPEs permitted activities are limited to those outlined below.

As of December 31, 2006, there have been 15 individual transactions processed through the QSPEs of which 10 are outstanding. In each case, Ambac sold fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPE and the absence of any agreement or obligation for Ambac to repurchase or redeem assets of the QSPE. Additionally, Ambac’s creditors do not have any rights with regards to the assets of the QSPEs. The purchase by the QSPE is financed through the issuance of MTNs, which are collateralized by the purchased assets. Derivative contracts (interest rate and currency swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are contractually limited to purchasing assets from Ambac, issuing

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

MTNs to fund such purchase, executing derivative hedges and related administrative services. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued or both. As of December 31, 2006, Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the QSPEs.

Ambac’s exposures under these financial guarantee insurance policies as of December 31, 2006 and December 31, 2005 are included in the disclosure in Note 16 “Guarantees in Force”. Pursuant to the terms of Ambac Assurance’s insurance policy, insurance premiums are paid to Ambac Assurance by the QSPEs and are earned in a manner consistent with other insurance policies, over the risk period. Any losses incurred would be included in Ambac’s Consolidated Statements of Operations. Under the terms of an Administrative Agency Agreement, Ambac provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.

Assets sold to the QSPEs during 2006, 2005 and 2004 were $450,000, $0 and $195,000, respectively. No gains or losses were recognized on the sale. As of December 31, 2006, the estimated fair value of financial assets, MTN liabilities and derivative hedge liabilities of the QSPEs was $2,013,730, $2,053,512 and $6,021, respectively. When market quotes are not available, fair values are based on internal valuation models, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $5,022, $5,713 and $6,042 for the years ended December 31, 2006, 2005 and 2004, respectively. Ambac also received fees for providing other services amounting to $328, $321 and $450 for 2006, 2005 and 2004, respectively.

VIE Beneficial Interest:

Ambac owns a beneficial interest in a special purpose entity that meets the definition of a VIE. This entity has issued floating rate beneficial interests to investors and invested the proceeds in fixed rate municipal debt securities. These beneficial interests are directly secured by the related municipal debt securities. Ambac is the primary beneficiary of this entity as a result of its beneficial interest. The fixed rate municipal debt securities, which are reported as Investments in fixed income securities, at fair value on the Consolidated Balance Sheets, were $258,976 and $258,806 as of December 31, 2006 and 2005, respectively. The beneficial interests issued to third parties, reported as Obligations under investment and payment agreements on the Consolidated Balance Sheets, were $248,415 and $248,760 as of December 31, 2006 and 2005, respectively. Under the terms of these beneficial interests, the investors have the contractual right to redeem their investment at any time, with five business days notice. As of December 31, 2006 and 2005, the interest rates on these beneficial interests ranged from 2.95% to 4.01% and from 1.49% to 3.55%, respectively.

12        RETIREMENT PLANS

Pensions and Postretirement Health Care and Other Benefits:

Ambac has a defined benefit pension plan covering substantially all employees of Ambac. The benefits are based on years of service and the employee’s average highest salary during five consecutive years of employment within the last ten years of employment. During 2006, the Compensation

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

Committee of the Board of Directors approved an amendment to the Pension Plan that terminated the Plan effective December 31, 2006. Benefits under the Plan will cease to accrue as of December 31, 2006. Management’s current intention is to settle the Plan’s obligations in 2007. No funding contribution was made to the plan in 2006. Effective January 1, 2007 the Compensation Committee replaced this benefit with an increased matching contribution to Ambac’s defined contribution plan.

The table below sets forth a reconciliation of the beginning and ending projected benefit obligation, beginning and ending balances of the fair value of pension plan assets, and the funded status of the pension plan as of December 31, 2006 and 2005.

	2006			2005
Accumulated Benefit Obligation at End of Year:	$	32,011		$	24,729
Change in Projected Benefit Obligation:
Projected benefit obligation at beginning of year	$	31,074		$	25,429
Service cost		2,242			2,078
Interest cost		1,704			1,551
Actuarial loss		5,106			2,371
Benefits paid		(417	)		(355	)
Curtailment		(7,698	)		—
Projected benefit obligation at end of year	$	32,011		$	31,074
Change in Plan Assets:
Fair value of plan assets at beginning of year	$	30,620		$	26,818
Actual return on plan assets		3,940			1,957
Company contributions		—			2,200
Benefits paid		(417	)		(355	)
Fair value of plan assets at end of year	$	34,143		$	30,620
Funded status	$	2,132		$	(454	)

Net pension costs for 2006, 2005 and 2004 included the following components:

	2006			2005			2004
Service cost	$	2,242		$	2,078		$	1,697
Interest cost		1,704			1,551			1,283
Expected return on plan assets		(2,520	)		(2,393	)		(2,027	)
Recognized prior service costs		(105	)		(145	)		(144	)
Recognized net loss		268			258			102
Other		179			—			136
Net periodic pension cost	$	1,768		$	1,349		$	1,047

Ambac provides postretirement and postemployment benefits, including health and life benefits covering substantially all employees who meet certain age and service requirements. Effective August 1, 2005, new employees were not eligible for postretirement benefits. All plans are contributory. None of the plans are currently funded. Postretirement and postemployment benefits expense was $1,072, $915

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

and $522 in 2006, 2005 and 2004, respectively. The unfunded accumulated postretirement benefit obligation was $6,016 as of December 31, 2006. The assumed health care cost trend rates range from 9% in 2007, decreasing ratably to 6% in 2010. Increasing the assumed health care cost trend rate by one percentage point in each future year would increase the accumulated postretirement benefit obligation at December 31, 2006, by $1,280 and the 2006 benefit expense by $263. Decreasing the assumed health care cost trend rate by one percentage point in each future year would decrease the accumulated postretirement benefit obligation at December 31, 2006 by $1,045 and the 2006 benefit expense by $207.

The following table sets forth projected benefit payments from Ambac’s defined benefit pension and postretirement plans and reflects expected future service where appropriate:

	Amount
2007	$	32,114
2008		129
2009		131
2010		161
2011		190
All later years		1,455
	$	34,180

Amounts recognized in Accumulated Other Comprehensive Income at December 31, 2006 are as follows:

	2006
Net Actuarial Loss	$	2,653
Prior service cost/(credit)		(366	)
	$	2,287

Amounts recognized in Accumulated Other Comprehensive Income expected to be amortized during fiscal year 2007 are as follows:

Recognized actuarial loss	$	1,737
Recognized prior service cost/(credit)		(55	)
	$	(1,682	)

Assumptions:

The following assumptions were used to determine the projected benefit obligations for the pension and postretirement plans at the measurement date (December 31) and the net periodic cost for the year:

At year end:	2006		2005
Discount rate (pension plan)	4.75	%	5.50	%
Discount rate (postretirement plan)	5.75	%	5.50	%
Rate of compensation increase	N/A		4.00	%

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

During the current year:	2006		2005		2004
Discount rate (pension and postretirement plans)	5.50	%	5.75	%	6.00	%
Expected long-term return on pension plan assets	8.25	%	8.75	%	8.75	%
Rate of compensation increase	4.00	%	4.50	%	4.50	%

The discount rate used in determining the projected benefit obligation for the pension plan is based on the intention to settle the plan’s liabilities in 2007. The discount rate used in determining the projected benefit obligations for the postretirement plan is selected by reference to the year-end Moody’s corporate AA rate, as well as other high-quality indices with similar duration to that of the benefit plans. The return on plan assets reflects the weighted-average of the expected long-term rates of return for the security classes of investments.

Pension Plan Assets:

Prior to the decision to terminate the pension plan, Ambac employed a total return investment approach whereby a mix of equity and bond mutual funds were used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities, plan funded status, and corporate financial condition. The plan strives to have diversification so that adverse or unexpected results from one security class will not have an unduly detrimental impact on the entire portfolio. The investment policy establishes a target allocation for each class which is rebalanced as deemed necessary. Target asset allocations were 40% large capitalization U.S. equity index mutual funds, 30% U.S. bond index mutual funds, 20% international equity mutual funds and 10% small capitalization U.S. equity mutual funds. At December 31, 2006, given the decision to terminate the plan, assets were invested in Treasury bonds with a 2007 maturity date.

The fair value of total plan assets at December 31, 2006 and 2005 by asset category were as follows:

	2006		2005
Equity mutual funds	—		75	%
Bond mutual funds	—		25	%
Treasury Bonds	100	%	—
	100	%	100	%

Savings Incentive Plan:

Substantially all employees of Ambac are covered by a defined contribution plan (the “Savings Incentive Plan”). Ambac makes an employer matching contribution of 50% of the employee’s contributions up to 6% of such participants’ base compensation, subject to limits set by the Internal Revenue Code. Effective January 1, 2007, the Compensation Committee of the Board of Directors approved an increase to the matching contribution from 50% to 100% of the employees contribution up to 6%. Ambac may also make a Basic Profit Sharing contribution of 3% of base compensation and a Supplemental Profit Sharing contribution of an additional 3% of base compensation to eligible employees. The total cost of the Savings Incentive Plan was $3,757, $3,521 and $3,256 in 2006, 2005 and 2004, respectively.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

13        STOCK COMPENSATION

Stock Options:

Stock options awarded to eligible employees are exercisable and expire as specified at the time of grant. Such options are awarded based on the fair market value of the Common Stock as traded on the New York Stock Exchange on the grant date and have a term of seven years from the date of the grant. All employee stock option agreements provide that vesting is accelerated in certain circumstances, such as upon retirement, permanent disability or death.

As mentioned in Note 2, “Stock Compensation Plans”, with the adoption of SFAS 123-R, Ambac used a Monte Carlo simulation model for the 2006 stock option grant. The model utilizes multiple input variables that determine the probability of satisfying each market condition stipulated in the option grant and calculates the fair market value for each option granted based on certain assumptions. In prior years’, the Black-Scholes model was used to value stock options. The assumptions for the 2006, 2005 and 2004 stock option grants are as follows:

	2006		2005	2004
Risk-free interest rate	4.3% - 4.4	%	3.6%	2.6%
Expected volatility	25.3	%	26.6%	28.0%
Suboptimal factor	175	%	Not Applicable	Not Applicable
Dividend yield	0.80	%	0.63%	0.60%
Expected life	5.23 years		4 years	4 years

The expected volatility is based on the average of implied volatility in Ambac’s traded options and historical volatility levels on Ambac’s common stock over the contractual term of the option. Utilized in the Monte Carlo simulation, the suboptimal factor represents the option holder’s expected exercise behavior, that is, the percentage multiplied by the option grant’s strike price results in the market price at which Ambac expects the holder to exercise their option. The determination of the suboptimal factor is based on the exercise history of Ambac’s previous grants considering management’s future expectation of exercise behavior. The expected dividend yield is based on historical dividend payments. The risk-free interest rates reflect the yields on U.S. Treasuries over the contractual term of the award. For the Monte Carlo simulation model, we have adjusted the contractual term of the option for the effect of retirement-eligible participants to arrive at the expected term assumption.

A summary of option activity for the period ending December 31, 2006 is as follows:

	Shares		Weighted Average Exercise Price		Aggregate Intrinsic Value		Weighted Average Remaining Contractual Life
Outstanding at beginning of year	4,338,886		$	59.55
Granted	665,650		$	74.45
Exercised	(1,188,442	)	$	51.46
Forfeited or expired	(66,275	)	$	73.04
Outstanding at end of year	3,749,819		$	64.52	$	93,115	3.6
Exercisable	1,657,930		$	55.22	$	56,594	2.2

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The grant date fair value of stock options granted during 2006, 2005 and 2004 were $22.25, $21.23 and $16.93, respectively. The intrinsic value for stock options exercised during 2006, 2005 and 2004 was $37,334, $25,245 and $56,990, respectively.

As of December 31, 2006, there were $12,842 of total unrecognized compensation costs related to unvested stock options granted. These costs are expected to be recognized over a weighted average period of 3.2 years. Gross stock option expense for 2006, 2005 and 2004 was $15,079, $10,169 and $12,314, respectively. The net income effect from stock options for 2006, 2005 and 2004 were $5,692, $3,857, and $4,251, respectively.

Cash received from stock option exercises for 2006 was $61,190. The income tax benefits from share-based arrangements totaled $17,819 for 2006, with approximately $12,342 attributed to stock option exercises. Excess tax benefits are included in financing activities of the Consolidated Statements of Cash Flows.

RSUs:

RSUs are granted to all eligible employees based upon the performance of Ambac, the performance of the employee’s department and the performance of the employee. Officers at the level of Managing Director and above, can, in lieu of the first twenty-five percent of their cash bonus, receive RSUs. These RSUs are granted at a twenty-five percent discount to the fair market value of Ambac common stock on the date of grant. These employees can elect to defer more than twenty-five percent of their cash bonus in the form of RSUs, however, the aforementioned discount does not apply. RSUs do not have a vesting period in excess of four years. Typically, RSU agreements provide that vesting is accelerated in certain circumstances, such as retirement, permanent disability or death. As of December 31, 2006, 1,288,484 RSUs remained outstanding, of which (i) 549,995 units required future service as a condition to the delivery of the underlying shares of common stock and (ii) 738,489 units did not require future service.

Information with respect to the RSU awards is as follows:

	2006		2005		2004
RSUs awarded		260,086		270,728		380,779
Weighted average fair value per share	$	75.13	$	78.75	$	73.65
Gross RSU expense	$	22,448	$	19,047	$	12,547
Net income effect	$	9,629	$	8,011	$	5,412

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

A summary of RSU activity for 2006 is as follows:

	2006
			Weighted Average Grant Date Fair Value
	Shares
Outstanding at beginning of year	1,535,309		$	56.78
Granted	260,086		$	75.13
Delivered	(466,865	)	$	43.40
Forfeited	(40,046	)	$	74.84
Outstanding at end of year	1,288,484		$	64.62

As of December 31, 2006, there was $16,093 of total unrecognized compensation costs related to unvested RSUs granted. These costs are expected to be recognized over a weighted average period of 1.8 years. The fair value for RSUs vested during 2006, 2005 and 2004 was $8,511, $9,986 and $12,912, respectively.

14        COMMITMENTS AND CONTINGENCIES

Ambac is responsible for leases on the rental of office space. The lease agreements, which expire periodically through September 2019, contain provisions for scheduled periodic rent increases and are accounted for as operating leases. An estimate of future net minimum lease payments in each of the next five years ending December 31, and the periods thereafter, is as follows:

	Amount
2007	$	9,260
2008		9,338
2009		9,497
2010		9,944
2011		9,967
All later years		72,489
	$	120,495

Rent expense for the aforementioned leases amounted to $9,966, $10,018 and $8,507 for the years ended December 31, 2006, 2005 and 2004, respectively.

A subsidiary of Ambac provides a $360,000 liquidity facility to a reinsurance company which acts as reinsurer with respect to a portfolio of life insurance policies. The liquidity facility, which is guaranteed by Ambac Assurance, provides temporary funding in the event that the reinsurance company’s capital is insufficient to make payments under the reinsurance agreement. The reinsurance company is required to repay all amounts drawn under the liquidity facility. No amounts have been drawn under this facility at December 31, 2006.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

15        STOCKHOLDERS’ EQUITY

Ambac is authorized to issue 350,000,000 shares of Common Stock, par value $0.01 per share, of which 109,193,096 were issued as of December 31, 2006. Ambac is also authorized to issue 4,000,000 shares of Preferred Stock, par value $0.01 per share, none of which was issued and outstanding as of December 31, 2006.

Dividends declared per share amounted to $0.66, $0.55, and $0.47 in 2006, 2005, and 2004, respectively.

Stockholder Rights Plan:

Ambac maintained a Stockholder Rights Plan under which stockholders received (after giving effect to two stock splits since adoption of the Plan) one Right for each three shares of Common Stock owned. The Rights expired on January 31, 2006 and Ambac’s Board of Directors decided not to renew the Stockholder Rights Plan.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

16        GUARANTEES IN FORCE

The par amount of financial guarantees outstanding were $567,578,000 and $523,247,000 at December 31, 2006 and 2005, respectively. The par amount of financial guarantees outstanding, net of reinsurance, was $519,043,000 and $479,085,000 at December 31, 2006 and 2005, respectively. As of December 31, 2006 and 2005, the guarantee portfolio was diversified by type of guaranteed bond as shown in the following table:

	Net Par Amount Outstanding(1)
(Dollars in Millions)	2006		2005
Public Finance:
Lease and tax-backed revenue	$	89,042	$	82,584
General obligation		62,834		57,982
Utility revenue		38,313		36,877
Health care revenue		27,849		26,994
Transportation revenue		24,979		23,718
Higher education		22,068		20,203
Housing revenue		10,996		10,152
Other		6,181		5,556
Total Public Finance		282,262		264,066
Structured Finance:
Mortgage-backed and home equity		46,239		48,869
Pooled debt obligations		40,568		25,746
Asset-backed and conduits		34,815		32,505
Student loan		18,404		16,538
Investor-owned utilities		17,345		16,398
Other		5,212		4,296
Total Structured Finance		162,583		144,352
International Finance:
Pooled debt obligations		19,978		23,427
Asset-backed and conduits		17,863		15,356
Mortgage-backed and home equity		11,951		14,627
Investor-owned and public utilities		10,531		8,052
Sovereign/sub-sovereign		6,344		3,585
Transportation		6,303		4,951
Other		1,228		669
Total International Finance		74,198		70,667
	$	519,043	$	479,085

(1) Included in the above exposures are credit derivatives. Total credit derivative net par outstanding amounted to $55,460 and $43,712 at December 31, 2006 and 2005, respectively.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

As of December 31, 2006 and 2005, the International Finance guaranteed portfolio is shown in the following table by location of risk:

	Net Par Amount Outstanding
(Dollars in Millions)	2006		2005
United Kingdom	$	27,253	$	22,761
Australia		6,126		5,139
Germany		5,852		5,895
Japan		4,391		4,274
Italy		2,167		1,843
Internationally diversified		19,180		22,874
Other international		9,229		7,881
Total International Finance	$	74,198	$	70,667

Internationally diversified obligations represent pools of geographically diversified exposures which includes significant components of domestic exposure.

Gross financial guarantees in force (principal and interest) was $887,448,000 and $801,085,000 at December 31, 2006 and 2005, respectively. Net financial guarantees in force (after giving effect to reinsurance) was $802,694,000 and $726,612,000 as of December 31, 2006 and 2005, respectively.

In the United States, California and New York were the states with the highest aggregate net par amounts in force, accounting for 10.6% and 6.6% of the total at December 31, 2006. No other state accounted for more than five percent. The highest single insured risk represented 0.5% of the aggregate net par amount guaranteed.

In connection with its financial guarantee business, Ambac has outstanding commitments to provide guarantees of $25,551,000 at December 31, 2006. These commitments relate to potential future debt issuances or increases in funding levels for existing insurance or credit derivative transactions. Commitments relating to future debt issuances generally have fixed termination dates and are contingent on the satisfaction of all conditions set forth in the contract. Since these commitments may expire unused or be reduced or cancelled at the counterparty’s request, the total commitment amount does not necessarily reflect actual future guaranteed amounts.

17        FAIR VALUE OF FINANCIAL INSTRUMENTS

The following fair value amounts were determined by using independent market information when available, and valuation models when market quotes were not available. In cases where specific market quotes are unavailable, interpreting market data and estimating fair values require considerable judgment by management. Accordingly, the estimates presented are not necessarily indicative of the amount Ambac could realize in a current market exchange. The following methods and assumptions

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Investments: The fair values of fixed income investments are based primarily on quoted market prices received from a nationally recognized pricing service or dealer quotes. When quotes are not available, fair values are estimated based upon internal valuation models.

Short-term investments and cash: The fair values of short-term investments and cash approximates amortized cost.

Other investments: The fair value of other investments, primarily mutual funds, are based on quoted market prices received from a nationally recognized pricing service.

Securities purchased under agreements to resell: The fair value of securities purchased under agreements to resell approximates carrying value.

Investment income due and accrued: The fair value of investment income due and accrued approximates carrying value.

Loans: The fair values of loans is estimated based upon internal valuation models.

Derivative contracts: The fair values of interest rate swaps, currency swaps, total return swaps and structured credit derivative transactions are determined by market quotes or valuation models when market quotes are not available.

Obligations under investment, payment and investment repurchase agreements: The fair value of the liability for investment agreements, payment and repurchase agreements is estimated based upon internal valuation models.

Securities sold under agreements to repurchase: The fair value of securities sold under agreements to repurchase approximates carrying value.

Long-term Debt: The fair value of debentures is based on quoted market prices.

Accrued interest payable: The fair value of accrued interest payable approximates carrying value.

Liability for net financial guarantees written: The fair value of the liability for those financial guarantees written is based on the estimated cost to reinsure those exposures at current market rates, which amount consists of the current unearned premium reserve less prepaid reinsurance plus the present value of estimated future installment premiums, less an estimated ceding commission thereon. The estimate of the amounts and timing of the future installment premiums is based on contractual premium rates, debt service schedules and expected run-off scenarios.

119

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The carrying amount and estimated fair value of financial instruments are presented below:

	As of December 31,
	2006				2005
(Dollars in Millions)	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets:
Fixed income securities	$	16,800	$	16,800	$	14,735	$	14,735
Fixed income securities pledged as collateral		307		307		371		371
Short-term investments		312		312		472		472
Other investments		14		14		14		14
Cash		32		32		28		28
Securities purchased under agreements to resell		273		273		419		419
Investment income due and accrued		193		193		171		171
Loans		625		805		685		858
Derivative assets		1,019		1,019		981		981
Financial liabilities:
Obligations under investment, repurchase and payment agreements		8,357		8,667		7,253		7,577
Long-term debt		992		1,019		1,192		1,228
Accrued interest payable		105		105		100		100
Derivative liabilities		667		667		808		808
Liability for net financial guarantees written:		2,722		3,508		2,638		3,314

18        INSURANCE REGULATORY RESTRICTIONS

Ambac Assurance is subject to insurance regulatory requirements of the States of Wisconsin and New York, and the other jurisdictions in which it is licensed to conduct business.

Ambac Assurance’s ability to pay dividends is generally restricted by law and subject to approval by the Office of the Commissioner of Insurance of the State of Wisconsin. Wisconsin insurance law restricts the payment of dividends in any 12-month period without regulatory approval to the lesser of (a) 10% of policyholders’ surplus as of the preceding December 31 and (b) the greater of (i) statutory net income for the calendar year preceding the date of dividend, minus realized capital gains for that calendar year and (ii) the aggregate of statutory net income for three calendar years preceding the date of the dividend, minus realized capital gains for those calendar years and minus dividends paid or credited within the first two of the three preceding calendar years. Additionally, no quarterly dividend may exceed the dividend paid in the corresponding quarter of the preceding year by more than 15% without notifying the Wisconsin Insurance Commissioner 30 days in advance of payment. Based upon these restrictions, at December 31, 2006, the maximum amount that will be available during 2007 for payment of dividends by Ambac Assurance is approximately $370,000. Ambac Assurance paid cash dividends of $136,000, $353,400 and $103,600 on its common stock in 2006, 2005 and 2004, respectively. The 2005 amounts required regulatory approval since it exceeded the statutorily prescribed threshold.

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The New York Financial Guarantee Insurance Law establishes single risk limits applicable to obligations insured by Ambac Assurance. Such limits are specific to the type of insured obligation (for example, municipal or asset-backed). The limits compare the insured net par outstanding and average annual debt service, net of reinsurance and collateral, for a single risk to the insurer’s qualified statutory capital, which is defined as the sum of the insurer’s policyholders’ surplus and contingency reserves. As of December 31, 2006 and 2005, Ambac Assurance and its subsidiaries were in compliance with these regulatory requirements.

Ambac Assurance’s statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by the Wisconsin Insurance Department. Wisconsin has adopted the National Association of Insurance Commissioners’ statutory accounting practices (“NAIC SAP”) as a component of its prescribed accounting practices. Wisconsin’s accounting practice for changes to the contingency reserve differ from those practices of NAIC SAP. Under NAIC SAP, contributions to and releases from the contingency reserve are recorded via a direct charge or credit to surplus. Under the Wisconsin Administrative Code, contributions to and release from the contingency reserve are to be recorded through underwriting income. Ambac Assurance received permission of the Wisconsin Insurance Commissioner to record contributions to and releases from the contingency reserve in accordance with NAIC SAP. Statutory surplus is the same using each of these accounting practices. Statutory net income is higher than if Ambac Assurance had reported the net contributions in accordance with the Wisconsin Administrative Code by $322,786, $265,536 and $235,881 for 2006, 2005 and 2004, respectively.

Statutory capital and surplus was $3,696,876 and $3,327,484 at December 31, 2006 and 2005, respectively. Qualified statutory capital was $6,370,991 and 5,648,813 at December 31, 2006 and 2005, respectively. Statutory net income for Ambac Assurance was $788,989, $707,402 and $693,176 for 2006, 2005 and 2004, respectively. Statutory capital and surplus differs from stockholders’ equity determined under GAAP principally due to statutory accounting rules that treat loss reserves, premiums earned, policy acquisition costs and deferred income taxes differently.

19        SEGMENT INFORMATION

Ambac has two reportable segments, as follows: (1) Financial Guarantee, which provides financial guarantees (including credit derivatives) for public finance, structured finance and other obligations; and (2) Financial Services, which provides investment agreements, funding conduits, interest rate, total return and currency swaps, principally to clients of the financial guarantee business, which includes municipalities and other public entities, health care organizations, investor-owned utilities and asset-backed issuers. Ambac’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different marketing strategies, personnel skill sets and technology.

Ambac Assurance guarantees the swap and investment agreement obligations of its Financial Services affiliates. Intersegment revenues include the premiums earned under those agreements and dividends received from its Financial Services subsidiaries. Such premiums are determined as if they were premiums paid by third parties, that is, at current market prices.

121

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

Information provided below for “Corporate and Other” relates to Ambac corporate activities, including interest expense on debentures. Corporate and other revenue from unaffiliated customers consists primarily of interest income. Intersegment revenues consist of dividends received.

The following table is a summary of the financial information from continuing operations by reportable segment as of and for the years ended December 31, 2006, 2005 and 2004:

	Financial Guarantee		Financial Services			Corporate and Other			Intersegment Eliminations			Total Consolidated
2006:
Revenues:
Unaffiliated customers	$	1,350,980	$	468,719		$	12,405		$	—		$	1,832,104
Intersegment		55,089		(9,773	)		167,338			(212,654	)		—
Total revenues	$	1,406,069	$	458,946		$	179,743		($	212,654	)	$	1,832,104
Income before income taxes:
Unaffiliated customers	$	1,197,236	$	96,426		($	83,449	)	$	—		$	1,210,213
Intersegment		65,745		(13,135	)		163,358			(215,968	)		—
Total income before income taxes	$	1,262,981	$	83,291		$	79,909		($	215,968	)	$	1,210,213
Total assets	$	10,690,956	$	9,487,052		$	89,805		$	—		$	20,267,813
2005:
Revenues:
Unaffiliated customers	$	1,276,903	$	333,901		$	3,345		$	—		$	1,614,149
Intersegment		1,975		(3,139	)		353,400			(352,236	)		—
Total revenues	$	1,278,878	$	330,762		$	356,745		($	352,236	)	$	1,614,149
Income before income taxes:
Unaffiliated customers	$	1,009,346	$	80,963		($	67,545	)	$	—		$	1,022,764
Intersegment		8,867		(2,699	)		350,280			(356,448	)		—
Total income before income taxes	$	1,018,213	$	78,264		$	282,735		($	356,448	)	$	1,022,764
Total assets	$	9,655,161	$	8,593,256		$	297,441		$	—		$	18,545,858
2004:
Revenues:
Unaffiliated customers	$	1,163,563	$	236,345		$	1,656		$	—		$	1,401,564
Intersegment		23,255		(5,571	)		108,240			(125,924	)		—
Total revenues	$	1,186,818	$	230,774		$	109,896		($	125,924	)	$	1,401,564
Income before income taxes:
Unaffiliated customers	$	987,400	$	52,731		($	63,349	)	$	—		$	976,782
Intersegment		28,823		(5,779	)		105,747			(128,791	)		—
Total income before income taxes	$	1,016,223	$	46,952		$	42,398		($	128,791	)	$	976,782
Total assets	$	9,167,861	$	8,440,952		$	64,383		$	—		$	17,673,196

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AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The following tables summarize gross premiums written and net premiums earned and other credit enhancement fees included in the Financial Guarantee segment, by location of risk for the years ended December 31, 2006, 2005 and 2004:

	2006		2005		2004
Gross premiums written:
United States	$	709,299	$	866,749	$	819,321
United Kingdom		143,872		81,492		110,225
Other international		143,498		147,782		118,790
Total:	$	996,669	$	1,096,023	$	1,048,336
Net premiums earned and other credit enhancement fees:
United States	$	645,819	$	651,175	$	553,717
United Kingdom		77,781		64,335		60,731
Other international		147,783		150,905		150,062
Total:	$	871,383	$	866,415	$	764,510

Internationally diversified includes significant components of domestic exposure.

20        DISCONTINUED OPERATIONS

In November 2003, Ambac announced that it had entered into an agreement to sell the operations of Cadre Financial Services, Inc. (“Cadre”) and Ambac Securities, Inc., (“Ambac Securities”) its investment advisory and cash management business. As a registered adviser with the SEC, Cadre was subject to regulation in certain aspects of its business, particularly with respect to investment advisory services provided to investment companies and clients. Cadre provided investment advisory and administrative services to money market funds that are primarily offered to qualified participants, including school districts, health care service providers and municipalities. Ambac Securities’ principal business was the distribution of money market funds to the education, health care and municipal sectors, as well as the brokering of short-term fixed income securities trades on behalf of its clients. This business had been part of Ambac’s Financial Services segment. The decision to sell its investment advisory and cash management business has enabled Ambac to focus on its core financial guarantee business. The sale closed during the first quarter of 2004.

Following the November 2003 announcement of the pending sale, Cadre and Ambac Securities results were reported in Ambac’s Consolidated Statements of Operations as discontinued operations. Summarized financial information for discontinued operations is as follows:

	2006		2005		2004
Total revenues	$	—	$	—	$	469
Loss from discontinued operations		—		—		(1,349	)
Income tax (benefit) expense		—		—		(60	)
Net loss from discontinued operations	$	—	$	—	($	1,289	)

123

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

21        QUARTERLY FINANCIAL INFORMATION (unaudited)

	First		Second		Third			Fourth		Full Year
2006:
Gross premiums written	$	219,058	$	313,500	$	212,335		$	251,776	$	996,669
Net premiums written		227,815		255,753		185,984			223,621		893,173
Net premiums earned and other credit enhancement fees		208,420		224,984		214,590			223,389		871,383
Financial guarantee net investment income		101,734		104,455		107,156			110,540		423,885
Financial services revenue		97,591		144,609		115,403			111,116		468,719
Losses and loss expenses		127		12,822		(2,543	)		9,598		20,004
Financial guarantee underwriting and operating expenses		37,858		31,865		30,186			33,831		133,740
Financial services expenses		78,537		93,836		100,245			99,675		372,293
Income before income taxes		301,641		326,963		297,149			284,460		1,210,213
Net income		221,140		238,570		213,523			202,678		875,911
Net income per share:
Basic	$	2.08	$	2.24	$	2.00		$	1.90	$	8.22
Diluted	$	2.06	$	2.22	$	1.98		$	1.88	$	8.15
2005:
Gross premiums written	$	229,221	$	322,713	$	238,010		$	306,079	$	1,096,023
Net premiums written		255,848		268,675		203,714			268,113		996,350
Net premiums earned and other credit enhancement fees		211,796		205,863		231,179			217,577		866,415
Financial guarantee net investment income		90,700		92,157		98,539			96,700		378,096
Financial services revenue		67,030		103,985		86,560			76,326		333,901
Losses and loss expenses		23,472		21,657		89,126			15,601		149,856
Financial guarantee underwriting and operating expenses		33,260		28,829		27,757			27,855		117,701
Financial services expenses		54,599		60,830		65,514			71,995		252,938
Income before income taxes		251,972		260,910		226,978			282,904		1,022,764
Net income		185,543		186,098		175,117			204,252		751,010
Net income per share:
Basic	$	1.68	$	1.71	$	1.63		$	1.92	$	6.94
Diluted	$	1.66	$	1.69	$	1.61		$	1.90	$	6.87

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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

(a) Evaluation of Disclosure Controls and Procedures. Ambac Financial Group’s management, with the participation of Ambac Financial Group’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Ambac Financial Group’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this report. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, Ambac Financial Group’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Ambac Financial Group’s disclosure controls and procedures are effective at the reasonable assurance level in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Ambac Financial Group (including its consolidated subsidiaries) in the reports that it files or submits under the Exchange Act.

(b) Changes in Internal Controls Over Financial Reporting. There have not been any changes in Ambac Financial Group’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during Ambac Financial Group’s fiscal quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, Ambac Financial Group’s internal control over financial reporting.

The report called for by Item 308(a) of Regulation S-K is incorporated herein by reference to Management’s Report on Internal Control Over Financial reporting, included in Part II, Item 8 of this report.

The attestation report called for by Item 308 (b) of Regulation S-K is incorporated herein by reference to Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting, included in Part II, Item 8 of this report.

Item 9B. Other Information.

None

Part III

Item 10. Directors and Executive Officers of the Registrant.

Information relating to the Registrant’s executive officers and directors, including its audit committee and audit committee financial experts will be in the Registrant’s definitive Proxy Statement

125

for its 2007 Annual Meeting of Shareholders to be held on May 8, 2007, which will be filed within 120 days of the end of our fiscal year ended December 31, 2006 (the 2007 Proxy Statement) and is incorporated herein by reference. Information relating to the Registrant’s Code of Business Conduct is included in Part I, Item 1 of the Annual Report on Form 10-K.

Item 11. Executive Compensation.

Information relating to the Registrant’s executive officer and director compensation will be in the 2007 Proxy Statement and is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

Information relating to security ownership of certain beneficial owners of the Registrant’s common stock and information relating to the security ownership of the Registrant’s management will be in the 2007 Proxy Statement and is incorporated herein by reference.

Information relating to compensation plans under which equity securities of the Registrant are authorized for issuance will be in the 2007 Proxy Statement and is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions.

None.

Item 14. Principal Accountant Fees and Services.

This item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A.

Part IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

(a) Documents filed as a part of this report:

1. Financial Statements

The consolidated financial statements included in Item 8 above are filed as part of this Annual Report on Form 10-K.

126

2. Financial Statement Schedules

The financial statement schedules filed herein, which are the only schedules required to be filed, are as follows:

Report of Independent Registered Public Accounting Firm			(Page S-1	)
Schedule I	—	Summary of Investments Other Than Investments in Related Parties	(Page S-2	)
Schedule II	—	Condensed Financial Information of Registrant (Parent Company Only)	(Pages S-3 to S-7	)
Schedule IV	—	Reinsurance	(Page S-8	)

3. Exhibits

The following items are annexed as exhibits:

Exhibit Number	Description
3.01	Conformed Amended and Restated Certificate of Incorporation of Ambac Financial Group filed with the Secretary of State of the State of Delaware on July 11, 1997. (Filed as Exhibit 4.05 to Ambac Financial Group’s Quarterly Report for the quarter ended September 30, 1997 and incorporated herein by reference.)
3.02	Conformed Copy of the Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Ambac Financial Group, Inc. filed with the Secretary of State of the State of Delaware on May 13, 1998. (Filed as Exhibit 4.04 to the Ambac Financial Group Inc.’s Quarterly Report for the quarter ended June 30, 1998 and incorporated herein by reference.)
3.03	Conformed Copy of Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Ambac Financial Group, Inc. filed with the Secretary of State of the State of Delaware on May 28, 2004. (Filed as Exhibit 3.03 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.)
3.04	By-laws of Ambac Financial Group, Inc., as amended through January 27, 2004. (Filed as Exhibit 3.03 to Ambac Financial Group Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference.)
4.01	Definitive Engraved Stock Certificate representing shares of Common Stock. (Filed as Exhibit 4.01 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference.)
4.02	Indenture, dated as of August 1, 1991, between Ambac Financial Group, Inc. and The Bank of New York (as Successor Trustee to The Chase Manhattan Bank (National Association)). (Filed as Exhibit 4.01 to Ambac Financial Group, Inc.’s Registration Statement on Form S-3 (Reg. No. 33-59290) and incorporated herein by reference.)

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Exhibit Number	Description
4.03	Indenture dated as of August 24, 2001 between Ambac Financial Group, Inc. and The Bank of New York (as Successor Trustee to the Chase Manhattan Bank). (Filed as Exhibit 4.1 to Ambac Financial Group, Inc.’s Amendment No. 2 to Registration Statement on Form S-3 (Reg. No. 333-57206) and incorporated herein by reference.)
4.04	Indenture dated as of April 22, 2003 between Ambac Financial Group, Inc. and The Bank of New York (as Successor Trustee to JP Morgan Chase Bank). (Filed as Exhibit 4.1 to Ambac Financial Group, Inc.’s Registration Statement on Form S-3 (Reg. No. 333-104758) and incorporated herein by reference.)
4.05	Indenture dated as of February 15, 2006 between Ambac Financial Group, Inc. and the Bank of New York as Trustee. (Filed as Exhibit 4.1 to Ambac Financial Group Inc.’s Shelf Registration on Form S-3 dated February 16, 2006 and incorporated herein by reference.)
4.06	Junior Subordinated Indenture dated as of February 12, 2007 between Ambac Financial Group, Inc. and the Bank of New York as Trustee. (Filed as Exhibit 4.11 to Ambac Financial Group, Inc.’s Current Report on Form 8-K dated February 12, 2007 and incorporated herein by reference.)
4.07	First Supplemental Indenture dated as of February 7, 2007 between Ambac Financial Group, Inc. and the Bank of New York as Trustee. (Filed as Exhibit 1.01 to Ambac Financial Group, Inc.’s Current Report on Form 8-K dated February 12, 2007 and incorporated herein by reference.)
4.08	Form of 9.38% Debenture due August 1, 2011. (Filed as Exhibit 4.02 to the Registration Statement on Form S-1 (Reg. No. 33-40385) and incorporated herein by reference.)
4.09	Form of 7.50% Debenture due May 1, 2023. (Filed as Exhibit 4.06 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1998 and incorporated herein by reference.)
4.10	Form of 5.95% Debenture due February 28, 2103 (Filed as Exhibit 2 to Ambac Financial Group, Inc.’s Registration Statement on Form 8-A dated February 26, 2003 and incorporated herein by reference.)
4.12	Form of 5.875% Debentures due March 24, 2103. (Filed as Exhibit 2 to Ambac Financial Group, Inc.’s Registration Statement on Form 8-A dated March 26, 2003 and incorporated herein by reference)
4.13	Form of 5.95% Debentures due December 5, 2035. (Filed as Exhibit 4.13 to Ambac Financial Group, Inc.’s Current Report on From 8-K dated November 29, 2005 and incorporated herein by reference.)
4.14	Form of 6.15% Directly Issued Subordinated Capital Securities due February 15, 2037. (Filed as Exhibit 4.13 to Ambac Financial Group Inc.’s Current Report on Form 8-K dated February 12, 2007 and incorporated herein by reference.)
4.15	Replacement Capital Covenant dated as of February 12, 2007 by Ambac Financial Group, Inc. and in favor of and for the benefit of each Covered Debt Holder. (Filed as Exhibit 4.14 to Ambac Financial Group, Inc.’s Current Report on Form 8-K dated February 12, 2007 and incorporated herein by reference.

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Exhibit Number		Description
10.01	*	Employment Agreement dated as of January 27, 2004 by and between Ambac Financial Group, Inc. and Robert J. Genader. (Filed as Exhibit 10.02 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003 and incorporated herein by reference.)
10.02	*+	Employment Agreement dated as of January 30, 2007 by and between Ambac Financial Group, Inc. and William T. McKinnon.
10.03	*+	Directors’ Compensation Table (effective as of July 25, 2006.)
10.04	*	Ambac Financial Group, Inc. 1991 Stock Incentive Plan, as amended as of December 2, 1997 (Filed as Exhibit 10.02 to Ambac Financial Group, Inc. Annual Report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference.)
10.05	*	Ambac Financial Group, Inc. 1997 Equity Plan, amended as of July 19, 2004. (Filed as Exhibit 10.06 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.)
10.06	*+	Form of Restricted Stock Unit Award.
10.07	*+	Form of Stock Option Award.
10.08	*+	January 2007 Award of Restricted Stock Units to William McKinnon.
10.09	*	Ambac Financial Group, Inc. 1997 Non-Employee Directors Equity Plan. (as amended through October 24, 2006.) (Filed as Exhibit 10.39 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 and incorporated herein by reference.)
10.10	*	Form of Notice of Award of Directors’ Five Year Restricted Stock Units. (Filed as Exhibit 10.12 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.)
10.11	*	Form of Notice of Award of Directors’ Annual Stock Units. (Filed as Exhibit 10.13 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004 and incorporated herein by reference.)
10.12	*	Ambac Financial Group, Inc. 1997 Executive Incentive Plan, amended as of January 23, 2006. (Filed as Exhibit 10.14 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31,2005 and incorporated herein by reference.)
10.13	*	Ambac Financial Group, Inc. Deferred Compensation Plan for Outside Directors, effective as of December 1, 1993 as amended through October 15, 2002. (Filed as Exhibit 10.07 to Ambac Financial Group, Inc.’s Annual Report of Form 10-K for the year ended December 31, 2002 and incorporated herein by reference.)

+ Filed herewith.

* Management contract or compensatory plan, contract or arrangement required to be filed as an exhibit pursuant to Item 15(c) of Form 10-K.

129

Exhibit Number		Description
10.14	*	Ambac Financial Group, Inc. 1997 Equity Plan Senior Officer Deferred Compensation Sub-Plan of the 1997 Equity Plan effective as of October 26, 1999 (Filed as Exhibit 10.27 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the period ended September 30, 1999 and incorporated herein by reference.)
10.15	*	Form of Amended and Restated Management Retention Agreement dated as of December 2, 1997. (Filed as Exhibit 10.08 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference.)
10.16	*	The Ambac Financial Group, Inc. Non-Qualified Savings Incentive Plan (effective as of January 1, 1995). (Filed as Exhibit 10.16 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the period ended September 30, 1995, and incorporated herein by reference.)
10.17	*	Amendment Number 1 to the Ambac Financial Group, Inc. Non-Qualified Savings Incentive Plan effective as of April 30, 1997. (Filed as Exhibit 10.10 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference.)
10.18	*	Ambac Financial Group, Inc. Excess Benefits Pension Plan (Amended and Restated as of January 1, 1994) (As amended through October 25, 1995). (Filed as Exhibit 10.17 to Ambac Financial Group, Inc.’ Quarterly Report on Form 10-Q for the period ended September 30, 1995, and incorporated herein by reference.)
10.19	*	Amendment Number 1 to the Ambac Financial Group, Inc. Excess Benefits Pension Plan effective as of April 30, 1997. (Filed as Exhibit 10.12 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference.)
10.20	*	Supplemental Pension Agreement between Ambac Financial Group, Inc. and Philip B. Lassiter dated April 30, 1997. (Filed as Exhibit 10.24 in Ambac Financial Group, Inc.’s Quarterly Report Form 10-Q for the quarter ended June 30, 1997, and incorporated herein by reference.)
10.21	*	Ambac Financial Group, Inc. Supplemental Pension Plan (Amended and Restated as of January 1, 1995) (As amended through October 25, 1995). (Filed as Exhibit 10.18 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the period ended September 30, 1995, and incorporated herein by reference.)
10.22	*	Amendment Number 1 to the Ambac Financial Group, Inc. Supplemental Pension Plan effective as of April 30, 1997. (Filed as Exhibit 10.18 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference.)

* Management contract or compensatory plan, contract or arrangement required to be filed as an exhibit pursuant to Item 15(c) of Form 10-K.

130

Exhibit Number	Description
10.23	Lease Agreement, dated as of January 1, 1992 between South Ferry Building Company and Ambac Assurance Corporation. (Filed as Exhibit 10.36 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1992 and incorporated herein by reference.)
10.24	Amendment to Lease Agreement dated August 1, 1997 between South Ferry Building Company and Ambac Assurance Corporation. (Filed as Exhibit 10.20 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997 and incorporated herein by reference.)
10.25	Amendment to Lease Agreement dated December 23, 2002 between South Ferry Building Company and Ambac Assurance Corporation. (Filed as Exhibit 10.20 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference.)
10.26	Tax Settlement Agreement, dated as of March 30, 1993, among Citicorp, Citibank, N.A., Citicorp Financial Guaranty Holdings, Inc., Ambac Financial Group, Inc., Ambac Assurance Corporation, American Municipal Bond Holding Company and Health Care Investment Analysts, Inc. (Filed as Exhibit 10.02 to Ambac Financial Group, Inc.’s Registration Statement on Form S-3 (Registration No. 33-59290) and incorporated herein by reference.)
10.27	Conformed Copy of U.S. $400,000,000 Revolving Credit Agreement, dated as of July 28, 2005 among Ambac Financial Group and Ambac Assurance Corporation as the Borrowers, certain commercial lending institutions, as Lenders, Citibank, N.A., as Administrative Agent, The Bank of New York and KeyBank, National Association, as Co-Syndication Agents and Citibank Global Markets, Inc. as Sole Book Runner. (Filed as Exhibit 10.40 to Ambac Financial Group, Inc.’s Current Report on Form 8-K dated July 28, 2005 and incorporated herein by reference.)
10.28	Amendment Number 1, dated as of July 28, 2006, to the $400,000,000 Revolving Credit Agreement dated as of July 28, 2005 among Ambac Financial Group and Ambac Assurance Corporation as the Borrowers, certain commercial lending institutions, as Lenders, Citibank, N.A., as Administrative Agent, The Bank of New York and KeyBank, National Association, as Co-Syndication Agents and Citibank Global Markets, Inc. as Sole Book Runner. (Filed as Exhibit 10.42 to Ambac Financial Group, Inc.’s Quarterly Report on Form 10-Q for the Quarter Ended June 30, 2006 and incorporated herein by reference).
10.29	Put Option Agreement between Ambac Assurance Corporation and Dutch Harbor Finance Master Trust, on Behalf of its Series Dutch Harbor Finance Sub-Trust I, dated as of December 3, 2001. (Filed as Exhibit 10.27 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference.)
10.30	Put Option Agreement between Ambac Assurance Corporation and Dutch Harbor Finance Master Trust, on Behalf of its Series Dutch Harbor Finance Sub-Trust II, dated as of December 3, 2001. (Filed as Exhibit 10.28 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference.)

131

Exhibit Number	Description
10.31	Put Option Agreement between Ambac Assurance Corporation and Dutch Harbor Finance Master Trust, on Behalf of its Series Dutch Harbor Finance Sub-Trust III, dated as of December 3, 2001. (Filed as Exhibit 10.29 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference.)
10.32	Put Option Agreement between Ambac Assurance Corporation and Dutch Harbor Finance Master Trust, on Behalf of its Series Dutch Harbor Finance Sub-Trust IV, dated as of December 3, 2001. (Filed as Exhibit 10.30 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2001 and incorporated herein by reference.)
10.33	Put Option Agreement between Ambac Assurance Corporation and Anchorage Finance Master Trust on Behalf of its Series Anchorage Finance Sub-Trust I, dated May 23, 2002. (Filed as Exhibit 10.27 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference.)
10.34	Put Option Agreement between Ambac Assurance Corporation and Anchorage Finance Master Trust on Behalf of its Series Anchorage Finance Sub-Trust II, dated May 23, 2002. (Filed as Exhibit 10.28 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference.)
10.35	Put Option Agreement between Ambac Assurance Corporation and Anchorage Finance Master Trust on Behalf of its Series Anchorage Finance Sub-Trust III, dated May 23, 2002. (Filed as Exhibit 10.29 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference.)
10.36	Put Option Agreement between Ambac Assurance Corporation and Anchorage Finance Master Trust on Behalf of its Series Anchorage Finance Sub-Trust IV, dated May 23, 2002. (Filed as Exhibit 10.30 to Ambac Financial Group, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002 and incorporated herein by reference.)
10.37+	Master Confirmation of Capped Accelerated Stock Buyback dated as of February 7, 2007 between Ambac Financial Group, Inc. and Goldman, Sachs & Co.
10.38+	Supplemental Confirmation of Capped Accelerated Stock Buyback dated as of February 7, 2007 between Ambac Financial Group, Inc. and Goldman, Sachs & Co.
10.39+	Amendment to the Master Confirmation and Supplemental Confirmation of Capped Accelerated Stock Buyback dated as of February 21, 2007 between Ambac Financial Group, Inc. and Goldman, Sachs & Co.
12.01+	Statement re computation of ratios.
21.01+	List of Subsidiaries of Ambac Financial Group, Inc.
23.01+	Consent of Independent Registered Public Accounting Firm
24.01+	Power of Attorney from Robert J. Genader.
24.02+	Power of Attorney from Michael A. Callen.
24.03+	Power of Attorney from Jill M. Considine.

132

Exhibit Number	Description
24.04+	Power of Attorney from W. Grant Gregory.
24.05+	Power of Attorney from Phillip B. Lassiter.
24.06+	Power of Attorney from Sean T. Leonard.
24.07+	Power of Attorney from Thomas C. Theobald.
24.08+	Power of Attorney from Laura S. Unger.
24.09+	Power of Attorney from Henry D.G. Wallace.
31.1+	Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) Promulgated under the Securities Exchange Act of 1934, as amended.
31.2+	Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) Promulgated under the Securities Exchange Act of 1934, as amended.
32.1++	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2++	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.01+	Ambac Assurance Corporation and Subsidiaries Consolidated Financial Statements (with independent auditors’ report thereon) as of December 31, 2006 and 2005.

+ Filed herewith.

++ Furnished herewith

133

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	AMBAC FINANCIAL GROUP, INC.
	(Registrant)
Dated: February 28, 2007	By: /s/ Sean T. Leonard
	Name:  Sean T. Leonard
	Title:    Senior Vice President and
	Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature	Title	Date
Robert J. Genader* Robert J. Genader	President and Chief Executive Officer and Director (Principal Executive Officer)	February 28, 2007
/s/ Sean T. Leonard Sean T. Leonard	Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)	February 28, 2007
Michael A. Callen* Michael A. Callen	Director	February 28, 2007
Jill M. Considine* Jill M. Considine	Director	February 28, 2007
W. Grant Gregory* W. Grant Gregory	Director	February 28, 2007
Phillip B. Lassiter* Phillip B. Lassiter	Director	February 28, 2007
Thomas C. Theobald* Thomas C. Theobald	Director	February 28, 2007
Laura S. Unger* Laura S. Unger	Director	February 28, 2007
Henry D.G. Wallace* Henry D.G. Wallace	Director	February 28, 2007

134

* Sean T. Leonard, by signing his name hereto, does hereby sign this Annual Report on Form 10-K on behalf of each of the directors and officers of the Registrant after whose typed names asterisks appear pursuant to powers of attorney duly executed by such directors and officers and filed with the Securities and Exchange Commission as exhibits to this report.

By:	/s/ Sean T. Leonard
	Sean T. Leonard Attorney-in-fact

135

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Ambac Financial Group, Inc.:

Under date of February 28, 2007, we reported on the consolidated balance sheets of Ambac Financial Group, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006, which are included in this Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules in this Form 10-K. These financial statement schedules are the responsibility of Ambac Financial Group, Inc.’s management. Our responsibility is to express an opinion on these financial statement schedules based on our audits.

In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. As discussed in Note 2 to the consolidated financial statements, in 2006 Ambac Financial Group, Inc. changed its methods of accounting for variable interest entities and stock-based compensation.

/s/    KPMG LLP

New York, New York

February 28, 2007

S-1

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

SCHEDULE I - SUMMARY OF INVESTMENTS

Other Than Investments in Related Parties

December 31, 2006

(Dollar Amounts in Thousands)

Type of Investment	Amortized Cost		Estimated Fair Value		Amount at which shown in the balance sheet
U.S. government obligations	$	177,165	$	174,022	$	174,022
U.S. agency obligations		757,823		789,394		789,394
Municipal obligations		7,891,422		8,126,831		8,126,831
Mortgage- and asset-backed securities		7,007,566		7,020,737		7,020,737
Corporate obligations		691,993		719,625		719,625
Foreign obligations		269,834		276,830		276,830
Short-term		311,759		311,759		311,759
Other		13,427		14,391		14,391
Total	$	17,120,989	$	17,433,589	$	17,433,589

.

S-2

AMBAC FINANCIAL GROUP, INC.

SCHEDULE II—CONDENSED FINANCIAL INFORMATION

OF REGISTRANT (PARENT COMPANY ONLY)

Condensed Balance Sheets

December 31, 2006 and 2005

(Dollar Amounts in Thousands Except Share Data)

	2006			2005
ASSETS
Assets:
Cash	$	101		$	1,695
Investments in subsidiaries		7,148,184			6,329,623
Short-term investments, at cost (approximates fair value)		65,581			65,504
Other investments (cost of $582 in 2006 and $512 in 2005)		995			865
Securities purchased under agreement to resell		—			200,000
Deferred income taxes receivable		2,393			6,726
Other assets		23,083			29,333
Total assets	$	7,240,337		$	6,633,746
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Debentures	$	991,804		$	1,191,734
Current income taxes payable		11,129			9,722
Note payable to subsidiary		8,942			8,942
Accrued interest payable		13,467			16,966
Other liabilities		30,806			23,620
Total liabilities		1,056,148			1,250,984
Stockholders’ equity:
Preferred stock, par value $0.01 per share; authorized shares—4,000,000; issued and outstanding shares—none		—			—
Common Stock, par value $0.01 per share; authorized shares—350,000,000 at December 31, 2006 and 350,000,000 at December 31, 2005; issued shares—109,193,096 at December 31, 2006 and at December 31, 2005		1,092			1,092
Additional paid-in capital		790,168			723,680
Accumulated other comprehensive income		197,576			202,312
Retained earnings		5,454,575			4,703,256
Common Stock held in treasury at cost, 3,462,543 shares at December 31, 2006 and 3,553,650 shares at December 31, 2005		(259,222	)		(247,578	)
Total stockholders’ equity		6,184,189			5,382,762
Total liabilities and stockholders’ equity	$	7,240,337		$	6,633,746

S-3

AMBAC FINANCIAL GROUP, INC.

SCHEDULE II—CONDENSED FINANCIAL INFORMATION

OF REGISTRANT (PARENT COMPANY ONLY)

Condensed Statements of Operations

Three Years Ended December 31,

(Dollar Amounts in Thousands)

	2006			2005			2004
Revenues:
Dividend income	$	167,162		$	353,400		$	108,091
Interest and other income		11,812			3,345			1,824
Net realized gains (losses)		791			—			(18	)
Total revenues		179,765			356,745			109,897
Expenses:
Interest expense		75,835			56,481			54,952
Operating expenses		17,063			9,959			10,683
Total expenses		92,898			66,440			65,635
Income before income taxes and equity in undistributed net income of subsidiaries		86,867			290,305			44,262
Federal income tax benefit		(28,103	)		(22,090	)		(22,340	)
Income before equity in undistributed net income of subsidiaries		114,970			312,395			66,602
Equity in undistributed net income of subsidiaries		760,941			438,615			657,949
Net income	$	875,911		$	751,010		$	724,551

S-4

AMBAC FINANCIAL GROUP, INC.

SCHEDULE II—CONDENSED FINANCIAL INFORMATION

OF REGISTRANT (PARENT COMPANY ONLY)

Condensed Statements of Stockholders’ Equity

Three Years Ended December 31,

(Dollar Amounts in Thousands)

(Dollars in Thousands) Years Ended December 31,	2006						2005						2004
Retained Earnings:
Balance at January 1	$	4,703,256					$	4,042,644					$	3,390,653
Net income		875,911		$	875,911			751,010		$	751,010			724,551		$	724,551
Dividends declared – common stock		(69,910	)					(58,805	)					(50,910	)
Dividends on restricted stock units		(636	)					—						—
Exercise of stock options		(54,046	)					(31,593	)					(21,650	)
Balance at December 31	$	5,454,575					$	4,703,256					$	4,042,644
Accumulated Other Comprehensive Income:
Balance at January 1	$	202,312					$	296,814					$	266,919
Unrealized (losses) gains on securities, ($26,882), ($124,780), and $15,131, pre-tax, in 2006, 2005 and 2004, respectively (1)					(15,396	)					(87,280	)					8,368
Gains on derivative hedges, $9,210, $1,205, and $29,725 pre-tax in 2006, 2005 and 2004, respectively					5,149						1,122						17,851
Adjustment to initially apply FASB Statement No. 158, ($3,518) pre-tax in 2006					(2,287	)					—						—
Foreign currency gain (loss)					7,798						(8,344	)					3,676
Other comprehensive (loss) income		(4,736	)		(4,736	)		(94,502	)		(94,502	)		29,895			29,895
Total comprehensive income				$	871,175					$	656,508					$	754,446
Balance at December 31	$	197,576					$	202,312					$	296,814
Preferred Stock:
Balance at January 1 and December 31	$	—					$	—					$	—
Common Stock:
Balance at January 1	$	1,092					$	1,089					$	1,073
Issuance of stock		—						3						16
Balance at December 31	$	1,092					$	1,092					$	1,089
Additional Paid-in Capital:
Balance at January 1	$	723,680					$	694,465					$	606,468
Stock based compensation		48,669						17,986						19,223
Excess tax benefit related to share-based compensation		17,819						9,468						29,499
Issuance of stock		—						1,761						43,973
Capital issuance costs		—						—						(4,698	)
Balance at December 31	$	790,168					$	723,680					$	694,465
Common Stock Held in Treasury at Cost:
Balance at January 1	$	(247,578	)				$	—					$	—
Cost of shares acquired		(126,703	)					(309,670	)					(51,781	)
Shares issued under equity plans		115,059						62,092						51,781
Balance at December 31	$	(259,222	)				$	(247,578	)				$	—
Total Stockholders’ Equity at December 31	$	6,184,189					$	5,382,762					$	5,035,012
(1) Disclosure of reclassification amount:				2006			2005			2004
Unrealized holding (losses) gains arising during period				($	10,505	)	($	84,273	)	$	32,062
Less: reclassification adjustment for net gains included in net income					4,891			3,007			23,694
Net unrealized (losses) gains on securities				($	15,396	)	($	87,280	)	$	8,368

S-5

AMBAC FINANCIAL GROUP, INC.

SCHEDULE II—CONDENSED FINANCIAL INFORMATION

OF REGISTRANT (PARENT COMPANY ONLY)

Condensed Statements of Cash Flows

Three Years Ended December 31,

(Dollar Amounts in Thousands)

	2006			2005			2004
Cash flows from operating activities:
Net income	$	875,911		$	751,010		$	724,551
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Equity in undistributed net income of Subsidiaries		(760,941	)		(438,615	)		(657,949	)
Net realized (gains) losses		(791	)		—			18
Increase (decrease) in current income taxes payable/receivable		11,238			47,804			(4,283	)
Decrease (increase) in other assets		6,250			(6,188	)		(1,603	)
Other, net		1,695			11,757			10,534
Net cash provided by operating activities		133,362			365,768			71,268
Cash flows from investing activities:
Proceeds from sales of bonds		—			—			16,761
Proceeds from the sale of Cadre Financial Services		—			—			3,676
Purchases of bonds		—			(193,832	)		—
Change in short-term investments		(77	)		(29,138	)		(667	)
Securities purchased under agreements to resell		200,000			(200,000	)		—
Other, net		721			(53	)		330
Net cash provided by (used in) investing activities		200,644			(423,023	)		20,100
Cash flows from financing activities:
Dividends paid		(69,910	)		(58,805	)		(50,910	)
Proceeds from issuance of long-term debt		—			396,332			—
Payments for redemption of long-term debt		(200,000	)		—			—
Issuance of common stock		—			1,764			43,989
Purchases of treasury stock		(126,703	)		(309,670	)		(51,781	)
Proceeds from sale of treasury stock		61,013			30,608			30,073
Contribution to subsidiaries		—			(1,735	)		(62,606	)
Net cash (used in) provided by financing activities		(335,600	)		58,494			(91,235	)
Net cash flow		(1,594	)		1,239			133
Cash at January 1		1,695			456			323
Cash at December 31	$	101		$	1,695		$	456
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes	$	245,069		$	182,000		$	175,000
Interest expense on debt	$	79,860		$	46,120		$	55,166

Supplemental disclosure of non-cash financing activities:

Ambac Financial Group, Inc. contributed fixed income securities to Ambac Assurance Corporation amounting to $197,375 in December 2005.

S-6

AMBAC FINANCIAL GROUP, INC.

SCHEDULE II—CONDENSED FINANCIAL INFORMATION

OF REGISTRANT (PARENT COMPANY ONLY)

Note to Condensed Financial Information

The condensed financial information of Ambac Financial Group, Inc. for the years ended December 31, 2006, 2005 and 2004, should be read in conjunction with the consolidated financial statements of Ambac Financial Group, Inc. and Subsidiaries and the notes thereto. Investments in subsidiaries are accounted for using the equity method of accounting.

S-7

AMBAC FINANCIAL GROUP, INC. AND SUBSIDIARIES

SCHEDULE IV—REINSURANCE

(Dollar Amounts in Thousands)

Insurance Premiums Written	Gross Amount		Ceded to Other Companies		Assumed from Other Companies		Net Amount		Percentage of Amount Assumed to Net
Year ended December 31, 2004	$	1,011,911	$	70,946	$	36,425	$	977,390	3.73	%
Year ended December 31, 2005	$	1,043,576	$	99,673	$	52,447	$	996,350	5.26	%
Year ended December 31, 2006	$	960,372	$	103,496	$	36,297	$	893,173	4.06	%

S-8

INDEX TO EXHIBITS

Exhibit Number	Description
10.02*+	Employment Agreement dated as of January 30, 2007 by and between Ambac Financial Group, Inc. and William T. McKinnon.
10.03*+	Directors’ Compensation Table (effective as of July 25, 2006.)
10.06*+	Form of Restricted Stock Unit Award.
10.07*+	Form of Stock Option Award.
10.08*+	January 2007 Award of Restricted Stock Units to William McKinnon.
10.37+	Master Confirmation of Capped Accelerated Stock Buyback dated as of February 7, 2007 between Ambac Financial Group, Inc. and Goldman, Sachs & Co.
10.38+	Supplemental Confirmation of Capped Accelerated Stock Buyback dated as of February 7, 2007 between Ambac Financial Group, Inc. and Goldman, Sachs & Co.
10.39+	Amendment to the Master Confirmation and Supplemental Confirmation of Capped Accelerated Stock Buyback dated as of February 21, 2007 between Ambac Financial Group, Inc. and Goldman, Sachs & Co.
12.01	Statement re computation of ratios.
21.01	List of Subsidiaries of Ambac Financial Group, Inc.
23.01	Consent of Independent Registered Public Accounting Firm.
24.01	Power of Attorney from Robert J. Genader.
24.02	Power of Attorney from Michael A. Callen.
24.03	Power of Attorney from Jill M. Considine.
24.04	Power of Attorney from W. Grant Gregory.
24.05	Power of Attorney from Phillip B. Lassiter.
24.06	Power of Attorney from Sean T. Leonard.
24.07	Power of Attorney from Thomas C. Theobald.
24.08	Power of Attorney from Laura S. Unger.
24.09	Power of Attorney from Henry D.G. Wallace.
31.1	Certification of Chief Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) Promulgated under the Securities Exchange Act of 1934, as amended.
31.2	Certification of Chief Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) Promulgated under the Securities Exchange Act of 1934, as amended.
32.1++	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2++	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.01	Ambac Assurance Corporation and Subsidiaries Consolidated Financial Statements (with independent auditors’ report thereon) as of December 31, 2006 and 2005.

* Management contract or compensatory plan, contract or arrangement required to be filed as an exhibit pursuant to item 15(c) of Form 10-K.

+ Filed herewith.

++ Furnished herewith.

EX-10.02

Exhibit 10.02

EMPLOYMENT AGREEMENT

EMPLOYMENT AGREEMENT dated as of January 30, 2007 by and between AMBAC FINANCIAL GROUP, INC., a Delaware corporation (the “Company”), and WILLIAM T. McKINNON ( the “Executive”).

WHEREAS, the Executive currently serves as Senior Managing Director and Chief Risk Officer of the Company; and

WHEREAS, the Company and the Executive wish to enter into this Agreement to provide for the continuation of the Executive’s service with the Company on the terms and conditions set forth herein;

NOW, THEREFORE, in consideration of the premises and the mutual covenants herein contained, the parties hereto agree as follows (capitalized terms used herein without definition shall have the meanings ascribed to such terms in Section 6 below):

1. Employment and Duties.

(a) Term of the Agreement. This Agreement will apply for a non-renewable term beginning on the date this Agreement is signed by both the Executive and the Company and ending on January 30, 2009 (the “Term”). The Executive’s employment may continue beyond the end of the Term, but nothing herein shall require the Executive to continue his employment with the Company after the end of the Term. In addition, nothing in this Agreement shall alter the Executive’s status as an “at will” employee of the Company, subject to the Executive’s rights and obligations under this Agreement.

(b) General. The Executive will continue to serve as Senior Managing Director and Chief Risk Officer of the Company during the Term.

(c) Full-Time Employment. The Executive shall devote his full-time working hours and best efforts to his duties hereunder.

2. Relation of this Agreement to Retention Agreement.

The Company and the Executive are parties to an Amended and Restated Management Retention Agreement, dated as of January 27, 2004 (the “Retention Agreement”), that sets forth certain provisions applicable to the Executive’s employment in the event of a “Change in Control” as defined therein. Notwithstanding anything to the contrary in this Agreement, following a Change in Control, the term of the Executive’s employment, as well as his compensation and benefits, rights upon termination of employment and other matters provided for in the Retention Agreement, shall be governed by the Retention Agreement (or any successor thereto) rather than the present Agreement. Without limiting the generality of the preceding sentence, following a Change in Control: (i) the equity grant provided for in Section

3(b) below shall automatically vest pursuant to the terms of the Retention Agreement; and (ii) the definition of “Cause” set forth in the Retention Agreement shall apply, rather than the definition set forth in this Agreement.

3. Compensation and Other Benefits.

Subject to the provisions of this Agreement, the Company shall pay and provide the following compensation and other benefits to the Executive during the Term as compensation for services rendered hereunder:

(a) Salary. Effective as of the date of this Agreement, the Executive’s annual salary (the “Salary”) shall be $400,000. The Salary is payable in accordance with the Company’s payroll practices as established by the Company from time to time. The Compensation Committee of the Board of Directors (or any successor thereto) (the “Committee”) shall periodically review and may increase, but not decrease, the Executive’s Salary.

(b) Special Equity Grant. Management will recommend to the Committee that, in connection with its meeting to be held on January 29, 2007, the Committee approve a special grant to the Executive of restricted stock units (“RSUs”) under the Company’s 1997 Equity Plan, as amended (the “Equity Plan”). The number of RSUs included in such award will be determined by dividing (i) $750,000 by (ii) the Fair Market Value of a share of the Company’s common stock (the “Common Stock”) on the date the Committee approves such award. All RSUs included in such award will vest on the third anniversary of the date of the grant ; provided, however, that if the Executive elects to retire at any time prior to the third anniversary of the date of grant, notwithstanding the foregoing or terms of the Equity Plan or award agreement, only that portion RSUs proportionate to time worked, defined as X divided by Y, (X = the number of whole months worked from the Term through the retirement date; Y = thirty-six) will vest . Regardless of when they vest, the RSUs included in the Executive’s award shall be settled by delivery of the corresponding shares of Common Stock to the Executive on July 29, 2010 or the six month anniversary of the termination of the Executive’s employment, whichever is sooner, or as promptly thereafter as practicable. Such settlement shall be subject to the provisions of Section 5(b) below.

(c) Annual Bonus. The Executive shall participate in a bonus arrangement pursuant to which he shall be eligible to earn an annual bonus, based on the Company’s achieving certain performance goals that the Committee shall establish. The Executive’s guaranteed minimum bonus for the 2007 performance year shall be $800,000 and for the 2008 performance year shall be $850,000, which amounts shall be paid regardless of the Company’s performance or results. The amounts specified in the preceding sentence are minimum guaranteed amounts and shall not preclude the Committee from paying the Executive a higher annual bonus for 2007 and/or 2008. The Executive shall have the opportunity, on the same terms and conditions available to the Company’s other senior executives, to defer all or a portion of his annual bonus in the form of restricted stock units. To the extent not so deferred, the Executive’s bonus for each year will be paid at the same time that the Company pays the cash portion of annual bonuses to its other senior executives.

(d) Long-Term Incentive Compensation. The Executive will receive long-term incentive compensation awards under the Equity Plan (or any successor or similar equity plan or program of the Company) as follows: in January 2008, the Company will make awards to the Executive consisting of $325,000 in stock options and $425,000 in RSUs, and in January 2009, the Company will make awards to the Executive consisting of $325,000 in stock options and $425,000 in RSUs. The number of stock options and RSUs corresponding to such amounts and included in such awards will be determined on the same basis that the Committee uses to determine the size of equity awards to the Company’s other senior executives. The Executive’s awards shall be subject to the vesting requirements and other terms and conditions applicable to equity awards made at the same time to the Company’s other senior executives.

(e) Expenses. The Company shall reimburse the Executive for reasonable travel and other business-related expenses incurred by him in performance of the business of the Company.

(f) 401(k), Welfare and Fringe Benefits. The Executive shall participate in each 401(k), welfare, life insurance, health, disability and other fringe benefit plan or program maintained by the Company for its executive officers in accordance with the terms thereof.

(g) Termination Due to Death or Disability. In the event of the Executive’s Disability, the Company shall be entitled to terminate his employment. Notwithstanding anything contained in this Agreement to the contrary, if the Executive’s employment terminates before the end of the Term due to death or Disability, any Salary earned by the Executive up to the date of such termination, plus a pro rata portion (based on the number of days elapsed prior to such termination) of his guaranteed bonus and long-term incentive compensation (which, at the Company’s discretion can be paid in cash or RSUs/options) for the year in which such termination occurs, shall be paid to the Executive or his estate, as the case may be, within 30 days of his termination date. All stock options, restricted stock, restricted stock units or other awards awarded to the Executive under the Equity Plan or any other equity compensation plan of the Company (including without limitation the awards provided for in Sections 3(b) and 3(d) above) shall be fully vested as of the date of the Executive’s death or termination of employment due to Disability.

(h) Continuation at the End of the Term. If the Executive’s employment with the Company continues “at will” following the expiration of the Term, then, during the twelve month period following the expiration of the Term, the Executive’s annual rate of Salary will not be less than the annual rate of Salary in effect for him immediately prior to the expiration of the Term and the Executive will also continue to be eligible for a bonus and to participate in the long-term incentive programs of the Company, as in effect from time to time, in a manner commensurate with the participation of other similarly situated employees of the Company and the Company’s then current practices and valuation methodologies regarding long-term incentives.

4. Protection of the Company’s Interests.

(a) Confidential Information. Except for actions taken in the course of his employment hereunder or as required by law, at no time shall the Executive divulge, furnish or make accessible to any person any information of a confidential or proprietary nature obtained by him while in the employ of the Company. Upon termination of his employment with the Company, the Executive shall return to the Company all such information which exists in written or other physical form and all copies thereof in his possession or under his control.

(b) Other Covenants. In consideration of the Company’s undertakings and agreements herein, the Executive agrees that for the period beginning on the date of this Agreement and continuing through the first anniversary of the last day of the Term (that is, through January 30, 2010 ), he will not engage in Competition and will not make any Wrongful Solicitation. For the avoidance of doubt, the prohibitions referred to herein end on January 30, 2010.

5. Remedies.

(a) Injunctive Relief. Without intending to limit the remedies available to the Company, the Executive acknowledges that a breach by any party of any of the covenants contained in Section 4 may result in material and irreparable injury to the Company and its Affiliates for which there is no adequate remedy at law, that it shall not be possible to measure damages for such injuries precisely and that, in the event of such a breach or threat thereof, the Company shall be entitled to seek a temporary restraining order and/or a preliminary or permanent injunction in a federal or state court of competent jurisdiction sitting in the State of New York, County of New York restraining the Executive from engaging in activities prohibited by Section 4 or compelling compliance with Section 4 and shall be entitled to seek such other relief, including, without limitation, the recovery of money damages, as may be available at law or equity.

(b) Forfeiture; Clawback. In addition to the remedies set forth above in Section 5(a), if:

(x) the Executive voluntarily terminates (this sub-paragraph x shall not include retirement by the Executive) his employment with the Company and its Subsidiaries before the end of the Term;

(y) the Company terminates the Executive’s employment for Cause: or

(z) the Executive breaches any of the provisions of Section 4(a) or 4(b),

then, in any such case, the following shall apply:

(i) the Company shall cease to have any obligation to make any of the payments provided for in Section 3 that it has not made as of the date such breach occurs;

(ii) the Executive shall repay to the Company any amount already paid to him pursuant to Section 3(c), (but only to the extent above the Executive’s minimum guaranteed bonus pursuant to such Section3(c)); and

(iii) the Executive shall forfeit the equity awards provided for in Section 3(b) and 3(d), whether or not vested, and, to the extent that (A) any restricted stock units included in any such award have already been settled, the Executive shall return to the Company the shares of Common Stock delivered upon settlement (or shall pay to the Company the equivalent amount in cash based on the Fair Market Value of such shares of Common Stock at the time of forfeiture) and (B) the Executive has exercised any stock options included in any such award, the Executive shall pay to the Company promptly upon demand an amount equal to the excess of the Fair Market Value, determined at the time of such exercise, of the shares of Common Stock subject to such option (or the portion thereof that was exercised) over the exercise price thereof.

(c) Termination by the Company Without Cause or Resignation by Executive for Good Reason

(i) The Term and Executive’s employment hereunder may be terminated by the Company without Cause or by Executive’s resignation for Good Reason, as defined herein.

(ii) For purposes of this Agreement, “Good Reason” shall mean the failure of the Company to pay or cause to be paid any of the following when due hereunder: (w) Executive’s Base Salary; (x) Executive’s Annual Bonus; or (y) the RSU Payment; provided that the events described in this Section will constitute Good Reason only if the Company fails to cure such event within 30 days after receipt from Executive of written notice of the event which constitutes Good Reason.

(iii) If Executive’s employment is terminated by the Company without Cause or if Executive resigns for Good Reason, Executive shall be entitled to continue to receive all compensation and other benefits set forth in Section 3 herein until the end of the Term.

6. Definitions. For purposes of this Agreement, the following definitions shall apply.

“Affiliate” includes any company or other entity or person controlling, controlled by or under common control with the Company.

“Cause” means any of the following:

(i) the willful commission by the Executive of acts that are dishonest and demonstrably and materially injurious to the Company or any of its Affiliates, monetarily or otherwise;

(ii) the conviction of the Executive for a felonious act resulting in material harm to the financial condition or business reputation of the Company or any of its Affiliates;

(iii) a breach of any of the covenants set forth in Section 4 of this Agreement; or

(iv) the Executive’s continuous failure to perform his duties as Senior Managing Director and Chief Risk Officer in a manner consistent with the standard which he performs such duties as of the date of this Agreement, provided that the Committee has notified the Executive in writing of the respects in which it believes he has failed to perform satisfactorily and has provided the Executive with at least 20 business days to correct such failure. It shall not be a basis to terminate the Executive’s employment for Cause under this clause (iv) solely as a result of a risk assessment by or attributable to the Executive that subsequently results in liability to the Company if, in making such assessment, the Executive acted in good faith and in the ordinary course of his duties to the Company and with the reasonable care and diligence customarily applied by risk-management professionals to such matters.

The Executive will be considered to engage in “Competition” if he (i) enters into a relationship as an employee, officer, partner, member, director, independent contractor, consultant, advisor or agent of, or in any similar relationship with, a Competitor or (ii) either alone, or in concert with others, acquires beneficial ownership (within the meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended) of 5% or more of any class of equity securities of a Competitor.

“Competitor” means the following entities:

· Assured Guaranty Corporation (“AGO”)

· Financial Guaranty Insurance Company (“FGIC”);

· Financial Security Assurance Inc. (“FSA Guarantee”);

· MBIA Insurance Corporation (“MBIA”);

· Security Capital Assurance, Inc. (“SCA”); and

· Any other triple-A rated monoline insurance company that enters the financial guarantee business during the Term (a “New Competitor”);

and also includes, for each of AGO, FGIC, FSA Guarantee, MBIA, SCA and any New Competitor, that entity’s parent entities, subsidiaries and other affiliates and its successor or surviving entities (e.g., as a result of merger, consolidation, sale of business, reincorporation or any similar transaction).

“Disability” shall be defined in the same manner as such term or a similar term is defined in any long-term disability policy maintained by the Company which covers the Executive and is in effect on the date of the Executive’s termination of employment with the Company. Any dispute as to whether or not the Executive is disabled within the meaning of the preceding sentence shall be resolved by the Company’s long-term disability carrier.

“Fair Market Value” means, with respect to the Company’s Common Stock, the closing quoted selling price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange for the relevant date of determination.

“Subsidiary” means (i) a corporation or other entity with respect to which the Company, directly or indirectly, has the power, whether through the ownership of voting securities, by contract or otherwise, to elect at least a majority of the members of such corporation’s board of directors or analogous governing body, or (ii) any other corporation or other entity in which the Company, directly or indirectly, has an equity or similar interest and which the Committee designates as a Subsidiary for purposes of this Agreement.

A “Wrongful Solicitation” will be considered to occur upon either of the following events:

(1) the Executive directly or indirectly hires or attempts to hire any person who is, or during the 120 days preceding the Executive’s action in hiring or attempting to hire such person was, employed by the Company or any of its Subsidiaries (except that no Wrongful Solicitation shall be considered to have occurred if the person’s employment had been involuntarily terminated by the Company and its Subsidiaries); or

(2) the Executive solicits any business of any person or entity who is, or within the one year preceding such solicitation was, a customer or client of the Company or any of its Subsidiaries, or works for, or on behalf of, any such customer or client.

7. General Provisions.

(a) Notices. Any notice hereunder by either party to the other shall be given in writing by personal delivery, telex, telecopy or certified mail, return receipt requested, to the applicable address set forth below:

To the Company:	Ambac Financial Group, Inc.
	One State Street Plaza
	New York, NY 10004
	Attention: Chief Administrative Officer
To the Executive:	at the address indicated on the signature page hereof

or to such other person or other address as either party may specify to the other in writing.

(b) Limited Waiver. The waiver by the Company or the Executive of a violation of any of the provisions of this Agreement, whether express or implied, shall not operate or be construed as a waiver of any subsequent violation of any such provision.

(c) Assignment. No right, benefit or interest hereunder shall be subject to assignment, encumbrance, charge, pledge, hypothecation or set off by the Executive in respect of any claim, debt, obligation or similar process. The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business or assets or the Company to assume expressly and to agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place.

(d) Amendment. This Agreement may not be amended, modified or canceled except by written agreement of the Executive and the Company.

(e) Unsecured Promise. No benefit or promise hereunder shall be secured by any specific assets of the Company. Unless otherwise stated herein, the Executive shall have only the rights of an unsecured general creditor of the Company in seeking satisfaction of such benefits or promises.

(f) Governing Law. This Agreement has been made in and shall be governed by and construed in accordance with the laws of the State of New York.

(g) Entire Agreement. This Agreement sets forth the entire agreement and understanding of the parties hereto with respect to the matters covered hereby.

(h) Headings. The headings and captions of the Sections of this Agreement are included solely for convenience of reference and shall not control the meaning or interpretation of any provisions of this Agreement.

(i) Counterparts. This Agreement may be executed by the parties hereto in counterparts, each of which shall be deemed an original, but all such counterparts shall together constitute one and the same document.

[Signature Page Follows]

IN WITNESS WHEREOF, the parties have executed this Agreement effective as of the day and year first written above.

AMBAC FINANCIAL GROUP, INC.
By:	/Robert J. Genader/
	Name: Robert J. Genader Title: Chairman, President and CEO

EXECUTIVE
	/William T. McKinnon/
	William T. McKinnon

Address:  

EX-10.03

Exhibit 10.03

AMBAC FINANCIAL GROUP, INC.

2006 Directors Compensation Table *

EFFECTIVE AS OF JULY 25, 2006

TYPE OF FEE	AMOUNT		MANNER OF PAYMENT
Annual Fees/Awards
·         Annual fee for serving as a director of Ambac Financial Group, Inc.	$80,000	**	$80,000 payable quarterly in arrears in cash
·         Annual fee for serving as a director of Ambac Assurance Corporation	None
·         Annual fee for chairing the Audit and Risk Assessment Committee of Ambac Financial Group, Inc.	$20,000		Payable quarterly in arrears in cash
·         Annual fee for chairing the Compensation Committee or Governance Committee of Ambac Financial Group, Inc.	$10,000		Payable quarterly in arrears in cash
·         Annual fee for serving as Presiding Director of Ambac Financial Group, Inc.	$25,000		Payable quarterly in arrears in cash
Travel and Related Expenses
·         Travel and related expenses incurred in attending a stockholder, board or committee meeting	100% of expenses incurred		Payable in cash promptly upon submission of receipts to the Ambac Financial Group, Inc.

Note: Presiding Director was previously call Lead Director.

No Non-Chairman Fee as of July 25, 2006 (Phillip B. Lassiter resigned as Chairman of the Board)

* Directors who are employees of Ambac Financial Group, Inc. and its affiliates are not paid any fees or other compensation for serving as directors, but are reimbursed for travel and related expenses incurred in attending meetings.

** The cash portion of the annual fee is prorated to reflect service on the Board of less than one full year prior to the relevant annual meeting of stockholders.

Ambac Financial Group, Inc.

Directors Compensation Table

EFFECTIVE AS OF MAY 4, 2004

(CONTINUED PAGE 2 OF 2)

TYPE OF FEE	AMOUNT	MANNER OF PAYMENT
Stock Awards
·         Annual Award of Restricted Units   of Common Stock (RSUs)	Value of $60,000 RSUs on date of the Annual Meeting	·         The value of $60,000 of RSUs will be awarded annually on the date of the annual meeting of stockholders. The number of RSUs shall be equal to $60,000 divided by the average of the high and low selling price of Ambac’s Common Stock on the NYSE on the date of the Annual Meeting. ·         The RSUs vest on the first anniversary of the grant
·         Five-year Award of RSUs	Value of $210,000 RSUs on date of Annual Meeting (only granted once every 5 years)	·         The value of $210,000 of RSUs are awarded on the date of the annual meeting of stockholders coincident with, or first succeeding the director’s election to the Ambac Financial Group, Inc. Board. The number of RSUs shall be equal to $210,000 divided by the average of the high and low selling price of Ambac’s Common Stock on the NYSE on the date of the Annual Meeting. ·         These RSUs vest on the date of the annual meeting held in the fifth year following the date of grant ·         Assuming the director remains on the Board following vesting, he or she will be awarded an additional $210,000 in RSUs ·         RSUs are awarded under the 1997 Non-Employee Directors Plan, as amended

OTHER BENEFITS	DESCRIPTION
·         Deferred compensation	Under the Deferred Compensation Plan for Outside Directors and Eligible Senior Officers, non-employee directors may elect to defer all or part of their director compensation (including both annual and meeting fees) that is paid in cash
·         Health and welfare	Each non-employee director is permitted to enroll (without paying any premium) in the Ambac Financial Group, Inc. medical and dental plan and is eligible to receive a $50,000 term life insurance policy (without paying any premium)

EX-10.06

Exhibit 10.06

AMBAC FINANCIAL GROUP, INC.

1997 EQUITY PLAN

JANUARY 2007 NOTICE OF AWARD OF 2006 LONG TERM

INCENTIVE COMPENSATION IN THE FORM OF RESTRICTED STOCK UNITS

Ambac Financial Group, Inc., a Delaware corporation and its Subsidiaries (referred to herein as either the “Company” or “Ambac”), have adopted the Ambac 1997 Equity Plan (the “Plan”), for the purposes of providing an incentive to selected employees of the Company and its affiliates to remain in its employ and to increase their interest in the success of the Company. The Company pursues these goals by providing selected employees with opportunities through the Plan to increase their proprietary interest in the Company and to receive compensation based upon the Company’s success.

This 2007 Restricted Stock Unit Notice of Award (the “Notice of Award”) sets forth the terms and conditions of the restricted stock units that have been granted under the Plan to the individual identified on Annex A (the “Participant”). This Notice of Award sets forth the number of restricted stock units that the Participant will receive, the date of grant and the applicable vesting schedule.

1. Incorporation of Plan Terms.

This Notice of Award and the restricted stock units granted hereby are subject to the Plan, the terms of which are incorporated herein by reference. If there is any conflict or inconsistency between the Plan and this Notice of Award, the Plan shall govern. Capitalized terms used in this Notice of Award without definition shall have the meanings assigned to them in the Plan. A copy of the Plan is available on Ambac’s intranet site.

2. Grant of Restricted Stock Units.

Subject to the conditions contained herein and in the Plan, the Company grants to the Participant, as of the date of grant indicated on Annex A (the “Date of Grant”), the number of restricted stock units (the “RSUs”) specified on Annex A.

3. Terms and Conditions of the RSUs.

The RSUs shall have the following terms and conditions:

(a) General. Each RSU shall represent the unsecured promise of the Company to transfer to the Participant, on the settlement date of such RSU and subject to the terms and conditions set forth in this Notice of Award, one share of the Company’s common stock, par value $0.01 per share (the “Common Stock”).

(b) Vesting.

(i) Normal Vesting. The RSUs will ordinarily vest in accordance with the vesting schedule set forth on Annex A hereto.

(ii) Accelerated Vesting. Notwithstanding Section 3(b)(i), any RSUs that have not previously vested shall vest in full upon the termination of the Participant’s employment with the Company and its Subsidiaries by reason of death, Permanent Disability or Retirement at age 55 or older after at least five years of continuous service with the Company and its Subsidiaries (including service within a corporation or other entity acquired by the Company). "Permanent Disability" shall mean circumstances that entitled the Participant to receive benefits under the long-term disability policy maintained by the Company or any of its Subsidiaries for the participant.

(iii) Forfeiture. Unless the Compensation Committee of the Board of Directors of the Company (the “Committee”), in its sole discretion, determines otherwise, any RSUs that have not vested in accordance with this Section 3(b) shall be forfeited by the Participant upon the Participant’s termination of employment with the Company and its subsidiaries; provided, however, that a Participant’s RSUs may become vested as of the date of the Participant’s termination of employment if the termination of employment is mutually agreed to by the Participant and the Company, and the Participant (A) signs a waiver and release, in the form requested by the Company, irrevocably waiving any and all claims, liabilities and causes of action relating to the Participant’s employment with the Company and its affiliates and the termination thereof, (B) signs a noncompetition agreement in the form requested by the Company, and (C) takes any further action requested by the Company.

(c) Dividends and Distribution on Common Stock. In the event that, following the Date of Grant and prior to the settlement of any RSU, the Company pays any cash or other dividend or makes any other distribution in respect of the Common Stock, each RSU shall be credited with an additional number of RSUs (including fractions thereof) determined by dividing (i) the amount or cash, or the value (as determined by the Committee) of any other property, paid or distributed in respect of one outstanding share of Common Stock by (ii) the closing price of a share of Common

Stock as reported on the composite tape for securities listed on the New York Stock Exchange, or such other national securities exchange as may be designated by the Committee, or in the event that the Common Stock is not listed for trading on a national securities exchange but is quoted on an automated quotation system, on such automated quotation system, in any such case for the date of such payment or distribution (or if there were no sales on the date of such payment or distribution, the closing price as reported on such composite tape or automated quotation system for the most recent day during which a sale occurred). Any RSUs so credited shall be subject to the same vesting provisions as the RSU in respect of which they are credited. Except as otherwise expressly provided in this Notice of Award, the Participant shall have no right as a shareholder with respect to any RSUs until a certificate or certificates evidencing such shares shall have been issued to the Participant according to the terms of Section 3(d) below.

(d) Delivery of Share Certificates.

(i) Ordinary Settlement. Settlement of any RSUs shall occur following the date on which such RSUs vest except that if the Committee elects to accelerate vesting pursuant to Section 3(b)(iii), such RSUs shall be settled after the normal vesting date as set forth in Annex A hereto. RSUs will be settled, at the election of the Participant, either by:

(A) Delivery of a stock certificate or certificates representing the number of shares of Common Stock equal to the number of RSUs being settled (any fractional RSU being rounded up to the next whole RSU). Certificates shall be issued in the name of the Participant (or of the person or persons to whom such RSUs were transferred by will or the laws of descent and distribution or pursuant to a Qualified Domestic Relations Order).

(B) The transfer of the corresponding number of shares of Common Stock equal to the number of RSUs being settled (or any fractional RSU being rounded up to the next whole RSU) to the brokerage account designated by the Participant to the Company in writing prior to settlement.

(ii) Payment Restrictions for Specified Employees. If the Participant is a "Specified Employee" within the meaning of Section 409A(a)(2)(B) of the Code, then, anything in this Notice of Award to the contrary not withstanding, no settlement of RSUs in connection with the Participant’s termination of employment (other than by reason of death) shall be made before the earlier to occur of (X) the date which is six months and one day following the date of such termination of employment and (Y) the date of the Participant’s death following termination of employment.

(iii) Transfer Restrictions on Common Stock. Shares of Common Stock issued upon the settlement of RSUs will not be subject to restrictions on transfer (except for any restrictions imposed by the federal securities laws or other applicable laws or regulations and for any restrictions under the Company’s trading policies applicable to employees). However, shares of common stock issued upon

settlement of RSUs granted at a discount to the Fair Market Value of Ambac stock on the date of grant will be subject to transfer restrictions until such time as the Eligible Individual meets and/or exceeds Ambac’s Stock Ownership Guidelines.

(iv) Normal Settlement and Deferral of Payment Subject to Section 162(m). Subject to the other terms and conditions of this Notice of Award and the terms of the Plan, Ambac shall settle RSUs on or as soon as practicable following the vesting date (the “Settlement Date”); provided, however, that to the extent that, as of the Settlement Date, Ambac reasonably anticipates that its federal tax deduction with respect to such settlement would be limited or eliminated by application of Section 162(m) of the Internal Revenue Code of 1986, as amended, or any regulations thereunder (or under any successor provisions thereto) (the “Code”), then the settlement of the RSUs shall automatically be deferred until the earliest date at which Ambac reasonably anticipates that its deduction of the amount of the settlement will not be so limited or eliminated (it being understood that so many of such RSUs as can be settled on the Settlement Date without limiting or eliminating Ambac’s deduction will be settled on the Settlement Date and that any RSUs whose settlement is deferred past the Settlement Date shall be settled on one or more future dates as and to the extent that the conditions to settlement set forth in this sentence are satisfied).

(e) Transfer Restrictions on RSUs. RSUs may not be transferred, except by will or the laws of descent and distribution or pursuant to a Qualified Domestic Relations Order.

(f) Immediate Cancellation of RSUs and Return of Share Value. Notwithstanding any other provision of this Notice of Award, the Committee may (i) cancel all or any portion of the RSUs then outstanding (whether or not then vested and whether or not subject to a deferred settlement election) and (ii) may require the Participant to repay to the Company all or any portion of the Share Value (as hereinafter defined) that the Participant realizes from the settlement of RSUs occurring within six months before or after the Participant’s termination of employment for any reason with the Company and its Subsidiaries, if the Participant engages in Competitive Activity (as defined herein) within six months following termination of such employment. The Participant will be considered to engage in “Competitive Activity” if the Participant (1) enters into a relationship as an employee, officer, partner, member, director, independent contractor, consultant, advisor, or agent of, or in any similar relationship with, any corporation, partnership, limited liability company, joint venture or other business entity that engages in any activity which the Committee determines to be competitive with a principal business activity of the Company (a “Competitor”), where the Participant will be responsible for providing services which are similar or substantially related to the services that the Participant provided during any of the last three years of the Participant’s employment with the Company and its Subsidiaries or (2) either alone, or in concert with others, acquires or maintains beneficial ownership (within the meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended) of 5% or more of any class of equity securities of a Competitor. For purposes hereof, “Share Value” in respect of an RSU means a cash amount equal to the amount of income

included (or to be included) in respect of the settlement of such RSU on the Form W-2 (or successor form) that the Company or one of its Subsidiaries issues to the Participant for the year in which such settlement occurs. If the Participant is required to repay any Share Value to the Company pursuant to this Section 3(f), the Participant shall pay such amount in such manner and on such terms and conditions as the Company may require, and the Company shall be entitled to withhold or set-off against any other amount owed to the Participant by the Company or its Subsidiaries (other than any amount owed to the Participant under any retirement plan intended to be qualified under Section 401(a) of the Code) up to an amount sufficient to satisfy the unpaid obligation of the Participant under this Section 3(f).

(g) Cancellation for Specified Activity. Notwithstanding any other provision of this Notice of Award, the Committee may cancel all or any portion of the RSUs then outstanding (whether or not vested) if at any time the Participant initiates or becomes a party to any lawsuit or other legal action in any federal or state court in which the Participant seeks damages or injunctive or other equitable relief from or against the Company, any of its Subsidiaries or any of its officers, employees or directors in connection with any claim arising from or relating to the Participant’s employment with the Company or any of its Subsidiaries or the termination of such employment (and regardless of whether any such termination is the result of the Participant’s voluntary resignation or retirement or of the involuntary termination of the Participant’s employment by the Company or one of its subsidiaries). This Section 3(g) is not intended as a waiver by the Participant of any claims the Participant may have against the Company, any of its subsidiaries or any of its officers, employees or directors. Instead, it provides for the consequences specified in the second preceding sentence in the event the Participant engages in the conduct described therein.

4. Tax Withholding.

(a) Prior to either the transfer of shares of Common Stock to the Participant’s brokerage account or the delivery of any certificates evidencing shares of Common Stock to be issued in connection with the full or partial settlement of the RSUs, the Company shall have the right to require the Participant to remit to the Company an amount sufficient to satisfy the minimum Federal, State and local tax withholding requirements. The Company may permit the Participant to satisfy this obligation, in whole or in part, by directing the Company to withhold shares of Common Stock that would otherwise be received by the Participant, pursuant to such rules as the Committee may establish from time to time.

(b) Upon vesting of any portion of the RSUs, the Participant shall be required to satisfy, within 30 days of vesting, all Social Security and Medicare taxes due upon vesting. The Participant must either submit a check or money order, payable to Ambac Financial Group, Inc., to Ambac’s Senior Vice President and Chief Administrative Officers or his or her designee or direct the Company to withhold a portion of his or her salary to pay for any Social Security and Medicare taxes due upon vesting.

5. No Restriction on Right to Effect Corporate Changes; No Right to Continued Employment.

(a) Neither the Plan, this Notice of Award, the grant of the RSUs nor any action taken hereunder shall affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalizations, reorganizations or other changes in the Company’s capital structure or its business, or any merger or consolidation of the Company, or any issue of bonds, debentures, preferred or prior preference stocks ahead of or convertible into, or otherwise affecting the Common Stock or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise.

(b) This Notice of Award is not an employment agreement. Nothing in this Notice of Award or the Plan, or the granting to the Participant of the RSUs, shall alter the Participant’s status as an "at-will" employee of the Company or be construed as guaranteeing employment by, or as giving the Participant any right to continue in the employ of, the Company or any of its subsidiaries during any period (including without limitation the period between the Date of Grant and the settlement date of any RSUs, or any portion thereof), or as limiting or restricting the right of the Company to terminate the Participant’s employment at any time, for any reason, with or without cause.

6. Adjustment of and Changes in Shares.

In the event of any merger, consolidation, recapitalization, reclassification, stock split, stock dividend, special cash dividend, split-up, spin-off, or other transaction or change in corporate structure affecting the Common Stock, the Committee shall make equitable adjustments in order to preserve, but not increase, the benefits or potential benefits intended to be made available to participants granted RSUs. Any adjustments shall be determined by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final.

7. Preemption of Applicable Laws and Regulations.

Anything herein to the contrary notwithstanding, if, at any time specified herein for the issuance of shares of Common Stock to the Participant, any law, regulation or requirement of any governmental authority having jurisdiction requires either the Company or the Participant to take any action in connection with the shares then to be issued, the issuance of such shares shall be deferred until such action shall have been taken.

8. Committee Decisions Final.

Any dispute or disagreement which shall rise under, or as a result of, or pursuant to, or in connection with, this Notice of Award shall be determined by the Committee, and any such determination or any other determination by the Committee under or pursuant to this Notice of Award and any interpretation by the Committee of the terms hereof shall be final and binding on all persons affected thereby.

9. Amendments.

The Committee shall have the power to alter or amend the terms of the RSUs as set forth herein, from time to time, in any manner consistent with the Plan; provided, however, that no amendment will be made that is inconsistent with the American Jobs Creation Act of 2004. Any alteration or amendment of the terms of the RSUs by the Committee shall, upon adoption, become and be binding on all persons affected thereby without requirement for consent or other action with respect thereto by any such person. The Committee shall give written notice to the Participant of any such alteration or amendment as promptly as practicable after it is adopted. The foregoing shall not restrict the ability of the Participant and the Company by mutual consent to alter or amend the terms of the RSUs in any manner which is consistent with the Plan and approved by the Committee. Notwithstanding anything in the Plan to the contrary, the Committee may amend or terminate the Plan, without the consent of any Participant, to the extent it deems necessary or desirable to comply with the American Jobs Creation Act of 2004.

10. Notice Requirements.

Any notice which either party hereto may be required or permitted to give to the other shall be in writing. Notice may be delivered to the Company personally or by mail, postage prepaid, addressed as follows: Ambac Financial Group, Inc., One State Street Plaza, New York, New York 10004, attention: Senior Vice President, Chief Administrative Officer, Employment Counsel, or at such other address as the Company, by notice to the Participant, may designate in writing from time to time. Notice to the Participant shall be directed either to the Participant’s address as shown on the records of the Company or at such other address as the Participant, by notice to the Company, may designate in writing from time to time or to the Participant by a combination of interoffice mail and email.

11. Governing Law.

The terms and conditions stated herein are to be governed by, and construed in accordance with, the laws of the State of Delaware.

12. Entire Agreement; Headings.

This Notice of Award (which includes Annex A) and the other related documents expressly referred to herein set forth the entire agreement and understanding between the parties hereto and supersede all prior agreements and understandings relating to the subject matter hereof. The headings of Sections and subsections herein are included solely for convenience of reference and shall not affect the meaning of any of the provisions of this Notice of Award.

EX-10.07

Exhibit 10.07

Ambac 1997 Equity Plan

2007 NOTICE OF 2006 STOCK OPTION AWARD

Table of Contents

1.	Incorporation of Plan Terms	1
2.	Grant of Option	1
3.	Terms and Conditions of the Option	1
4.	Termination of Employment	4
5.	Transfer; Option Exercisable Only by Participant and Permitted Transferees	6
6.	Tax Withholding	7
7.	No Restriction on Right to Effect Corporate Changes; No Right to Employment	7
8.	Adjustment of and Changes in Shares	7
9.	Change in Control	7
10.	Preemption of Applicable Laws and Regulations	9
11.	Committee Decisions Final	9
12.	Amendments	9
13.	Notice Requirements	9
14.	Governing Law	9
15.	Entire Agreement; Headings	9
Annex A: Stock Option Award and Vesting Schedule

Ambac 1997 Equity Plan

2007 NOTICE OF 2006 STOCK OPTION AWARD

Ambac Financial Group, Inc., a Delaware corporation (the “Company”), has adopted the Ambac 1997 Equity Plan, as amended (the “Plan”), for the purposes of providing an incentive to selected employees of the Company and its affiliates to remain in its employ and to increase their interest in the success of the Company by providing them with opportunities to increase their proprietary interest in the Company and to receive compensation based upon the Company’s success.

This 2007 Notice of 2006 Stock Option Award (the “Award Agreement”) sets forth the terms and conditions of the stock options granted pursuant to the Plan. Annex A of this Award Agreement (“Annex A”) names the individual to whom the option is granted (the “Participant”) and sets forth the number of shares of common stock of the Company (“Common Stock”) subject to the option, the exercise price of such option, the date of grant and the expiration date of such option and the vesting schedule applicable thereto.

1. Incorporation of Plan Terms.

This Award Agreement and the option granted hereby shall be subject to the Plan, the terms of which are incorporated herein by reference, and in the event of any conflict or inconsistency between the Plan and this Award Agreement, the Plan shall govern. Capitalized terms used herein without definition shall have the meanings assigned to them in the Plan, a copy of which has been furnished to the Participant.

2. Grant of Option.

Subject to the conditions contained herein and in the Plan, the Company grants to the Participant, as of the date of grant indicated on Annex A (the “Date of Grant”), an option (the “Option”) to purchase the number of shares of Common Stock specified on Annex A, at an exercise price (the “Exercise Price”) specified on Annex A. The shares of Common Stock issuable upon exercise of the Option are from time to time referred to herein as the “Option Shares.” The grant of an Option shall impose no obligation on the part of the Participant to exercise the Option. The Option shall vest and be exercisable as hereinafter provided.

3. Terms and Conditions of the Option.

The Option is granted subject to the following terms and conditions:

(a) Vesting; Exercisability. The Option shall vest and become exercisable in accordance with the vesting schedule set forth on Annex A, unless the Option has earlier vested or been forfeited in accordance with the terms hereof.

(b) Term of the Option. The Option shall terminate and no longer be exercisable on the earlier of (i) the seventh anniversary of the Date of Grant or (ii) the date specified for termination of the Option in Sections 4(a), 4(b) and 4(c) below; provided, however, if the termination date falls on a date which the Participant is prohibited by Corporation policy in effect on such date, from engaging in transactions in the Corporation’s securities, such termination date shall be extended to the first date that the Participant is permitted to engage in transactions in the Corporation’s securities under such Corporation policy.

(c) Notice of Exercise. Subject to Sections 3(d), 3(f) and 4 hereof, the Participant may exercise all or any portion of the Option (to the extent vested) by giving notice of exercise to the Company or the Company’s agent,

provided, however, that no less than 10 Option Shares may be purchased upon any exercise of the Option unless the number of Option Shares purchased at such time is the total number of Option Shares in respect of which the Option is then exercisable, and provided, further, that in no event shall the Option be exercisable for a fractional share. The date of exercise of an Option shall be the later of (i) the date on which the Company or the Company’s agent receives such notice or (ii) the date on which the conditions provided in Sections 3(d) and 3(f) are satisfied. Notwithstanding any other provision of this Award Agreement, the Participant may not exercise the Option, whether in whole or in part, and no Option Shares will be issued by the Company in respect of any such attempted exercise, at any time when such exercise is prohibited by Company policy then in effect concerning transactions by the Participant in the Company’s securities.

(d) Payment. Prior to the issuance of a certificate pursuant to Section 3(g) hereof evidencing the Option Shares in respect of which all or a portion of the Option shall have been exercised, the Participant shall have paid to the Company the Exercise Price for all Option Shares purchased pursuant to the exercise of such Option. Payment may be made by personal check, bank draft or postal or express money order (such modes of payment are collectively referred to as “cash”) payable to the order of the Company in U.S. dollars. Payment may also be made in mature shares of Common Stock owned by the Participant, or in any combination of cash or such mature shares as the Committee in its sole discretion may approve. Such shares shall be valued at their Fair Market Value as of the date of exercise. Payment of the Exercise Price in mature shares of Common Stock owned by the Participant shall be made by delivering to the Company the share certificate(s) representing the required number of shares, with the Participant signing his or her name on the back, or by attaching executed stock powers (with the signature of the Participant guaranteed in either case); payment of the exercise price in mature shares of Common Stock owned by the Participant may also be made through constructive surrender, by submission of an attestation of ownership in the form approved by the Company and with such signatures or other guarantees as may be required by the Company. The Company may also permit the Participant to pay for such Option Shares by directing the Company to withhold shares of Common Stock that would otherwise be received by the Participant, pursuant to such rules as the Committee may establish from time to time. In the discretion of the Committee, and in accordance with rules and procedures established by the Committee (or by any person to whom authority to establish such rules and procedures shall have been delegated by the Committee), the Participant may be permitted to make a “cashless” exercise of all or a portion of the Option.

(e) Stockholder Rights. The Participant shall have no rights as a stockholder with respect to any shares of Common Stock issuable upon exercise of the Option until the Participant shall become the holder of record thereof, and no adjustment shall be made for dividends or distributions or other rights in respect of any share for which the record date is prior to the date upon which the Participant shall become the holder of record thereof.

(f) Limitation on Exercise. The Option shall not be exercisable unless the offer and sale of Common Stock pursuant thereto has been registered under the Securities Act of 1933, as amended (the “1933 Act”), and qualified under applicable state “blue sky” laws or the Company has determined that an exemption from registration under the 1933 Act and from qualification under such state “blue sky” laws is available.

(g) Issuance of Shares. Subject to the foregoing conditions, as soon as is reasonably practicable after its receipt of a proper notice of exercise and payment of the Exercise Price for the number of shares with respect to which the Option is exercised, the Company either (i) shall deliver or cause to be delivered to the Participant (or to such person to whom the Option has been transferred pursuant to Section 5 hereof; or following the Participant’s death, to such other person entitled to exercise the Option), at the principal office of the Company or at such other location as may be acceptable to the Company and the Participant (or such other person), one or more stock certificates in the name of the Participant (or of the person or persons to whom such option was transferred by will or the laws of descent and distribution or pursuant to a Qualified Domestic Relations Order) for the appropriate number of shares of Common Stock issued in connection with such exercise or (ii) shall transfer the appropriate number of shares of Common Stock issued in connection with such exercise to the brokerage account designated by the Participant to the Company in writing prior to exercise. Such shares shall be fully paid and nonassessable.

(h) Non-qualified Status of the Option. The Option granted hereby is not intended to qualify, and shall not be treated, as an “incentive stock option” within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”).

(i) Cancellation. Notwithstanding any other provision of this Award Agreement, the Committee may cancel all or any unexercised portion of the Option, whether or not vested, if at any time the Participant initiates or becomes a party to any lawsuit or other legal action in any federal or state court in which the Participant seeks damages or injunctive or other equitable relief from or against the Company, any of its Subsidiaries or any of its officers, employees or directors in connection with any claim arising from or relating to the Participant’s employment with the Company or any of its Subsidiaries or the termination of such employment (and regardless of whether any such termination is the result of the Participant’s voluntary resignation or retirement or of the involuntary termination of the Participant’s employment by the Company or one of its subsidiaries). This Section 3(i) is not intended as a waiver by the Participant of any claims the Participant may have against the Company, any of its subsidiaries or any of its officers, employees or directors. Instead, it provides for the consequences specified in the second preceding sentence in the event the Participant engages in the conduct described therein.

(j) Notice Period. Notwithstanding any other provision of this Award Agreement, the Committee may cancel all or any unexercised portion of the Option, whether or not vested, if the Participant resigns his or her employment with the Company and its Subsidiaries without having provided the Company or the Subsidiary that employs the Participant with at least three months advance written notice (the “Notice Period”) prior to termination of employment. During this Notice Period the Participant (i) shall remain employed by the Company and its Subsidiaries and receive base salary and certain benefits, but will not accrue any rights to a bonus, and (ii) shall not commence employment with any other employer or directly or indirectly induce or solicit any client of the Company or any of its subsidiaries to terminate or modify its relationship with any of them.

4. Termination of Employment.

(a) General. Subject to Section 4(c) hereof, if the Participant’s employment with the Company and its Subsidiaries terminates for any reason other than death or Permanent Disability (as defined herein) prior to the satisfaction of any vesting period requirement under Section 3(a) hereof, the unvested portion of the Option shall be forfeited to the Company, and the Participant shall have no further right or interest therein, unless the Committee in its sole discretion shall determine otherwise, provided, however, that in the case of a termination of employment mutually agreed to by the Participant and the Company (or the relevant employer Subsidiary), but not in the case of a termination for Cause (as defined herein), if the Participant (A) signs a waiver and a release, in the form requested by the Company, irrevocably waiving any and all claims and liabilities relating to the Participant’s employment with the Company and its affiliates and the termination thereof, (B) signs a noncompetition agreement in the form requested by the Company, and (C) takes any further action requested by the Company to perfect such release and waiver, then at the Company’s discretion, the Option shall be deemed to have vested in full as of the date of the Participant’s termination of employment.

(b) Exercise Following Termination of Employment. If the Participant’s employment with the Company and its Subsidiaries terminates for any reason other than death, Permanent Disability or Retirement (as defined herein) after the Option has vested in accordance with Sections 3(a) and 4(a) hereof with respect to all or a portion of the shares of Common Stock subject to the Option, the Participant shall have the right, subject to the terms and conditions hereof and of the Plan, to exercise the Option, to the extent it has vested as of the date of such termination of employment, at any time within one year after the date of such termination, subject to the earlier expiration of the Option as provided in Section 3(b).

(c) Exercise Following Termination of Employment Due to Death, Permanent Disability or Retirement.

(i) If the Participant’s employment with the Company and its Subsidiaries terminates due to (A) death or (B) Permanent Disability or (C) Retirement at age 55 or older after at least five years of continuous service with the Company and its Subsidiaries (including service with a corporation or other entity acquired by the

Company), in any such case prior to the satisfaction of any vesting period requirement under Section 3(a) hereof, the Option shall be deemed to have vested in full as of the date of death, termination due to Permanent Disability or such Retirement.

(ii) Following termination of employment due to death or Permanent Disability, the Option may be exercised by the Participant, or the Participant’s Permitted Transferee, estate, personal representative or beneficiary, as the case may be, within three years after the date of death or termination of employment due to Permanent Disability, subject to the earlier expiration of the Option as provided in Section 3(b). In the event of Retirement (whether or not Retirement results in full vesting of the Option pursuant to clause (i) above), the Participant or the Participant’s Permitted Transferee may exercise the Option, to the extent it has vested as of the date of Retirement, within three years after the date of Retirement, subject to the earlier expiration of the Option as provided in Section 3(b).

(d) Definitions. For purposes hereof, the following terms shall have the meanings specified below:

(i) Termination of Employment. The employment of the Participant shall be deemed terminated if the Participant is no longer employed by the Company or any of its Subsidiaries for any reason. The Committee shall have discretion to determine whether military or government service or an authorized leave of absence (as a result of disability or otherwise) shall constitute a termination of employment for purposes hereof.

(ii) Cause. Each of the following shall constitute “Cause” for termination of employment:

(a) the willful commission by the Participant of acts that are dishonest and demonstrably and materially injurious to the Company or any of its Subsidiaries or affiliates, monetarily or otherwise;

(b) the conviction of the Participant for a felonious act resulting in material harm to the financial condition or business reputation of the Company or any of its Subsidiaries or affiliates; or

(c) except for actions taken in the course of the Participant’s employment or as required by law, the Participant’s divulgation, furnishing or making accessible to any person any information of a confidential or proprietary nature obtained while in the employ of the Company or any of its Subsidiaries of affiliates, or the Participant’s failure, upon termination of his employment with the Company or any of its Subsidiaries or affiliates, to return to the Company all such information which exists in written or any other form (including without limitation in the form of computer files or disks) and all copies thereof in his possession or under his control.

Notwithstanding the foregoing, if the Company or any of its Subsidiaries or affiliates has entered or enters into any employment, management retention, change in control, severance or similar agreement with the Participant, which agreement sets forth a definition of “Cause”, then such definition, rather than the definition set forth above, shall control for purposes of this Award Agreement.

(iii) Permanent Disability. “Permanent Disability” shall mean circumstances that entitle the Participant to receive benefits under the long-term disability policy maintained by the Company or any of its Subsidiaries for the Participant.

(iv) Retirement. “Retirement” shall mean the termination of the Participant’s employment on or after age 55 and at least 5 years of service, except for Cause; provided , however, that the termination of the Participant’s employment will not be considered a Retirement if the Participant fails to provide the Company or the Subsidiary that employs the Participant with the written notice required by Section 3(j) hereof or fails to comply with the Participant’s obligations during the Notice Period as set forth in Section 3(j) hereof.

(e) Exercise Following Termination of Employment Subject to Company Policies on Insider Trading. Any exercise of the Option pursuant to Section 4(b) or 4(c) above following termination of the Participant’s employment for any reason other than death shall be subject to, and shall be permitted only to the extent such exercise complies with, the policies of the Company concerning insider trading.

(f) Cancellation of Option and Repayment of Option Gain. Notwithstanding any other provision of this Award Agreement, the Committee may cancel all or any portion of the Option, whether or not vested, and may require the Participant to repay to the Company all or any portion of the Option Gain (as defined herein) that the Participant realizes from any full or partial exercise of the Option occurring within six months before or after the termination of the Participant’s employment with the Company and its Subsidiaries, if (A) the Participant engages in Competitive Activity (as defined herein) within six months following the termination of the Participant’s employment or (B) the Participant fails to provide the Company or the Subsidiary that employs the Participant with the written notice required by Section 3(j) hereof or fails to comply with the Participant’s obligations during the Period Notice as set forth in Section 3(j) hereof. A Participant will be considered to engage in “Competitive Activity” if the Participant (1) enters into a relationship as an employee, officer, partner, member, director, independent contractor, consultant, advisor or agent of, or in any similar relationship with, any corporation, partnership, limited liability company, joint venture or other business entity that engages in any activity which the Committee determines is competitive with a principal business activity of the Company (a “Competitor”), where the Participant will be responsible for providing services which are similar or substantially related to the services that the Participant provided during any of the last three years of the Participant’s employment with the Company and its Subsidiaries or (2) either alone, or in concert with others, acquires or maintains beneficial ownership (within the meaning of Section 13(d) of the Exchange Act) of 5% or more of any class of equity securities of a Competitor. The amount of a Participant’s “Option Gain” realized upon full or partial exercise of an Option is the amount of income included (or to be included) in respect of such exercise on the Form W-2 (or successor form) that the Company or one of its Subsidiaries issues to the Participant for the year in which such exercise occurs. The Company may require the Participant, in connection with any full or partial exercise of an Option, to certify in a manner acceptable to the Company that the Participant has not engaged in Competitive Activity and may decline to give effect to such exercise if the Participant fails so to certify. If the Participant is required to repay any Option Gain to the Company pursuant to this Section 4(f), the Participant shall pay such amount in such manner and on such terms and conditions as the Company may require, and the Company shall be entitled to withhold or set-off against any other amount owed to the Participant by the Company or any of its Subsidiaries (other than any amount owed to the Participant under any retirement plan intended to be qualified under Section 401(a) of the Code) up to any amount sufficient to satisfy any unpaid obligation of the Participant under this Section 4(f).

5. Transfer; Option Exercisable Only by Participant and Permitted Transferees.

The Option may not be transferred, pledged, assigned, or otherwise disposed of, except (i) by will or the laws of descent and distribution, (ii) pursuant to a domestic relations order or (iii) for no consideration, to a member or members of the Participant’s immediate family (as defined below) or to one or more trusts or partnerships established in whole or in part for the benefit of one or more of such immediate family members (the parties identified in clauses (i), (ii), and (iii) being referred to collectively as “Permitted Transferees”). If the Option is transferred to a Permitted Transferee, it shall be further transferable only by will or the laws of descent and distribution or, for no consideration, to another Permitted Transferee of the Participant. The Participant shall promptly notify the Company of any proposed transfer to a Permitted Transferee in advance in writing and shall upon request provide the Company with information concerning the Permitted Transferee’s financial condition and investment experience. No assignment or transfer of the Option, or of the rights represented thereby, whether voluntary or involuntary, by operation of law or otherwise, except as permitted by this Section 5, shall vest in the assignee or transferee any interest or right in the Option, but immediately upon any attempt to assign or transfer the Option the same shall terminate and be of no force or effect. For purposes of this Option Agreement, the Participant’s “immediate family” means any child, stepchild, grandchild, spouse, son-in-law or daughter-in-law and shall include adoptive relationships.

6. Tax Withholding.

The Company shall have the right, prior to the issuance of shares as set forth in section 3(g) hereof, to require the Participant to remit to the Company an amount sufficient to satisfy the minimum required Federal, state or local tax withholding requirements. The Company may permit the Participant to satisfy, in whole or in part, such obligation to remit taxes, by directing the Company to withhold shares of Common Stock that would otherwise be received by the Participant, pursuant to such rules as the Committee may establish from time to time. The Company shall also have the right to deduct from all cash payments made pursuant to or in connection with the Option the minimum required Federal, state or local taxes required to be withheld with respect to such payments or such lesser amount as determined by the Company in order to assure that it complies with applicable accounting standards.

7. No Restriction on Right to Effect Corporate Changes; No Right to Employment.

Neither the Plan, this Award Agreement nor the existence of the Option shall affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalizations, reorganizations or other changes in the Company’s capital structure or its business, or any merger or consolidation of the Company, or any issue of bonds, debentures, preferred or prior preference stocks ahead of or convertible into, or otherwise affecting the Common Stock or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise.

In addition, neither this Award Agreement, the grant of the Option nor any action taken hereunder shall be deemed to limit or restrict the right of the Company to terminate the Participant’s employment at any time, for any reason, with or without Cause.

8. Adjustment of and Changes in Shares.

In the event of any merger, consolidation, recapitalization, reclassification, stock split, stock dividend, special cash dividend, split-up, spin-off, or other transaction or change in corporate structure affecting the Common Stock, the Committee shall make equitable adjustments in order to preserve, but not increase, the benefits or potential benefits intended to be made available to participants granted stock options. Any adjustments shall be determined by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final.

9. Change in Control.

(a) Committee Discretion to Take Certain Actions. The Committee, in its sole discretion, may at any time prior to, coincident with or after the time of a Change in Control (as defined herein):

(i) provide for the acceleration of any vesting conditions relating to the exercise of the Option or that the Option may be exercised in full on or before a date fixed by the Committee;

(ii) provide for the purchase of the Option, upon the Participant’s request, for an amount of cash equal to the amount, as determined by the Committee in its sole discretion, which could have been realized upon the exercise of the Option had the Option been currently exercisable;

(iii) make such adjustments to the Option as the Committee deems appropriate to reflect such Change in Control; or

(iv) cause the Option then to be assumed, or new rights substituted therefor, by the surviving corporation in such Change in Control.

Any such actions shall be authorized by the Committee, whose determination as to what actions shall be taken and the extent thereof, shall be final.

(b) Definitions. For purposes hereof, a “Change in Control” shall be deemed to occur on the date on which one of the following events occurs:

(i) the acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of the Common Stock then outstanding, but shall not include any such acquisition by:

(A) the Company;

(B) any Subsidiary of the Company;

(C) any employee benefit plan of the Company or of any Subsidiary of the Company;

(D) any Person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan;

(E) any Person who as of January 31, 1996 was the beneficial owner of 15% or more of the shares of Common stock outstanding on such date unless and until such Person, together with all affiliates and associates of such Person, becomes the beneficial owner of 25% or more of the shares of Common stock then outstanding whereupon a Change in Control shall be deemed to have occurred; or

(F) any Person who becomes the beneficial owner of 20% or more, or, with respect to a Person described in clause (E) above, 25% or more, of the shares of Common Stock then outstanding as a result of a reduction in the number of shares of Common Stock outstanding due to the repurchase of shares of Common Stock by the Company unless and until such Person, after becoming aware that such Person has become the beneficial owner of 20% or more, or 25% or more, as the case may be, of the then outstanding shares of Common Stock, acquires beneficial ownership of additional shares of Common Stock representing 1% or more of the shares of Common Stock then outstanding, whereupon a Change in Control shall be deemed to have occurred; or

(ii) individuals who, as of July 30, 1997, constitute the Board, and subsequently elected members of the Board whose election is approved or recommended by at least a majority of such current members or their successors whose election was so approved or recommended (other than any subsequently elected members whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board), cease for any reason to constitute at least a majority of such Board; or

(iii) approval by the stockholders of the Company of (A) a merger or consolidation of the Company with any other corporation, (B) the issuance of voting securities of the Company in connection with a merger or consolidation of the Company (or any Subsidiary) pursuant to applicable stock exchange requirements, or (C) sale or disposition of all or substantially all of the assets of the Company or the acquisition of assets of another corporation (each, a “Business Combination”), unless, in each case, immediately following such Business Combination, all or substantially all of the individuals and entities who were the beneficial owners of the Common Stock outstanding immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of the then outstanding shares of Common Stock and 70% of the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company’s assets either directly or

through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the Common Stock.

As used herein, “Person” means any individual, firm, corporation, partnership or other entity.

10. Preemption of Applicable Laws and Regulations.

Anything herein to the contrary notwithstanding, if, at any time specified herein for the issuance of shares of Common Stock to the Participant, any law, regulation or requirement of any governmental authority having jurisdiction shall require either the Company or the Participant to take any action in connection with the shares then to be issued, the issuance of such shares shall be deferred until such action shall have been taken.

11. Committee Decisions Final.

Any dispute or disagreement which shall arise under, or as a result of, or pursuant to, or in connection with, this Award Agreement or the Option shall be determined by the Committee, and any such determination or any other determination by the Committee under or pursuant to this Award Agreement and any interpretation by the Committee of the terms of the Option shall be final and binding on all persons affected thereby.

12. Amendments.

The Committee shall have the power to alter or amend the terms of the Option as set forth herein from time to time, in any manner consistent with the provisions of Section 16 of the Plan, and any alteration or amendment of the terms of the Option by the Committee shall, upon adoption, become and be binding on all persons affected thereby without requirement for consent or other action with respect thereto by any such person. The Committee shall give written notice to the Participant of any such alteration or amendment as promptly as practicable after the adoption thereof. The foregoing shall not restrict the ability of the Participant and the Company by mutual consent to alter or amend the terms of the Option in any manner which is consistent with the Plan and approved by the Committee. In addition, the terms of the Option may be amended or supplemented by any employment, management retention, severance or similar agreement (an “Employment Agreement”) entered into between the Company and the Participant (including any such agreement entered into prior to the Date of Grant) and approved, to the extent such Employment Agreement amends or supplements the terms of the Option, by the Committee.

13. Notice Requirements.

Any notice which either party hereto may be required or permitted to give to the other shall be in writing. Such notice may be delivered to the Company personally or by mail, postage prepaid, addressed as follows: Ambac Financial Group, Inc., One State Street Plaza, New York, New York 10004, attention: Senior Vice President, Chief Administrative Officer and Employment Counsel, or at such other address as the Company, by notice to the Participant, may designate in writing from time to time, and to the Participant at the Participant’s address as shown on the records of the Company or at such other address as the Participant, by notice to the Company, may designate in writing from time to time.

14. Governing Law.

The terms and conditions stated herein are to be governed by, and construed in accordance with, the laws of the State of Delaware.

15. Entire Agreement; Headings.

This Award Agreement (which includes Annex A) and the other related documents expressly referred to herein (including, if applicable, any Employment Agreement) set forth the entire agreement and understanding

between the parties hereto and supersede all prior agreements and understandings relating to the subject matter hereof. In the event of a discrepancy or inconsistency in the number of shares of common stock covered by the Option, the Date of Grant, the vesting schedule, the Exercise Price or any other term in this Award Agreement and the resolutions of the Committee authorizing the grant of the Option covered hereby, such resolutions shall control and the Company shall have the right, in its sole discretion, to replace the Award Agreement or any portion thereof (including any portion of Annex A) with a correct version. The headings of Sections and subsections herein are included solely for convenience of reference and shall not affect the meaning of any of the provisions of this Award Agreement.

AMBAC FINANCIAL GROUP, INC.

EX-10.08

Exhibit 10.08

AMBAC FINANCIAL GROUP, INC.

1997 EQUITY PLAN

JANUARY 2007 NOTICE OF SPECIAL KEY SENIOR EXECUTIVE OFFICER AWARD OF 2006 LONG TERM

INCENTIVE COMPENSATION IN THE FORM OF RESTRICTED STOCK UNITS

Ambac Financial Group, Inc., a Delaware corporation and its Subsidiaries (referred to herein as either the "Company" or "Ambac"), have adopted the Ambac 1997 Equity Plan (the "Plan"), for the purposes of providing an incentive to selected employees of the Company and its affiliates to remain in its employ and to increase their interest in the success of the Company. The Company pursues these goals by providing selected employees with opportunities through the Plan to increase their proprietary interest in the Company and to receive compensation based upon the Company’s success.

This 2007 Restricted Stock Unit notice of award (the "Notice of Award") is being made in accordance with the terms set forth in a certain employment agreement between William T. McKinnon and Ambac dated as of January 29, 2007 (the “McKinnon Employment Agreement”). This Notice of Award sets forth the terms and conditions of the restricted stock units that have been granted under the Plan to the Mr. McKinnon (the "Participant"). This Notice of Award sets forth the number of restricted stock units that the Participant will receive, the date of grant and the applicable vesting schedule.

1. Incorporation of Plan Terms.

This Notice of Award and the restricted stock units granted hereby are subject to the Plan, the terms of which are incorporated herein by reference. If there is any conflict or inconsistency between the Plan and this Notice of Award, the Plan shall govern. Capitalized terms used in this Notice of Award without definition shall have the meanings assigned to them in the Plan. A copy of the Plan is available on Ambac’s intranet site.

2. Grant of Restricted Stock Units.

Subject to the conditions contained herein and in the Plan, the Company grants to the Participant, as of the date of grant indicated on Annex A (the "Date of Grant"), the number of restricted stock units (the "RSUs") specified on Annex A.

3. Terms and Conditions of the RSUs.

The RSUs shall have the following terms and conditions:

(a) General. Each RSU shall represent the unsecured promise of the Company to transfer to the Participant, on the settlement date of such RSU and subject to the terms and conditions set forth in this Notice of Award, one share of the Company’s common stock, par value $0.01 per share (the "Common Stock").

(b) Vesting.

(i) Normal Vesting. The RSUs will ordinarily vest in accordance with the vesting schedule set forth on Annex A hereto.

(ii) Accelerated Vesting. Notwithstanding Section 3(b)(i), any RSUs that have not previously vested shall vest in full upon the termination of the Participant’s employment with the Company and its Subsidiaries by reason of death or Permanent Disability. "Permanent Disability" shall mean circumstances that entitled the Participant to receive benefits under the long-term disability policy maintained by the Company or any of its Subsidiaries for the participant.

(iii) Partial Vesting. Notwithstanding Section 3(b)(i) or the terms of the Plan, if the Participant elects to retire at any time prior to the third anniversary of the Date of Grant, only that portion of RSUs proportionate to time worked, defined as X divided by Y (X = the number of whole months worked from the Term (as defined in the McKinnon Employment Agreement) through the retirement date; Y =thirty-six) will vest. Regardless of when they vest, the RSUs awarded pursuant to this Notice of Award shall be settled by delivery of the corresponding shares of Common Stock.

(iv)

(c) Dividends and Distribution on Common Stock. In the event that, following the Date of Grant and prior to the settlement of any RSU, the Company pays any cash or other dividend or makes any other distribution in respect of the Common Stock, each RSU shall be credited with an additional number of RSUs (including fractions thereof) determined by dividing (i) the amount or cash, or the value (as determined by the Committee) of any other property, paid or distributed in respect of one outstanding share of Common Stock by (ii) the closing price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange, or such other national securities exchange as may be designated by the Committee, or in the event that the Common Stock is not listed for trading on a national securities exchange but is quoted on an automated quotation system, on such automated quotation system, in any such case for the date of such payment or distribution (or if there were no sales on the date

of such payment or distribution, the closing price as reported on such composite tape or automated quotation system for the most recent day during which a sale occurred). Any RSUs so credited shall be subject to the same vesting provisions as the RSU in respect of which they are credited. Except as otherwise expressly provided in this Notice of Award, the Participant shall have no right as a shareholder with respect to any RSUs until a certificate or certificates evidencing such shares shall have been issued to the Participant according to the terms of Section 3(d) below.

(d) Delivery of Share Certificates.

Settlement. Regardless of when they vest, the RSUs awarded pursuant to this Notice of Award shall be settled on (A) (i) July 29, 2010 or (ii) the six month anniversary of the Participant’s retirement, which ever is sooner, or (B) the date of the Participant’s death following termination of employment by delivery of the corresponding shares of Common Stock to the Participant, as promptly thereafter as practicable. Such settlement shall be subject to the provisions of Section 5(b) of the McKinnon Employment Agreement.

(i) RSUs will be settled, at the election of the Participant, either by:

(A) Delivery of a stock certificate or certificates representing the number of shares of Common Stock equal to the number of RSUs being settled (any fractional RSU being rounded up to the next whole RSU). Certificates shall be issued in the name of the Participant (or of the person or persons to whom such RSUs were transferred by will or the laws of descent and distribution or pursuant to a Qualified Domestic Relations Order).

(B) The transfer of the corresponding number of shares of Common Stock equal to the number of RSUs being settled (or any fractional RSU being rounded up to the next whole RSU) to the brokerage account designated by the Participant to the Company in writing prior to settlement.

(ii) Payment Restrictions for Specified Employees. If the Participant is a “Specified Employee” within the meaning of Section 409(a)(2)(B) of the Code, then, anything in this Notice of Award to the contrary notwithstanding, no settlement of RSUs in connection with the Participant’s termination of employment (other than by reason of death) shall be made before the earlier to occur of (X) the date which is six months and one day following the date of such termination of employment and (Y) the date of the Participant’s death following termination of employment.

(iii) Transfer Restrictions on Common Stock. Shares of Common Stock issued upon the settlement of RSUs will not be subject to restrictions on transfer (except for any restrictions imposed by the federal securities laws or other applicable laws or regulations and for any restrictions under the Company’s trading policies applicable to employees). However, shares of common stock issued upon

settlement of RSUs granted at a discount to the Fair Market Value of Ambac stock on the date of grant will be subject to transfer restrictions until such time as the Eligible Individual meets and/or exceeds Ambac’s Stock Ownership Guidelines.

(iv) Normal Settlement and Deferral of Payment Subject to Section 162(m). Subject to the other terms and conditions of this Notice of Award and the terms of the Plan, Ambac shall settle RSUs on or as soon as practicable following the vesting date (the “Settlement Date”); provided, however, that to the extent that, as of the Settlement Date, Ambac reasonably anticipates that its federal tax deduction with respect to such settlement would be limited or eliminated by application of Section 162(m) of the Internal Revenue Code of 1986, as amended, or any regulations thereunder (or under any successor provisions thereto) (the "Code"), then the settlement of the RSUs shall automatically be deferred until the earliest date at which Ambac reasonably anticipates that its deduction of the amount of the settlement will not be so limited or eliminated (it being understood that so many of such RSUs as can be settled on the Settlement Date without limiting or eliminating Ambac’s deduction will be settled on the Settlement Date and that any RSUs whose settlement is deferred past the Settlement Date shall be settled on one or more future dates as and to the extent that the conditions to settlement set forth in this sentence are satisfied).

(e) Transfer Restrictions on RSUs. RSUs may not be transferred, except by will or the laws of descent and distribution or pursuant to a Qualified Domestic Relations Order.

(f) Immediate Cancellation of RSUs and Return of Share Value. Notwithstanding any other provision of this Notice of Award, the Committee may (i) cancel all or any portion of the RSUs then outstanding (whether or not then vested and whether or not subject to a deferred settlement election) and (ii) may require the Participant to repay to the Company all or any portion of the Share Value (as hereinafter defined) that the Participant realizes from the settlement of RSUs occurring within six months before or after the Participant’s termination of employment for any reason with the Company and its Subsidiaries, if the Participant engages in Competitive Activity (as defined herein) within six months following termination of such employment. The Participant will be considered to engage in "Competitive Activity" if the Participant (1) enters into a relationship as an employee, officer, partner, member, director, independent contractor, consultant, advisor, or agent of, or in any similar relationship with, any corporation, partnership, limited liability company, joint venture or other business entity that engages in any activity which the Committee determines to be competitive with a principal business activity of the Company (a "Competitor"), where the Participant will be responsible for providing services which are similar or substantially related to the services that the Participant provided during any of the last three years of the Participant’s employment with the Company and its Subsidiaries or (2) either alone, or in concert with others, acquires or maintains beneficial ownership (within the meaning of Section 13(d) of the Securities Exchange Act of 1934, as amended) of 5% or more of any class of equity securities of a Competitor. For purposes hereof, "Share Value" in respect of an RSU means a cash amount equal to the amount of income

included (or to be included) in respect of the settlement of such RSU on the Form W-2 (or successor form) that the Company or one of its Subsidiaries issues to the Participant for the year in which such settlement occurs. If the Participant is required to repay any Share Value to the Company pursuant to this Section 3(f), the Participant shall pay such amount in such manner and on such terms and conditions as the Company may require, and the Company shall be entitled to withhold or set-off against any other amount owed to the Participant by the Company or its Subsidiaries (other than any amount owed to the Participant under any retirement plan intended to be qualified under Section 401(a) of the Code) up to an amount sufficient to satisfy the unpaid obligation of the Participant under this Section 3(f).

(g) Cancellation for Specified Activity. Notwithstanding any other provision of this Notice of Award, the Committee may cancel all or any portion of the RSUs then outstanding (whether or not vested) if at any time the Participant initiates or becomes a party to any lawsuit or other legal action in any federal or state court in which the Participant seeks damages or injunctive or other equitable relief from or against the Company, any of its Subsidiaries or any of its officers, employees or directors in connection with any claim arising from or relating to the Participant’s employment with the Company or any of its Subsidiaries or the termination of such employment (and regardless of whether any such termination is the result of the Participant’s voluntary resignation or retirement or of the involuntary termination of the Participant’s employment by the Company or one of its subsidiaries). This Section 3(g) is not intended as a waiver by the Participant of any claims the Participant may have against the Company, any of its subsidiaries or any of its officers, employees or directors. Instead, it provides for the consequences specified in the second preceding sentence in the event the Participant engages in the conduct described therein.

4. Tax Withholding.

(a) Prior to either the transfer of shares of Common Stock to the Participant’s brokerage account or the delivery of any certificates evidencing shares of Common Stock to be issued in connection with the full or partial settlement of the RSUs, the Company shall have the right to require the Participant to remit to the Company an amount sufficient to satisfy the minimum Federal, State and local tax withholding requirements. The Company may permit the Participant to satisfy this obligation, in whole or in part, by directing the Company to withhold shares of Common Stock that would otherwise be received by the Participant, pursuant to such rules as the Committee may establish from time to time. Under no circumstances will the Company permit the Participant to withhold shares of Common Stock in excess of the maximum Federal, state and local withholding requirements.

(b) Upon vesting of any portion of the RSUs, the Participant shall be required to satisfy, within 30 days of vesting, all Social Security and Medicare taxes due upon vesting. The Participant must either submit a check or money order, payable to Ambac Financial Group, Inc., to Ambac’s Senior Vice President and Chief Administrative Officers or his or her designee designee or direct the Company to withhold a portion of his or her salary to pay for any Social Security and Medicare taxes due upon vesting.

5. No Restriction on Right to Effect Corporate Changes; No Right to Continued Employment.

(a) Neither the Plan, this Notice of Award, the grant of the RSUs nor any action taken hereunder shall affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalizations, reorganizations or other changes in the Company’s capital structure or its business, or any merger or consolidation of the Company, or any issue of bonds, debentures, preferred or prior preference stocks ahead of or convertible into, or otherwise affecting the Common Stock or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise.

(b) This Notice of Award is not an employment agreement. Nothing in this Notice of Award or the Plan, or the granting to the Participant of the RSUs, shall alter the Participant’s status as an "at-will" employee of the Company or be construed as guaranteeing employment by, or as giving the Participant any right to continue in the employ of, the Company or any of its subsidiaries during any period (including without limitation the period between the Date of Grant and the settlement date of any RSUs, or any portion thereof), or as limiting or restricting the right of the Company to terminate the Participant’s employment at any time, for any reason, with or without cause.

6. Adjustment of and Changes in Shares.

In the event of any merger, consolidation, recapitalization, reclassification, stock split, stock dividend, special cash dividend, split-up, spin-off, or other transaction or change in corporate structure affecting the Common Stock, the Committee shall make equitable adjustments in order to preserve, but not increase, the benefits or potential benefits intended to be made available to participants granted RSUs. Any adjustments shall be determined by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final.

7. Preemption of Applicable Laws and Regulations.

Anything herein to the contrary notwithstanding, if, at any time specified herein for the issuance of shares of Common Stock to the Participant, any law, regulation or requirement of any governmental authority having jurisdiction requires either the Company or the Participant to take any action in connection with the shares then to be issued, the issuance of such shares shall be deferred until such action shall have been taken.

8. Committee Decisions Final.

Any dispute or disagreement which shall rise under, or as a result of, or pursuant to, or in connection with, this Notice of Award shall be determined by the Committee, and any such determination or any other determination by the Committee under or pursuant to this Notice of

Award and any interpretation by the Committee of the terms hereof shall be final and binding on all persons affected thereby.

9. Amendments.

The Committee shall have the power to alter or amend the terms of the RSUs as set forth herein, from time to time, in any manner consistent with the Plan; provided, however, that no amendment will be made that is inconsistent with the American Jobs Creation Act of 2004. Any alteration or amendment of the terms of the RSUs by the Committee shall, upon adoption, become and be binding on all persons affected thereby without requirement for consent or other action with respect thereto by any such person. The Committee shall give written notice to the Participant of any such alteration or amendment as promptly as practicable after it is adopted. The foregoing shall not restrict the ability of the Participant and the Company by mutual consent to alter or amend the terms of the RSUs in any manner which is consistent with the Plan and approved by the Committee. Notwithstanding anything in the Plan to the contrary, the Committee may amend or terminate the Plan, without the consent of any Participant, to the extent it deems necessary or desirable to comply with the American Jobs Creation Act of 2004.

10. Notice Requirements.

Any notice which either party hereto may be required or permitted to give to the other shall be in writing. Notice may be delivered to the Company personally or by mail, postage prepaid, addressed as follows: Ambac Financial Group, Inc., One State Street Plaza, New York, New York 10004, attention: Senior Vice President, Chief Administrative Officer, Employment Counsel, or at such other address as the Company, by notice to the Participant, may designate in writing from time to time. Notice to the Participant shall be directed either to the Participant’s address as shown on the records of the Company or at such other address as the Participant, by notice to the Company, may designate in writing from time to time or to the Participant by a combination of interoffice mail and email.

11. Governing Law.

The terms and conditions stated herein are to be governed by, and construed in accordance with, the laws of the State of Delaware.

12. Entire Agreement; Headings.

This Notice of Award (which includes Annex A) and the other related documents expressly referred to herein set forth the entire agreement and understanding between the parties hereto and supersede all prior agreements and understandings relating to the subject matter hereof. The headings of Sections and subsections herein are included solely for convenience of reference and shall not affect the meaning of any of the provisions of this Notice of Award.

EX-10.37

EXHIBIT 10.37

GOLDMAN, SACHS & CO. | 85 BROAD STREET | NEW YORK, NEW YORK 10004 | TEL: 212 902 1000

Opening Transaction

To:	Ambac Financial Group, Inc. One State Street Plaza New York, New York 10004
A/C:	[                    ]
From:	Goldman, Sachs & Co.
Re:	Capped Accelerated Stock Buyback
Ref. No:	As provided in the Supplemental Confirmation
Date:	February 7, 2007

This master confirmation (this “Master Confirmation”), dated as of February 7, 2007 is intended to supplement the terms and provisions of certain Transactions (each, a “Transaction”) entered into from time to time between Goldman, Sachs & Co. (“GS&Co.”) and Ambac Financial Group, Inc. (“Counterparty”). This Master Confirmation, taken alone, is neither a commitment by either party to enter into any Transaction nor evidence of a Transaction. The terms of any particular Transaction shall be set forth in (i) a Supplemental Confirmation in the form of Schedule A hereto (a “Supplemental Confirmation”), which shall reference this Master Confirmation and supplement, form a part of, and be subject to this Master Confirmation and (ii) a Trade Notification in the form of Schedule B hereto (a “Trade Notification”), which shall reference the relevant Supplemental Confirmation and supplement, form a part of, and be subject to such Supplemental Confirmation. This Master Confirmation, each Supplemental Confirmation and the related Trade Notification together shall constitute a “Confirmation” as referred to in the Agreement specified below.

The definitions and provisions contained in the 2002 ISDA Equity Derivatives Definitions (the “Equity Definitions”), as published by the International Swaps and Derivatives Association, Inc., are incorporated into this Master Confirmation. This Master Confirmation, each Supplemental Confirmation and the related Trade Notification evidence a complete binding agreement between Counterparty and GS&Co. as to the subject matter and terms of each Transaction to which this Master Confirmation, such Supplemental Confirmation and Trade Notification relate and shall supersede all prior or contemporaneous written or oral communications with respect thereto.

This Master Confirmation, each Supplemental Confirmation and each Trade Notification supplement, form a part of, and are subject to an agreement in the form of the 1992 ISDA Master Agreement (Multicurrency –Cross Border) (the “Agreement”) as if GS&Co. and Counterparty had executed the Agreement on the date of this Master Confirmation (but without any Schedule except for (i) the election of Loss and Second Method, New York law (without regard to the conflicts of law principles) as the governing law and US Dollars (“USD”) as the Termination Currency, (ii) the election that subparagraph (ii) of Section 2(c) will not apply to the Transactions, (iii) the replacement of the word “third” in the last line of Section 5(a)(i) with the word “first” and (iv) the election that the “Cross Default” provisions of Section 5(a)(vi) shall apply to Counterparty, with a “Threshold Amount” of USD50 million).

All provisions contained or incorporated by reference in the Agreement shall govern this Master Confirmation, each Supplemental Confirmation and each Trade Notification except as expressly modified herein.

If, in relation to any Transaction to which this Master Confirmation, a Supplemental Confirmation and a Trade Notification relate, there is any inconsistency between the Agreement, this Master Confirmation, any Supplemental Confirmation, any Trade Notification and the Equity Definitions, the following will prevail for purposes of such Transaction in the order of precedence indicated: (i) such Trade Notification, (ii) such Supplemental Confirmation; (iii) this Master Confirmation; (iv) the Agreement; and (v) the Equity Definitions.

1. Each Transaction constitutes a Share Forward Transaction for the purposes of the Equity Definitions. Set forth below are the terms and conditions which, together with the terms and conditions set forth in the related Supplemental Confirmation and Trade Notification (in respect of the relevant Transaction), shall govern each such Transaction.

General Terms:

Trade Date:	For each Transaction, as set forth in the Supplemental Confirmation.
Buyer:	Counterparty
Seller:	GS&Co.
Shares:	Common Stock, $0.01 par value of Counterparty (Ticker: ABK)
Forward Price:	The average of the VWAP Prices for each Exchange Business Day in the Calculation Period.
VWAP Price:	For any Exchange Business Day, as determined by the Calculation Agent based on the New York Stock Exchange 10b-18 Volume Weighted Average Price per Share for the regular trading session (including any extensions thereof) of the Exchange on such Exchange Business Day (without regard to pre-open or after hours trading outside of such regular trading session for such Exchange Business Day), as published by Bloomberg at 4:15 p.m. New York time (or 15 minutes following the end of any extension of the regular trading session) on such Exchange Business Day, on Bloomberg page “ABK.N <Equity> AQR_SEC” (or any successor thereto). For purposes of calculating the VWAP Price, the Calculation Agent will include only those trades that are reported during the period of time during which Counterparty could purchase its own shares under Rule 10b-18(b)(2) and pursuant to the conditions of Rule 10b-18(b)(3), each under the Exchange Act (as defined herein) (such trades, “Rule 10b-18 eligible transactions”).
Forward Price Adjustment Amount:	For each Transaction, as set forth in the Supplemental Confirmation.
Calculation Period:	The period from and including the first Exchange Business Day immediately following the Hedge Completion Date to and including the Termination Date (as adjusted in accordance with the provisions hereof).
Termination Date:	For each Transaction, the Scheduled Termination Date set forth in the Supplemental Confirmation (as the same may be postponed in accordance with the provisions hereof); provided that GS&Co. shall have the right to designate any date on or after the First Acceleration Date to be the Termination Date by providing notice to Counterparty of any such designation on such date.
First Acceleration Date:	For each Transaction, as set forth in the Supplemental Confirmation.

2

Hedge Period:	The period from and including the day immediately after the Trade Date to and including the Hedge Completion Date (as adjusted in accordance with the provisions hereof).
Hedge Completion Date:	For each Transaction, as set forth in the Trade Notification, to be the Exchange Business Day on which GS&Co. finishes establishing its initial Hedge Positions in respect of such Transaction, as determined by GS&Co. in its sole discretion, which date shall be subject to any limitations set forth in the Supplemental Confirmation.
Hedge Period Reference Price:	For each Transaction, as set forth in the Trade Notification, to be the average of the VWAP Prices for each Exchange Business Day in the Hedge Period.
Market Disruption Event:	The definition of “Market Disruption Event” in Section 6.3(a) of the Equity Definitions is hereby amended by deleting the words “at any time during the one-hour period that ends at the relevant Valuation Time” and inserting the words “at any time on any Scheduled Trading Day during the Hedge Period or Calculation Period or” after the word “material,” in the third line thereof.
	Notwithstanding anything to the contrary in the Equity Definitions, to the extent that a Disrupted Day occurs in the Hedge Period or the Calculation Period, the Calculation Agent may in good faith and acting in a commercially reasonable manner postpone the Hedge Completion Date or the Termination Date, as the case may be. In such event, the Calculation Agent must determine whether (i) such Disrupted Day is a Disrupted Day in full, in which case the VWAP Price for such Disrupted Day shall not be included for purposes of determining the Hedge Period Reference Price or the Forward Price, as the case may be, or (ii) such Disrupted Day is a Disrupted Day only in part, in which case the VWAP Price for such Disrupted Day shall be determined by the Calculation Agent based on Rule 10b-18 eligible transactions in the Shares on such Disrupted Day effected before the relevant Market Disruption Event occurred and/or after the relevant Market Disruption Event ended, and the weighting of the VWAP Price for the relevant Exchange Business Days during the Hedge Period or the Calculation Period, as the case may be, shall be adjusted in a commercially reasonable manner by the Calculation Agent for purposes of determining the Hedge Period Reference Price or the Forward Price, as the case may be, with such adjustments based on, among other factors, the duration of any Market Disruption Event and the volume, historical trading patterns and price of the Shares.
	If a Disrupted Day occurs during the Hedge Period or the Calculation Period, as the case may be, and each of the nine immediately following Scheduled Trading Days is a Disrupted Day, then the Calculation Agent, in its good faith and commercially reasonable discretion, may either (i) deem such ninth Scheduled Trading Day to be an Exchange Business Day and determine the VWAP Price for such ninth Scheduled Trading Day using its good faith estimate of the value of the Shares on such ninth Scheduled Trading Day based on the volume, historical trading patterns and price of the Shares and such other factors as it deems appropriate or (ii) further extend the Hedge Period or the Calculation Period, as the case may be, as it deems necessary to determine the VWAP Price.
Exchange:	New York Stock Exchange
Related Exchange(s):	All Exchanges.

3

Prepayment\Variable         Obligation:	Applicable
Prepayment Amount:	For each Transaction, as set forth in the Supplemental Confirmation.
Prepayment Date:	Three (3) Exchange Business Days following the Trade Date.
Counterparty Additional         Payment:	Counterparty shall pay GS&Co. the Counterparty Additional Payment Amount on the Counterparty Additional Payment Date.
Counterparty Additional         Payment Amount:	For each Transaction, as set forth in the Supplemental Confirmation.
Counterparty Additional         Payment Date:	The Prepayment Date
Settlement Terms:
Physical Settlement:	Applicable; provided that GS&Co. does not, and shall not, make the agreement or the representations set forth in Section 9.11 of the Equity Definitions related to the restrictions imposed by applicable securities laws with respect to any Shares delivered by GS&Co. to Counterparty under any Transaction.
Number of Shares         to be Delivered:	A number of Shares equal to (a) the Prepayment Amount divided by (b) the Forward Price minus the Forward Price Adjustment Amount; provided that the Number of Shares to be Delivered shall not be less than the Minimum Shares. The Number of Shares to be Delivered on the Settlement Date shall be reduced, but not below zero, by any Shares delivered pursuant to the Minimum Share Delivery described below.
Excess Dividend Amount:	For the avoidance of doubt, all references to the Excess Dividend Amount shall be deleted from Section 9.2(a)(iii) of the Equity Definitions.
Settlement Date:	Three (3) Exchange Business Days following the Termination Date.
Settlement Currency:	USD
Initial Share Delivery:	GS&Co. shall deliver a number of Shares equal to the Initial Shares to Counterparty on the Initial Share Delivery Date in accordance with Section 9.4 of the Equity Definitions, with the Initial Share Delivery Date deemed to be a “Settlement Date” for purposes of such Section 9.4.
Initial Share Delivery Date:	The Prepayment Date
Initial Shares:	For each Transaction, as set forth in the Supplemental Confirmation.
Minimum Share Delivery:	GS&Co. shall deliver a number of Shares equal to the excess, if any, of the Minimum Shares over the Initial Shares on the Minimum Share Delivery Date in accordance with Section 9.4 of the Equity Definitions, with the Minimum Share Delivery Date deemed to be a “Settlement Date” for purposes of such Section 9.4.

4

Minimum Share Delivery Date:	Three (3) Exchange Business Days following the Hedge Completion Date.
Minimum Shares:	For each Transaction, as set forth in the Supplemental Confirmation.
Share Adjustments:
Potential Adjustment Event:	Notwithstanding anything to the contrary in Section 11.2(e) of the Equity Definitions, an Extraordinary Dividend shall not constitute a Potential Adjustment Event.
Extraordinary Dividend:	For any calendar quarter occurring (in whole or in part) during the period from and including the first day of the Hedge Period to and including the Termination Date, any dividend or distribution on the Shares with an ex-dividend date occurring during such calendar quarter (other than any dividend or distribution of the type described in Section 11.2(e)(i) or Section 11.2(e)(ii)(A) or (B) of the Equity Definitions) (a “Dividend”) the amount or value of which (as determined by the Calculation Agent), when aggregated with the amount or value (as determined by the Calculation Agent) of any and all previous Dividends with ex-dividend dates occurring in the same calendar quarter, exceeds the Ordinary Dividend Amount.
Ordinary Dividend Amount:	For each Transaction, as set forth in the Supplemental Confirmation.
Method of Adjustment:	Calculation Agent Adjustment
Extraordinary Events:
Consequences of Merger Events and Tender Offers:
(a) Share-for-Share:	Modified Calculation Agent Adjustment; provided that Sections 12.2(e) and 12.3(d) shall each be amended hereby to delete the words “, expected dividends, stock loan rate”.
(b) Share-for-Other:	Cancellation and Payment
(c) Share-for-Combined:	Component Adjustment
Determining Party:	GS&Co.
Tender Offer:	Applicable
Cancellation Amount:	Section 12.8 of the Equity Definitions is hereby amended by deleting the second sentence in paragraph (d) thereof and by deleting paragraph (e) thereof.
Nationalization,         Insolvency or Delisting:	Cancellation and Payment; provided that in addition to the provisions of Section 12.6(a)(iii) of the Equity Definitions, it shall also constitute a Delisting if the Exchange is located in the United States and the Shares are not immediately re-listed, re-traded or re-quoted on any of the New York Stock Exchange, the American Stock Exchange, The NASDAQ Global Select Market or The NASDAQ Global Market (or their respective successors); if the Shares are immediately re-listed, re-traded or re-quoted on any such exchange or quotation system, such exchange or quotation system shall be deemed to be the Exchange.

5

Notwithstanding anything to the contrary in the Equity Definitions, if, as a result of a Nationalization, an Insolvency or a Delisting, Cancellation and Payment applies to one or more Transactions hereunder (whether in whole or in part), an Additional Termination Event (with the Transactions (or portions thereof) to which Cancellation and Payment applies being the Affected Transactions, Counterparty being the sole Affected Party and the Early Termination Date being the date on which such Transactions would be cancelled pursuant to Article 12 of the Equity Definitions) shall be deemed to occur, and, in lieu of Sections 12.7 and 12.8 of the Equity Definitions, Section 6 of the Agreement shall apply to such Affected Transactions.

Additional Disruption Events:

(a) Change in Law:	Applicable
(b) Failure to Deliver:	Applicable
(c) Insolvency Filing:	Applicable
(d) Loss of Stock Borrow:	Applicable; provided that Sections 12.9(a)(vii) and 12.9(b)(iv) of the Equity Definitions shall be amended by deleting the words “at a rate equal to or less than the Maximum Stock Loan Rate” and replacing them with “at a rate of return equal to or greater than zero”.
Hedging Party:	GS&Co.
Determining Party:	GS&Co.

Notwithstanding anything to the contrary in the Equity Definitions, if, as a result of an Additional Disruption Event, any Transaction is cancelled or terminated, an Additional Termination Event (with such terminated Transaction(s) being the Affected Transaction(s), Counterparty being the sole Affected Party and the Early Termination Date being the date on which such Transaction(s) would be cancelled or terminated pursuant to Article 12 of the Equity Definitions) shall be deemed to occur, and, in lieu of Sections 12.7 and 12.8 of the Equity Definitions, Section 6 of the Agreement shall apply to such Affected Transaction(s).

Non-Reliance/Agreements and Acknowledgements Regarding Hedging Activities/Additional Acknowledgements:	Applicable
Transfer:	Notwithstanding anything to the contrary in the Agreement, GS&Co. may assign, transfer and set over all rights, title and interest, powers, privileges and remedies of GS&Co. under this Transaction, in whole or in part, to an affiliate of GS&Co. whose obligations are guaranteed by The Goldman Sachs Group, Inc. without the consent of Counterparty.
GS&Co. Payment Instructions:
Counterparty’s Contact Details for Purpose of Giving Notice:

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	With a copy to:
	Telephone No.:
	Facsimile No.:
GS&Co.’s Contact Details for Purpose of Giving Notice:	Telephone No.:
	Facsimile No.:
	Attention: Equity Operations: Options and Derivatives
	With a copy to:
2. Calculation Agent.	GS&Co.

3. Additional Mutual Representations, Warranties and Covenants. In addition to the representations and warranties in the Agreement, each party represents, warrants and covenants to the other party that:

(a) Eligible Contract Participant. It is an “eligible contract participant”, as defined in the U.S. Commodity Exchange Act (as amended), and is entering into each Transaction hereunder as principal and not for the benefit of any third party.

(b) Accredited Investor. Each party acknowledges that the offer and sale of each Transaction to it is intended to be exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”), by virtue of Section 4(2) thereof and the provisions of Regulation D thereunder (“Regulation D”). Accordingly, each party represents and warrants to the other that (i) it has the financial ability to bear the economic risk of its investment in each Transaction and is able to bear a total loss of its investment, (ii) it is an “accredited investor” as that term is defined under Regulation D and (iii) the disposition of each Transaction is restricted under this Master Confirmation, the Securities Act and state securities laws.

4. Additional Representations, Warranties and Covenants of Counterparty. In addition to the representations, warranties and covenants in the Agreement and those contained herein, as of (i) the date hereof, (ii) the Trade Date for each Transaction hereunder and (iii) to the extent indicated below, each day during the Hedge Period and Calculation Period for each Transaction hereunder, Counterparty represents, warrants and covenants to GS&Co. that:

(a) the purchase or writing of each Transaction and the transactions contemplated hereby will not violate Rule 13e-1 or Rule 13e-4 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”);

(b) it is not entering into any Transaction (i) on the basis of, and is not aware of, any material non-public information with respect to the Shares (ii) in anticipation of, in connection with, or to facilitate, a distribution of its securities, a self tender offer or a third-party tender offer or (iii) to create actual or apparent trading activity in the Shares (or any security convertible into or exchangeable for the Shares) or to raise or depress or otherwise manipulate the price of the Shares (or any security convertible into or exchangeable for the Shares);

(c) each Transaction is being entered into pursuant to a publicly disclosed Share buy-back program and its Board of Directors has approved the use of derivatives to effect the Share buy-back program;

(d) without limiting the generality of Section 13.1 of the Equity Definitions, it acknowledges that GS&Co. is not making any representations or warranties with respect to the treatment of any Transaction under

7

FASB Statements 128, 133 as amended, or 149, 150, EITF 00-19, EITF 03-6 (or any successor issue statements) or under Financial Accounting Standards Board’s Liabilities & Equity Project;

(e) Counterparty is in compliance with its reporting obligations under the Exchange Act and its most recent Annual Report on Form 10-K, together with all reports subsequently filed by it pursuant to the Exchange Act, taken together and as amended and supplemented to the date of this representation, do not, as of their respective filing dates, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading;

(f) Counterparty shall report each Transaction as required under Regulation S-K and/or Regulation S-B under the Exchange Act, as applicable;

(g) Counterparty is not, and will not be, engaged in a “distribution” of Shares or securities that are convertible into, or exchangeable or exercisable for Shares for purposes of Regulation M promulgated under the Exchange Act (“Regulation M”) at any time during the Hedge Period or the Relevant Period for any Transaction unless Counterparty has provided written notice to GS&Co. of such distribution (a “Regulation M Distribution Notice”) not later than the Scheduled Trading Day immediately preceding the first day of the relevant “restricted period” (as defined in Regulation M); Counterparty acknowledges that any such notice may cause the Hedge Period or the Calculation Period to be extended or suspended pursuant to Section 5 below; accordingly, Counterparty acknowledges that its delivery of such notice must comply with the standards set forth in Section 6 below; “Relevant Period” means, for any Transaction, the period commencing on the first day of the Calculation Period and ending on the 20th Exchange Business Day immediately following the end of the Calculation Period, or such earlier day as elected by GS&Co. and communicated to Counterparty on such day;

(h) Counterparty acknowledges that each Transaction is a derivatives transaction in which it has granted GS&Co. an option; GS&Co. may purchase shares for its own account at an average price that may be greater than, or less than, the price paid by Counterparty under the terms of the related Transaction;

(i) as of the Trade Date, the Prepayment Date, the Initial Share Delivery Date, the Minimum Share Delivery Date and the Settlement Date for each Transaction, Counterparty is not “insolvent” (as such term is defined under Section 101(32) of the U.S. Bankruptcy Code (Title 11 of the United States Code) (the “Bankruptcy Code”)) and Counterparty would be able to purchase Shares for the Prepayment Amount for such Transaction in compliance with the laws of the jurisdiction of Counterparty’s incorporation;

(j) Counterparty is not and, after giving effect to any Transaction, will not be, required to register as an “investment company” as such term is defined in the Investment Company Act of 1940, as amended;

(k) Counterparty will not take any action or refrain from taking any action that would limit or in any way adversely affect GS&Co.’s rights under the Agreement, this Master Confirmation, any Supplemental Confirmation or any Trade Notification; and

(l) it has not and, during the Hedge Period or Relevant Period for any Transaction, will not enter into agreements similar to the Transactions described herein where any initial hedge period (however defined), the calculation period (however defined) or the relevant period (however defined) in such other transaction will overlap at any time (including as a result of extensions in such initial hedge period, calculation period or relevant period as provided in the relevant agreements) with any Hedge Period or Relevant Period under this Master Confirmation. In the event that the initial hedge period, calculation period or relevant period in any other similar transaction overlaps with any Hedge Period or Relevant Period under this Master Confirmation as a result of an extension of the Termination Date pursuant to Section 5 herein, Counterparty shall promptly amend such transaction to avoid any such overlap.

5. Suspension of Hedge Period or Calculation Period.

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(a) If Counterparty concludes that it will be engaged in a distribution of the Shares for purposes of Regulation M, Counterparty agrees that it will, on a day no later than the Scheduled Trading Day immediately preceding the start of the relevant restricted period, provide GS&Co. with a Regulation M Distribution Notice. If on any Scheduled Trading Day Counterparty delivers the Regulation M Distribution Notice in writing (and confirms by telephone) by 8:30 a.m. New York Time (the “Notification Time”), then such notice shall be effective as of such Notification Time. In the event that Counterparty delivers such Regulation M Distribution Notice in writing and/or confirms by telephone after the Notification Time, then such notice shall be effective as of 8:30 a.m. New York Time on the following Scheduled Trading Day or as otherwise required by law or agreed between Counterparty and GS&Co. Upon the effectiveness of such Regulation M Distribution Notice, the Calculation Period or the Hedge Period, as the case may be, shall be suspended and the Termination Date or the Hedge Completion Date or both, as the case may be, shall postponed for each Scheduled Trading Day in such restricted period; accordingly, Counterparty acknowledges that its delivery of such notice must comply with the standards set forth in Section 6 below, including, without limitation, the requirement that such notice be made at a time at which none of Counterparty or any officer, director, manager or similar person of Counterparty is aware of any material non-public information regarding Counterparty or the Shares.

(b) In the event that GS&Co. concludes, in its sole discretion, that it is appropriate with respect to any legal, regulatory or self-regulatory requirements or related policies and procedures (whether or not such requirements, policies or procedures are imposed by law or have been voluntarily adopted by GS&Co.), for it to refrain from purchasing Shares on any Scheduled Trading Day during the Hedge Period or the Calculation Period, GS&Co. may by written notice to Counterparty elect to suspend the Hedge Period or the Calculation Period, or both, as the case may be, for such number of Scheduled Trading Days as is specified in the notice. The notice shall not specify, and GS&Co. shall not otherwise communicate to Counterparty, the reason for GS&Co.’s election to suspend the Hedge Period or the Calculation Period, or both, as the case may be. The Hedge Period or the Calculation Period, or both, as the case may be, shall be suspended and the Termination Date shall be extended for each Scheduled Trading Day occurring during any such suspension.

(c) In the event that the Calculation Period or the Hedge Period, as the case may be, is suspended pursuant to Section 5(a) or 5(b) above during the regular trading session on the Exchange, such suspension shall be deemed to be an additional Market Disruption Event, and the second and third paragraphs under “Market Disruption Event” shall apply.

(d) In the event that the Calculation Period is extended pursuant to any provision hereof (including, without limitation, pursuant to Section 9(d) below), the Calculation Agent, in its commercially reasonable discretion, shall adjust any relevant terms of the related Transaction if necessary to preserve as nearly as practicable the economic terms of such Transaction prior to such extension; provided that Counterparty shall not be required to make any additional cash payments or deliver any Shares in connection with any such adjustments.

6. 10b5-1 Plan. Counterparty represents, warrants and covenants to GS&Co. that for each Transaction:

(a) Counterparty is entering into this Master Confirmation and each Transaction hereunder in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b5-1 under the Exchange Act (“Rule 10b5-1”). It is the intent of the parties that each Transaction entered into under this Master Confirmation comply with the requirements of Rule 10b5-1(c)(1)(i)(A) and (B) and each Transaction entered into under this Master Confirmation shall be interpreted to comply with the requirements of Rule 10b5-1(c).

(b) Counterparty will not seek to control or influence GS&Co. to make “purchases or sales” (within the meaning of Rule 10b5-1(c)(1)(i)(B)(3)) under any Transaction entered into under this Master Confirmation, including, without limitation, GS&Co.’s decision to enter into any hedging transactions. Counterparty represents and warrants that it has consulted with its own advisors as to the legal aspects of its adoption and implementation of this Master Confirmation, each Supplemental Confirmation and each Trade Notification under Rule 10b5-1.

(c) Counterparty acknowledges and agrees that any amendment, modification, waiver or termination of this Master Confirmation, the relevant Supplemental Confirmation or Trade Notification must be effected in accordance with the requirements for the amendment or termination of a “plan” as defined in Rule 10b5-1(c). Without limiting the generality of the foregoing, any such amendment, modification, waiver or termination shall be

9

made in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5, and no such amendment, modification, waiver or termination shall be made at any time at which Counterparty or any officer, director, manager or similar person of Counterparty is aware of any material non-public information regarding Counterparty or the Shares.

7. Counterparty Purchases.

Counterparty (or any “affiliated purchaser” as defined in Rule 10b-18 under the Exchange Act (“Rule 10b-18”)) shall not, without the prior written consent of GS&Co., directly or indirectly purchase any Shares, listed contracts on the Shares or securities that are convertible into, or exchangeable or exercisable for Shares (including, without limitation, any Rule 10b-18 purchases of blocks (as defined in Rule 10b-18)) during any Hedge Period or Relevant Period (as extended pursuant to the provisions hereof). During this time, any such purchases by Counterparty shall be made through GS&Co., or if not through GS&Co., with the prior written consent of GS&Co., and in compliance with Rule 10b-18 or otherwise in a manner that Counterparty and GS&Co. believe is in compliance with applicable requirements.

8. Additional Termination Event. The declaration of any Extraordinary Dividend by the Issuer during the Hedge Period and the Calculation Period will constitute an Additional Termination Event, with Counterparty as the sole Affected Party and all Transactions hereunder as the Affected Transactions.

9. Special Provisions for Merger Transactions. Notwithstanding anything to the contrary herein or in the Equity Definitions,

(a) Counterparty shall, prior to the opening of trading in the Shares on any day during any Hedge Period or Relevant Period on which Counterparty makes, or expects to be made, any public announcement (as defined in Rule 165(f) under the Securities Act of 1933, as amended) of any Merger Transaction, notify GS&Co. of such public announcement;

(b) promptly notify GS&Co. following any such announcement that such announcement has been made; and

(c) promptly provide GS&Co. with written notice specifying (i) Counterparty’s average daily Rule 10b-18 Purchases (as defined in Rule 10b-18) during the three full calendar months immediately preceding the Announcement Date that were not effected through GS&Co. or its affiliates and (ii) the number of Shares purchased pursuant to the proviso in Rule 10b-18(b)(4) under the Exchange Act for the three full calendar months preceding the Announcement Date. Such written notice shall be deemed to be a certification by Counterparty to GS&Co. that such information is true and correct. In addition, Counterparty shall promptly notify GS&Co. of the earlier to occur of the completion of such transaction and the completion of the vote by target shareholders. Counterparty acknowledges that any such notice may cause the terms of any Transaction to be adjusted or such Transaction to be terminated; accordingly, Counterparty acknowledges that its delivery of such notice must comply with the standards set forth in Section 6; and

(d) GS&Co. in its sole discretion may (i) make adjustments to the terms of any Transaction, including, without limitation, the Termination Date and the Forward Price Adjustment Amount to account for the number of Shares that could be purchased on each day during the Hedge Period or the Calculation Period in compliance with Rule 10b-18 following such public announcement, provided that Counterparty shall not be required to make any additional cash payments or deliver any Shares in connection with any such adjustments or (ii) treat the occurrence of such public announcement as an Additional Termination Event with Counterparty as the sole Affected Party.

“Merger Transaction” means any merger, acquisition or similar transaction involving a recapitalization as contemplated by Rule 10b-18(a)(13)(iv) under the Exchange Act.

10. Acknowledgments. The parties hereto intend for:

10

(a) Each Transaction to be a “securities contract” as defined in Section 741(7) of the Bankruptcy Code, a “swap agreement” as defined in Section 101(53B) of the Bankruptcy Code and a “forward contract” as defined in Section 101(25) of the Bankruptcy Code, and the parties hereto to be entitled to the protections afforded by, among other Sections, Sections 362(b)(6), 362(b)(17), 362(b)(27), 362(o), 546(e), 546(g), 546(j), 555, 556, 560 and 561 of the Bankruptcy Code;

(b) The Agreement to be a “master netting agreement” as defined in Section 101(38A) of the Bankruptcy Code;

(c) A party’s right to liquidate or terminate any Transaction, net out or offset termination values or payment amounts, and to exercise any other remedies upon the occurrence of any Event of Default or Termination Event under the Agreement with respect to the other party or any Extraordinary Event that results in the termination or cancellation of any Transaction to constitute a “contractual right” (as defined in the Bankruptcy Code); and

(d) All payments for, under or in connection with each Transaction, all payments for the Shares and the transfer of such Shares to constitute “settlement payments” and “transfers” (as defined in the Bankruptcy Code).

11. Credit Support Documents. The parties hereto acknowledge that no Transaction hereunder is secured by any collateral that would otherwise secure the obligations of Counterparty herein or pursuant to the Agreement.

12. Limitation on Set-off. (a) Notwithstanding anything to the contrary in the Agreement or the Equity Definitions, the calculation of any Settlement Amounts and Unpaid Amounts shall be calculated separately for (A) all Terminated Transactions in the Shares of the Issuer that qualify as equity under applicable accounting rules (collectively, the “Equity Shares”) as determined by the Calculation Agent and (B) all other Terminated Transactions under the Agreement including, without limitation, Transactions in Shares other than those of the Issuer (collectively, the “Other Shares”) and the netting and set-off provisions of the Agreement shall only operate to provide netting and set-off (i) among Terminated Transactions in the Equity Shares and (ii) among Terminated Transactions in the Other Shares. In no event shall the netting and set-off provisions of the Agreement operate to permit netting and set-off between Terminated Transactions in the Equity Shares and Terminated Transactions in the Other Shares.

(b) The parties agree that upon the occurrence of an Event of Default or Termination Event with respect to a party who is the Defaulting Party or an Affected Party (“X”), the other party (“Y”) will have the right (but not be obliged) without prior notice to X or any other person to set-off or apply any obligation of X owed to Y (or any Affiliate of Y) (whether or not matured or contingent and whether or not arising under the Agreement, and regardless of the currency, place of payment or booking office of the obligation) against any obligation of Y (or any Affiliate of Y) owed to X (whether or not matured or contingent and whether or not arising under the Agreement, and regardless of the currency, place of payment or booking office of the obligation). Y will give notice to the other party of any set-off effected under this Section 12.

Amounts (or the relevant portion of such amounts) subject to set-off may be converted by Y into the Termination Currency at the rate of exchange at which such party would be able, acting in a reasonable manner and in good faith, to purchase the relevant amount of such currency. If any obligation is unascertained, Y may in good faith estimate that obligation and set-off in respect of the estimate, subject to the relevant party accounting to the other when the obligation is ascertained. Nothing in this Section 12 shall be effective to create a charge or other security interest. This Section 12 shall be without prejudice and in addition to any right of set-off, combination of accounts, lien or other right to which any party is at any time otherwise entitled (whether by operation of law, contract or otherwise).

(c) Notwithstanding anything to the contrary in the foregoing, GS&Co. agrees not to set off or net amounts due from Counterparty with respect to any Transaction against amounts due from GS&Co. to Counterparty with respect to contracts or instruments that are not Equity Contracts. “Equity Contract” means any transaction or instrument that does not convey rights to GS&Co. senior to claims of common stockholders in the event of Counterparty’s bankruptcy.

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13. Staggered Delivery of Shares. (a) GS& Co. may satisfy its obligation to deliver the Initial Shares on the Initial Share Delivery Date by making separate deliveries of Shares at more than one time on the Initial Share Delivery Date, so long as the aggregate number of Shares so delivered is equal to the number of Initial Shares.

(b) GS&Co. may, by prior notice to Counterparty, elect to deliver the Shares it is required to deliver under “Minimum Share Delivery” (above) and/or the Number of Shares to be Delivered, as the case may be, on two or more dates (each, a “Staggered Delivery Date”) and/or at two or more times on the Staggered Delivery Date as follows:

(i) in such notice, GS&Co. will specify to Counterparty the related Staggered Delivery Dates (each of which will be on or prior to the Minimum Share Delivery Date or the Settlement Date, as the case may be) or delivery times and how it will allocate the Shares it is required to deliver among the Staggered Delivery Dates or delivery times; and

(ii) the aggregate number of Shares that GS&Co. will deliver to Counterparty hereunder on all such Staggered Delivery Dates and delivery times relating to the Minimum Share Delivery Date will equal the number of Shares that GS&Co. would otherwise be required to deliver on the Minimum Share Delivery Date, and the aggregate number of Shares that GS&Co. will deliver to Counterparty hereunder on all such Staggered Delivery Dates and delivery times relating to the Settlement Date will equal the Number of Shares to be Delivered that GS&Co. would otherwise be required to deliver on the Settlement Date.

14. Early Termination. In the event that an Early Termination Date (whether as a result of an Event of Default or a Termination Event) occurs or is designated with respect to any Transaction (except as a result of a Merger Event in which the consideration or proceeds to be paid to holders of Shares consists solely of cash), if GS&Co. would owe any amount to Counterparty pursuant to Section 6(d)(ii) of the Agreement (calculated as if the Transactions being terminated on such Early Termination Date were the sole Transactions under the Agreement) (any such amount, a “GS&Co. Amount”), then, in lieu of any payment of such GS&Co. Amount, Counterparty may, no later than the Early Termination Date or the date on which such Transaction is terminated, elect for GS&Co. to deliver to Counterparty a number of Shares (or, in the case of a Merger Event, a number of units, each comprising the number or amount of the securities or property that a hypothetical holder of one Share would receive in such Merger Event (each such unit, an “Alternative Delivery Unit” and, the securities or property comprising such unit, “Alternative Delivery Property”)) with a value equal to the GS&Co. Amount, as determined by the Calculation Agent (and the parties agree that, in making such determination of value, the Calculation Agent may take into account a number of factors, including the market price of the Shares or Alternative Delivery Property on the date of early termination and the prices at which GS&Co. purchases Shares or Alternative Delivery Property to fulfill its delivery obligations under this Section 14); provided that in determining the composition of any Alternative Delivery Unit, if the relevant Merger Event involves a choice of consideration to be received by holders, such holder shall be deemed to have elected to receive the maximum possible amount of cash. If Counterparty so elects for GS&Co. to deliver Alternative Delivery Property and such Alternative Delivery Property consists of or includes Shares not owned by GS&Co. or its affiliates in connection with the hedging of such Transaction as of such Early Termination Date, then GS&Co. shall effect any purchases of such Shares in a manner that would, if such purchases were made by Counterparty, satisfy the requirements of paragraphs (b)(2), (3) and (4) of Rule 10b-18, taking into account any Securities and Exchange Commission no-action letters as appropriate, except that GS&Co. shall not be responsible for any delays in between the execution and reporting of a trade of Shares on the Exchange and other circumstances beyond its control. In addition, if Counterparty so elects for GS&Co. to deliver Alternative Delivery Property and such Alternative Delivery Property consists of or includes securities of Counterparty, Counterparty shall be deemed to have repeated the representations and warranties contained in paragraph 4(b) of this Confirmation as of the time of such election.

15. Payment Date upon Early Termination. Notwithstanding anything to the contrary in Section 6(d)(ii) of the Agreement, all amounts calculated as being due in respect of an Early Termination Date under Section 6(e) of the Agreement will be payable on the day that notice of the amount payable is effective; provided that if Counterparty elects to receive Shares or Alternative Delivery Property in accordance with Section 14, such Shares or Alternative Delivery Property shall be delivered on a date selected by GS&Co as promptly as practicable.

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16. Special Provisions for Counterparty Payments. The parties hereby agree that, notwithstanding anything to the contrary herein or in the Agreement, in the event that an Early Termination Date (whether as a result of an Event of Default or a Termination Event) occurs or is designated with respect to any Transaction and, as a result, Counterparty owes to GS&Co. an amount calculated under Section 6(e) of the Agreement (calculated as if the Transactions being terminated on such Early Termination Date were the sole Transactions under the Agreement), such amount shall be deemed to be zero.

17. Claim in Bankruptcy. GS&Co. agrees that in the event of the bankruptcy of Counterparty, GS&Co. shall not have rights or assert a claim that is senior in priority to the rights and claims available to the shareholders of the common stock of Counterparty.

18. Governing Law. The Agreement, this Master Confirmation, each Supplemental Confirmation, each Trade Notification and all matters arising in connection with the Agreement, this Master Confirmation, each Supplemental Confirmation and each Trade Notification shall be governed by, and construed and enforced in accordance with, the laws of the State of New York (without reference to its choice of laws doctrine).

19. Offices.

(a) The Office of GS&Co. for each Transaction is: One New York Plaza, New York, New York 10004.

(b) The Office of Counterparty for each Transaction is: One State Street Plaza, New York, New York 10004.

20. Arbitration. The Agreement, this Master Confirmation, each Supplemental Confirmation and each Trade Notification are subject to the following arbitration provisions:

(a) All parties to this Confirmation are giving up the right to sue each other in court, including the right to a trial by jury, except as provided by the rules of the arbitration forum in which a claim is filed.

(b) Arbitration awards are generally final and binding; a party’s ability to have a court reverse or modify an arbitration award is very limited.

(c) The ability of the parties to obtain documents, witness statements and other discovery is generally more limited in arbitration than in court proceedings.

(d) The arbitrators do not have to explain the reason(s) for their award.

(e) The panel of arbitrators will typically include a minority of arbitrators who were or are affiliated with the securities industry, unless Counterparty is a member of the organization sponsoring the arbitration facility, in which case all arbitrators may be affiliated with the securities industry.

(f) The rules of some arbitration forums may impose time limits for bringing a claim in arbitration. In some cases, a claim that is ineligible for arbitration may be brought in court.

(g) The rules of the arbitration forum in which the claim is filed, and any amendments thereto, shall be incorporated into this Confirmation.

Counterparty agrees that any and all controversies that may arise between Counterparty and GS&Co., including, but not limited to, those arising out of or relating to the Agreement or any Transaction hereunder, shall be determined by arbitration conducted before The New York Stock Exchange, Inc. (“NYSE”) or NASD Dispute Resolution (“NASD-DR”), or, if the NYSE and NASD-DR decline to hear the matter, before the American Arbitration Association, in accordance with their arbitration rules then in force. The award of the arbitrator shall be final, and judgment upon the award rendered may be entered in any court, state or federal, having jurisdiction.

13

No person shall bring a putative or certified class action to arbitration, nor seek to enforce any pre-dispute arbitration agreement against any person who has initiated in court a putative class action or who is a member of a putative class who has not opted out of the class with respect to any claims encompassed by the putative class action until: (i) the class certification is denied; (ii) the class is decertified; or (iii) Counterparty is excluded from the class by the court.

Such forbearance to enforce an agreement to arbitrate shall not constitute a waiver of any rights under this Confirmation except to the extent stated herein.”

21. Counterparts. This Master Confirmation may be executed in any number of counterparts, all of which shall constitute one and the same instrument, and any party hereto may execute this Master Confirmation by signing and delivering one or more counterparts.

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Counterparty hereby agrees (a) to check this Master Confirmation carefully and immediately upon receipt so that errors or discrepancies can be promptly identified and rectified and (b) to confirm that the foregoing (in the exact form provided by GS&Co.) correctly sets forth the terms of the agreement between GS&Co. and Counterparty with respect to any particular Transaction to which this Master Confirmation relates, by manually signing this Master Confirmation or this page hereof as evidence of agreement to such terms and providing the other information requested herein and immediately returning an executed copy to Equity Derivatives Documentation Department, Facsimile No. 212-428-1980/83.

Yours faithfully, GOLDMAN, SACHS & CO.
By:	/DAVID GOLDENBERG/
	Authorized Signatory

Agreed and accepted by:

AMBAC FINANCIAL GROUP, INC.

By:	/DAVID TRICK/
	Name: David Trick
	Title: Managing Director

15

SCHEDULE A

SUPPLEMENTAL CONFIRMATION

To:	Ambac Financial Group, Inc. One State Street Plaza New York, New York 10004
From:	Goldman, Sachs & Co.
Subject:	Capped Accelerated Stock Buyback
Ref. No:	[Insert Reference No.]
Date:	[                    ], 2007

The purpose of this Supplemental Confirmation is to confirm the terms and conditions of the Transaction entered into between Goldman, Sachs & Co. (“GS&Co.”) and Ambac Financial Group, Inc. (“Counterparty”) (together, the “Contracting Parties”) on the Trade Date specified below. This Supplemental Confirmation is a binding contract between GS&Co. and Counterparty as of the relevant Trade Date for the Transaction referenced below.

1. This Supplemental Confirmation supplements, forms part of, and is subject to the Master Confirmation dated as of February 7, 2007 (the “Master Confirmation”) between the Contracting Parties, as amended and supplemented from time to time. All provisions contained in the Master Confirmation govern this Supplemental Confirmation except as expressly modified below.

2. The terms of the Transaction to which this Supplemental Confirmation relates are as follows:

Trade Date: [            ], 2007

Forward Price Adjustment Amount: [            ]% of the Hedge Period Reference Price

Hedge Completion Date: As set forth in the Trade Notification, but in no event later than [            ].

Scheduled Termination Date: As set forth in the Trade Notification, to be the date that follows the Hedge Completion Date by [            ].

First Acceleration Date: As set forth in the Trade Notification, to be the date that follows the Hedge Completion Date by [            ].

Prepayment Amount: USD[            ]

Counterparty Additional Payment Amount: USD[            ]

Initial Shares: [            ]

Minimum Shares: As set forth in the Trade Notification, to be a number of Shares equal to (a) the Prepayment Amount divided by (b) [            ]% of the Hedge Period Reference Price.

Ordinary Dividend Amount: For any calendar quarter, USD[            ]

3. Counterparty represents and warrants to GS&Co. that neither it nor any “affiliated purchaser” (as defined in Rule 10b-18 under the Exchange Act) has made any purchases of blocks pursuant to the proviso in Rule 10b-18(b)(4) under the Exchange Act during the four full calendar weeks immediately preceding the Trade Date.

4. This Supplemental Confirmation may be executed in any number of counterparts, all of which shall constitute one and the same instrument, and any party hereto may execute this Supplemental Confirmation by signing and delivering one or more counterparts.

Counterparty hereby agrees (a) to check this Supplemental Confirmation carefully and immediately upon receipt so that errors or discrepancies can be promptly identified and rectified and (b) to confirm that the foregoing (in the exact form provided by GS&Co.) correctly sets forth the terms of the agreement between GS&Co. and Counterparty with respect to this Transaction, by manually signing this Supplemental Confirmation or this page hereof as evidence of agreement to such terms and providing the other information requested herein and immediately returning an executed copy to Equity Derivatives Documentation Department, facsimile No. 212-428-1980/83.

Yours sincerely, GOLDMAN, SACHS & CO.
By:
	Authorized Signatory

Agreed and accepted by:

AMBAC FINANCIAL GROUP, INC.

By:
	Name:
	Title:

SCHEDULE B

TRADE NOTIFICATION

To:	Ambac Financial Group, Inc. One State Street Plaza New York, New York 10004
From:	Goldman, Sachs & Co.
Subject:	Capped Accelerated Stock Buyback
Ref. No:	[Insert Reference No.]
Date:	[Insert Date]

The purpose of this Trade Notification is to notify you of certain terms in the Transaction entered into between Goldman, Sachs & Co. (“GS&Co.”) and Ambac Financial Group, Inc. (“Counterparty”) (together, the “Contracting Parties”) on the Trade Date specified below.

This Trade Notification supplements, forms part of, and is subject to the Supplemental Confirmation dated as of [            ], 2007 (the “Supplemental Confirmation”) between the Contracting Parties, as amended and supplemented from time to time. The Supplemental Confirmation is subject to the Master Confirmation dated as of February 7, 2007 (the “Master Confirmation”) between the Contracting Parties, as amended and supplemented from time to time. All provisions contained in the Master Confirmation and the Supplemental Confirmation govern this Trade Notification except as expressly modified below.

Trade Date: [            ], 2007

Hedge Completion Date: [            ]

Scheduled Termination Date: [            ]

First Acceleration Date: [            ]

Hedge Period Reference Price: USD[            ]

Minimum Shares: [            ]

Yours sincerely, GOLDMAN, SACHS & CO.
By:
	Authorized Signatory

EX-10.38

Exhibit 10.38

SUPPLEMENTAL CONFIRMATION

To:	Ambac Financial Group, Inc. One State Street Plaza New York, New York 10004
From:	Goldman, Sachs & Co.
Subject:	Capped Accelerated Stock Buyback
Ref. No:	[                ]
Date:	February 7, 2007

The purpose of this Supplemental Confirmation is to confirm the terms and conditions of the Transaction entered into between Goldman, Sachs & Co. (“GS&Co.”) and Ambac Financial Group, Inc. (“Counterparty”) (together, the “Contracting Parties”) on the Trade Date specified below. This Supplemental Confirmation is a binding contract between GS&Co. and Counterparty as of the relevant Trade Date for the Transaction referenced below.

1. This Supplemental Confirmation supplements, forms part of, and is subject to the Master Confirmation dated as of February 7, 2007 (the “Master Confirmation”) between the Contracting Parties, as amended and supplemented from time to time. All provisions contained in the Master Confirmation govern this Supplemental Confirmation except as expressly modified below.

2. The terms of the Transaction to which this Supplemental Confirmation relates are as follows:

Trade Date: February 7, 2007

Prepayment Date: Three (3) Exchange Business Days following the Trade Date; provided that if the closing of the offering and sale of Counterparty’s USD400,000,000 Directly-Issued Subordinated Capital Securities with a scheduled maturity date of February 15, 2037 pursuant to the Underwriting Agreement dated as of the Trade Date between Counterparty and the underwriters named therein does not occur on such date, the Prepayment Date shall be the earlier of the date such closing does occur and six (6) Exchange Business Days following the Trade Date.

Forward Price Adjustment Amount: 0.115% of the Hedge Period Reference Price

Hedge Completion Date: As set forth in the Trade Notification, but in no event later than the date that follows the Trade Date by four weeks.

Scheduled Termination Date: As set forth in the Trade Notification, to be the date that follows the Hedge Completion Date by four months.

First Acceleration Date: As set forth in the Trade Notification, to be the date that follows the Hedge Completion Date by one month.

Prepayment Amount: USD400,000,000

Counterparty Additional Payment Amount: USD0.00

Initial Shares: 2,982,442

Minimum Shares: As set forth in the Trade Notification, to be a number of Shares equal to (a) the Prepayment Amount divided by (b) 104.5% of the Hedge Period Reference Price.

Ordinary Dividend Amount: For any calendar quarter, USD0.18

3. Counterparty represents and warrants to GS&Co. that neither it nor any “affiliated purchaser” (as defined in Rule 10b-18 under the Exchange Act) has made any purchases of blocks pursuant to the proviso in Rule 10b-18(b)(4) under the Exchange Act during the four full calendar weeks immediately preceding the Trade Date.

4. This Supplemental Confirmation may be executed in any number of counterparts, all of which shall constitute one and the same instrument, and any party hereto may execute this Supplemental Confirmation by signing and delivering one or more counterparts.

Counterparty hereby agrees (a) to check this Supplemental Confirmation carefully and immediately upon receipt so that errors or discrepancies can be promptly identified and rectified and (b) to confirm that the foregoing (in the exact form provided by GS&Co.) correctly sets forth the terms of the agreement between GS&Co. and Counterparty with respect to this Transaction, by manually signing this Supplemental Confirmation or this page hereof as evidence of agreement to such terms and providing the other information requested herein and immediately returning an executed copy to Equity Derivatives Documentation Department, facsimile No. 212-428-1980/83.

Yours sincerely,
GOLDMAN, SACHS & CO.
By:	/David Goldenberg/
	Authorized Signatory

Agreed and accepted by:

AMBAC FINANCIAL GROUP, INC.
By:	/David Trick/
	Name: David Trick Title: Managing Director

EX-10.39

EXHIBIT 10.39

AMENDMENT TO MASTER CONFIRMATION AND SUPPLEMENTAL CONFIRMATION

This AMENDMENT (this “Amendment”) is made as of February 21, 2007, between Goldman, Sachs & Co. (“GS&Co.”) and Ambac Financial Group, Inc. (“Counterparty”).

WHEREAS, GS&Co. and Counterparty are parties to the Master Confirmation, dated February 7, 2007, containing terms relating to capped accelerated stock buyback transactions to be entered into between GS&Co. and Counterparty (the “Master Confirmation”);

WHEREAS, GS&Co. and Counterparty entered into a capped accelerated stock buyback transaction (reference number SDB1624558024) (the “Transaction”) under the Master Confirmation, the terms of which are set forth in the Master Confirmation and the Supplemental Confirmation, dated February 7, 2007 (the “Supplemental Confirmation” and, together with the Master Confirmation, the “Transaction Confirmation”);

WHEREAS, GS&Co. and Counterparty desire to amend the Transaction Confirmation as set forth herein;

NOW, THEREFORE, in consideration of their mutual covenants herein contained, CS&Co. and Counterparty agree as follows:

Section 1. Terms Used but Not Defined Herein. Capitalized terms used but not defined herein shall have the meanings set forth in the Transaction Confirmation.

Section 2. Representations, Warranties and Covenants of Counterparty. Counterparty represents and warrants to GS&Co. that it is not entering into this Amendment (i) on the basis of, and it is not aware of, any material non-public information with respect to itself or the Shares (ii) in anticipation of, in connection with, or to facilitate, a distribution of its securities, a self tender offer or a third-party tender offer or (iii) to create actual or apparent trading activity in the Shares (or any security convertible into or exchangeable for the Shares) or to raise or depress or otherwise manipulate the price of the Shares (or any security convertible into or exchangeable for the Shares).

Section 3. Amendment to the Master Confirmation. The Master Confirmation is hereby amended as follows:

(a) The following definitions as hereby inserted after the definition or “Initial Shares” in Section 1 of the Master Confirmation:

“Interim Share Delivery:	GS&Co. shall deliver a number of Shares equal to the Interim Shares, if any, to Counterparty on the interim Share Delivery Date in accordance with Section 9.4 of the Equity Definitions, with the Interim Share Delivery Date deemed to be a “Settlement Date” for purposes of such Section 9.4.
Interim Share Delivery Date:	For each Transaction, as set forth in the Supplemental Confirmation.
Interim Shares:	For each Transaction, as set forth in the Supplemental Confirmation.”

(b) The definition of “Minimum Share Delivery” in Section 1 of the Master Confirmation is hereby amended by replacing the words “the Initial Shares” with the words “the sum of the Initial Shares and the Interim Shares”.

(c) Section 4(i) of the Master Confirmation is hereby amended by inserting the words “, the interim Share Delivery Date” immediately after the words “the Initial Share Delivery Date”.

Section 4. Amendment to the Supplemental Confirmation. The Supplemental Confirmation is hereby amended by inserting the following definitions after the definition of “Initial Shares” in Section 2 thereof:

“Interim Share Delivery Date:        February 21, 2007

Interim Shares:                                700,00”.

Section 4. Governing Law. This Amendment shall be governed by and construed in accordance with the laws of the State of New York.

Section 5. Confirmation of Agreements. Except as amended hereby, the Transaction Confirmation shall remain and continue in full force and effect and is hereby confirmed in all respects.

Section 6. Counterparts. This Amendment may be signed in any number of counterparts, each of which shall be an original, with the same effect as if all of the signatures thereto and hereto were upon the same instrument.

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the date first above written.

GOLDMAN, SACHS & CO.

/S/    CONRAD LANGENEGGER

Name:  Conrad Langenegger

Title:    Vice President

AMBAC FINANCIAL GROUP, INC.
By:
	Name: Title:

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the date first above written.

GOLDMAN, SACHS & CO.
By:
	Authorized Signatory

AMBAC FINANCIAL GROUP, INC.
By:	/S/  DAVID TRICK
	Name:  David Trick Title:    Managing Director & Treasurer

EX-12.01

EXHIBIT 12.01

Ambac Financial Group, Inc.

Ratio of Earnings to Fixed Charges

(In thousands, except ratios)

	Years Ended December 31,
	2006		2005		2004		2003		2002
Earnings:
Pre-tax income from continuing operations	$	1,210,213	$	1,022,764	$	976,782	$	849,589	$	563,331
Interest expense		75,294		55,896		54,322		54,201		43,724
Portion of rentals deemed to be interest		3,322		3,339		2,836		2,478		2,126
Earnings	$	1,288,829	$	1,081,999	$	1,033,940	$	906,268	$	609,181
Fixed Charges:
Interest Expense	$	75,294	$	55,896	$	54,322	$	54,201	$	43,724
Portion of rentals deemed to be interest		3,322		3,339		2,836		2,478		2,126
Fixed Charges	$	78,616	$	59,235	$	57,158	$	56,679	$	45,850
Ratio of earnings to fixed charges		16.4		18.3		18.1		16.0		13.3

EX-21.01

EXHIBIT 21.01

List of Subsidiaries of Ambac Financial Group, Inc.

The following is a list of significant and other subsidiaries of Ambac Financial Group, Inc. The state of incorporation of each subsidiary is included in parentheses after its name.

Ambac Assurance Corporation (Wisconsin)

Ambac Assurance UK Limited (United Kingdom Insurance Company)

Ambac Capital Corporation (Delaware)

Ambac Capital Funding, Inc. (Delaware)

Ambac Credit Products, LLC (Delaware)

Ambac Investments, Inc. (Delaware)

Ambac Financial Services, LLC (Delaware)

Ambac Capital Services, LLC (Delaware)

EX-23.01

Exhibit 23.01

Consent of Independent Registered Public Accounting Firm

The Board of Directors

Ambac Financial Group, Inc.:

We consent to the incorporation by reference in the registration statement No. 333-131888 on Form S-3, and in the registration statements Nos. 333-110145 and 333-52449 on Form S-8 of Ambac Financial Group, Inc. of our reports dated February 28, 2007, with respect to the consolidated balance sheets of Ambac Financial Group, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the each of the years in the three-year period ended December 31, 2006, and all related financial statement schedules, management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, and the effectiveness of internal control over financial reporting as of December 31, 2006, which reports appear in the December 31, 2006 Form 10-K of Ambac Financial Group, Inc. Our report with respect to the consolidated financial statements refers to changes, in 2006, in Ambac Financial Group, Inc.’s methods of accounting for variable interest entities and stock-based compensation.

/s/ KPMG LLP

New York, New York

February 28, 2007

EX-24.01

Exhibit 24.01

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned director and officer of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Sean T. Leonard and Anne Gill Kelly, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of February 2007.

/s/ Robert J. Genader

Robert J. Genader

EX-24.02

Exhibit 24.02

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned director of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Sean T. Leonard and Anne Gill Kelly, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of February 2007.

/s/ Michael A. Callen

Michael A. Callen

EX-24.03

Exhibit 24.03

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned director of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Sean T. Leonard and Anne Gill Kelly, as her true and lawful attorney-in-fact and agent, with full power of substitution, for her and in her name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of February 2007.

/s/ Jill M. Considine

Jill M. Considine

EX-24.04

Exhibit 24.04

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned director of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Sean T. Leonard and Anne Gill Kelly, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of February 2007.

/s/ W. Grant Gregory

W. Grant Gregory

EX-24.05

Exhibit 24.05

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned director and officer of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Sean T. Leonard and Anne Gill Kelly, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of February 2007.

/s/ Phillip B. Lassiter

Phillip B. Lassiter

EX-24.06

Exhibit 24.06

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned officer of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Anne Gill Kelly and Kevin J. Doyle, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of February 2007.

/s/ Sean T. Leonard

Sean T. Leonard

EX-24.07

Exhibit 24.07

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned director of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Sean T. Leonard and Anne Gill Kelly, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of

/s/ Thomas C. Theobald

Thomas C. Theobald

EX-24.08

Exhibit 24.08

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned director of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Sean T. Leonard and Anne Gill Kelly, as her true and lawful attorney-in-fact and agent, with full power of substitution, for her and in her name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of February 2007.

/s/ Laura S. Unger

Laura S. Unger

EX-24.09

Exhibit 24.09

AMBAC FINANCIAL GROUP, INC.

Power of Attorney

KNOW ALL MEN BY THESE PRESENTS that the undersigned director of Ambac Financial Group, Inc., a Delaware corporation, hereby constitutes and appoints each of Sean T. Leonard and Anne Gill Kelly, as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K for the year ended December 31, 2006, to be filed with the Securities and Exchange Commission and the New York Stock Exchange, and any and all amendments thereto, and any and all instruments and documents filed as a part of or in connection with the said Form 10-K or amendments thereto, and does hereby grant unto each said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that each said attorney-in-fact and agent shall do or cause to be done by virtue hereof.

IN WITNESS WHEREOF, the undersigned has subscribed these presents as of this 28th day of February 2007.

/s/ Henry D. G. Wallace

Henry D. G. Wallace

EX-31.1

EXHIBIT 31.1

Ambac Financial Group, Inc.

Certifications

I, Robert J. Genader, certify that:

1. I have reviewed this Annual Report on Form 10-K of Ambac Financial Group, Inc;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - -15(e) and 15d – 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

By:	/s/ Robert J. Genader
	Robert J. Genader
	Chairman, President and Chief Executive Officer

Date: March 1, 2007

EX-31.2

EXHIBIT 31.2

Ambac Financial Group, Inc.

Certifications

I, Sean T. Leonard, certify that:

1. I have reviewed this Annual Report on Form 10-K of Ambac Financial Group, Inc;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - -15(e) and 15d – 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

By:	/s/ Sean T. Leonard
	Sean T. Leonard
	Senior Vice President and Chief Financial Officer

Date: March 1, 2007

EX-32.1

EXHIBIT 32.1

Certification of CEO Pursuant to

18 U.S.C. Section 1350,

as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report on Form 10-K of Ambac Financial Group, Inc. (the "Company") for the period ended December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Robert J. Genader, as Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Robert J. Genader

Name: Robert J. Genader

Title: Chairman, President and Chief Executive Officer

Date: March 1, 2007

EX-32.2

EXHIBIT 32.2

Certification of CFO Pursuant to

18 U.S.C. Section 1350,

as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Annual Report on Form 10-K of Ambac Financial Group, Inc. (the "Company") for the period ended December 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), Sean T. Leonard, as Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Sean T. Leonard

Name: Sean T. Leonard

Title: Senior Vice President and Chief Financial Officer

Date: March 1, 2007

EX-99.01

EXHIBIT 99.01

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

(a wholly-owned subsidiary of Ambac Financial Group, Inc.)

Consolidated Financial Statements

December 31, 2006 and 2005

Report of Independent Registered Public Accounting Firm

The Board of Directors

Ambac Assurance Corporation:

We have audited the accompanying consolidated balance sheets of Ambac Assurance Corporation and subsidiaries (a wholly owned subsidiary of Ambac Financial Group, Inc.) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholder’s equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of Ambac Assurance Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Ambac Assurance Corporation and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2 to the consolidated financial statements, in 2006 Ambac Assurance Corporation changed its methods of accounting for variable interest entities and stock-based compensation.

/s/ KPMG LLP

New York, New York

February 28, 2007

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2006 and 2005

(Dollars in Thousands Except Share Data)

	2006		2005
ASSETS
Investments:
Fixed income securities, at fair value (amortized cost of $9,669,972 in 2006 and $8,551,247 in 2005)	$	9,877,920	$	8,763,832
Short-term investments, at cost (approximates fair value)		232,179		406,530
Other, (cost of $12,845 in 2006 and $13,025 in 2005)		13,397		13,308
Total investments		10,123,496		9,183,670
Cash		23,595		20,469
Securities purchased under agreements to resell		95,000		97,000
Receivable for securities sold		2,382		1,269
Investment income due and accrued		131,538		113,323
Reinsurance recoverable on paid and unpaid losses		3,921		3,730
Prepaid reinsurance		315,498		303,383
Deferred acquisition costs		252,115		201,518
Derivative assets		1,018,886		980,367
Loans		11,291		22,246
Other assets		83,841		140,751
Total assets	$	12,061,563	$	11,067,726
LIABILITIES AND STOCKHOLDER’S EQUITY
Liabilities:
Unearned premiums	$	3,048,039	$	2,952,696
Losses and loss expense reserve		220,074		304,139
Ceded reinsurance balances payable		20,080		23,746
Obligations under payment agreements		248,415		248,760
Deferred income taxes		208,053		206,727
Current income taxes		61,342		31,468
Payable for securities purchased		95,973		11,641
Derivative liabilities		920,399		879,818
Other liabilities		246,882		227,121
Total liabilities		5,069,257		4,886,116
Stockholder’s equity:
Preferred stock, par value $1,000 per share; authorized shares — 285,000; issued and outstanding shares — none		—		—
Common stock, par value $2.50 per share; authorized shares — 40,000,000; issued and outstanding shares — 32,800,000 at December 31, 2006 and December 31, 2005		82,000		82,000
Additional paid-in capital		1,508,828		1,453,060
Accumulated other comprehensive income		141,927		136,897
Retained earnings		5,259,551		4,509,653
Total stockholder’s equity		6,992,306		6,181,610
Total liabilities and stockholder’s equity	$	12,061,563	$	11,067,726

See accompanying Notes to Consolidated Financial Statements.

1

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations

(Dollars in Thousands)

	Years Ended December 31,
	2006			2005			2004
Revenues:
Financial Guarantee:
Gross premiums written	$	1,008,361		$	1,100,465		$	1,050,739
Ceded premiums written		(103,446	)		(99,673	)		(70,946	)
Net premiums written	$	904,915		$	1,000,792		$	979,793
Net premiums earned	$	824,579		$	820,967		$	723,436
Other credit enhancement fees		56,450			49,129			47,326
Net premiums earned and other credit enhancement fees		881,029			870,096			770,762
Net investment income		423,868			378,096			355,262
Net realized investment gains		7,085			6,307			30,004
Net mark-to-market gains on credit derivative contracts		9,068			13,618			17,734
Other income		34,962			5,453			6,756
Financial Services:
Interest income		13,124			12,043			12,059
Derivative products		20,592			18,157			35,568
Total revenues		1,389,728			1,303,770			1,228,145
Expenses:
Financial Guarantee:
Losses and loss expenses		20,004			149,856			69,600
Underwriting and operating expenses		133,790			117,701			106,714
Financial Services:
Interest from payment agreements		9,185			6,785			3,752
Derivative products		5,154			6,372			6,889
Total expenses		168,133			280,714			186,955
Income before income taxes		1,221,595			1,023,056			1,041,190
Income tax expense (benefit):
Current taxes		336,380			270,386			245,423
Deferred taxes		(683	)		(5,447	)		28,422
Total income taxes		335,697			264,939			273,845
Net income	$	885,898		$	758,117		$	767,345

See accompanying Notes to Consolidated Financial Statements.

2

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Stockholder’s Equity

(Dollars In Thousands)

	Years Ended December 31,
	2006						2005						2004
Retained Earnings:
Balance at January 1	$	4,509,653					$	4,104,936					$	3,440,591
Net income		885,898		$	885,898			758,117		$	758,117			767,345		$	767,345
Dividends declared – common stock		(136,000	)					(353,400	)					(103,000	)
Balance at December 31	$	5,259,551					$	4,509,653					$	4,104,936
Accumulated Other Comprehensive Income:
Balance at January 1	$	136,897					$	237,632					$	243,053
Unrealized losses on securities, $4,258, $142,141, and $14,005, pre-tax, in 2006, 2005 and 2004, respectively (1)					(2,768	)					(92,391	)					(9,098	)
Foreign currency gain (loss)					7,798						(8,344	)					3,677
Other comprehensive income (loss)		5,030			5,030			(100,735	)		(100,735	)		(5,421	)		(5,421	)
Total comprehensive income				$	890,928					$	657,382					$	761,924
Balance at December 31	$	141,927					$	136,897					$	237,632
Common Stock:
Balance at January 1 and December 31	$	82,000					$	82,000					$	82,000
Additional Paid-in Capital:
Balance at January 1	$	1,453,060					$	1,232,701					$	1,144,096
Capital contribution		—						199,110						62,606
Capital issuance costs		(3,498	)					(5,035	)					(4,698	)
Stock based compensation		46,317						15,925						14,339
Excess tax benefit related to share-based compensation		12,949						10,359						16,358
Balance at December 31	$	1,508,828					$	1,453,060					$	1,232,701
Total Stockholder’s Equity at December 31	$	6,992,306					$	6,181,610					$	5,657,269

(1)    Disclosure of reclassification amount:		2006			2005			2004
Unrealized holding gains (losses) arising during period	$	688		$	(89,038	)	$	9,863
Less: reclassification adjustment for net gains included in net income		3,456			3,353			18,961
Net unrealized losses on securities	$	(2,768	)	$	(92,391	)	$	(9,098	)

See accompanying Notes to Consolidated Financial Statements.

3

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Dollars in Thousands)

	Years Ended December 31,
	2006			2005			2004
Cash flows from operating activities:
Net income	$	885,898		$	758,117		$	767,345
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,813			4,167			2,744
Amortization of bond premium and discount		24,463			14,180			9,903
Share-based compensation		35,206			15,925			14,339
Current income taxes		29,874			15,268			3,944
Deferred income taxes		(597	)		(5,592	)		28,496
Deferred acquisition costs		(31,212	)		(17,429	)		(9,470	)
Unearned premiums, net		83,228			177,605			257,685
Losses and loss expenses		(84,256	)		63,119			50,906
Ceded reinsurance balances payable		(3,666	)		5,498			2,865
Net realized investment gains		(7,085	)		(6,307	)		(30,004	)
Other, net		45,450			2,490			(87,303	)
Net cash provided by operating activities		980,116			1,027,041			1,011,450
Cash flows from investing activities:
Proceeds from sales of bonds		575,341			1,490,139			1,534,720
Proceeds from matured bonds		378,381			353,727			355,264
Purchases of bonds		(1,994,377	)		(2,482,761	)		(2,596,124	)
Loans		10,955			(10,188	)		(3,571	)
Change in short-term investments		174,351			78,330			(270,516	)
Securities purchased under agreements to resell		2,000			(45,000	)		86,795
Other, net		1,057			(67,584	)		(5,628	)
Net cash used in investing activities		(852,292	)		(683,337	)		(899,060	)
Cash flows from financing activities:
Dividends paid		(136,000	)		(353,400	)		(103,000	)
Capital contributions		—			1,735			62,606
Capital issuance costs		(3,498	)		(5,035	)		(4,698	)
Payment agreements		(345	)		(380	)		(670	)
Net cash collateral received		2,196			17,175			16,062
Short-term financing to affiliates		—			—			(84,280	)
Excess tax benefit related to share-based compensation		12,949			—			—
Net cash used in financing activities		(124,698	)		(339,905	)		(113,980	)
Net cash flow		3,126			3,799			(1,590	)
Cash at January 1		20,469			16,670			18,260
Cash at December 31	$	23,595		$	20,469		$	16,670
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes	$	263,283		$	232,927		$	201,333
Interest on affiliate financings	$	—		$	—		$	151
Interest on payment agreements	$	8,674		$	5,889		$	3,082
Cash received during the year for:
Income taxes	$	—		$	896		$	—

Supplemental disclosure of non-cash financing activities:

Ambac Assurance received a capital contribution from its parent company in December 2005 in the form of fixed income and short-term securities amounting to $197,375.

See accompanying Notes to Consolidated Financial Statements.

4

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

1 BACKGROUND

Ambac Assurance Corporation is a leading provider of financial guarantees to clients in both the public and private sectors around the world. Ambac Assurance provides financial guarantees on public finance and structured finance obligations. Ambac Assurance has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch, Inc. Ambac Assurance is a wholly owned subsidiary of Ambac Financial Group, Inc. (“Ambac Financial Group”), a holding company whose subsidiaries provide financial guarantees and financial services to clients in both the public and private sectors around the world.

2 SIGNIFICANT ACCOUNTING POLICIES

The accompanying consolidated financial statements of Ambac Assurance and subsidiaries have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosures of contingent assets and liabilities. Actual results could differ from those estimates. The significant accounting policies of Ambac Assurance are described below:

CONSOLIDATION:

The consolidated financial statements include the accounts of Ambac Assurance and all other entities in which Ambac Assurance has a controlling financial interest. All significant intercompany balances have been eliminated. The usual condition for a controlling financial interest is ownership of a majority of the voting interests of an entity. However, a controlling financial interest may also exist in entities, such as special purpose entities (“SPEs”), through arrangements that do not involve controlling voting interests.

There are two different accounting frameworks applicable to SPEs; the qualifying SPE (“QSPE”) framework under Statement of Financial Accounting Standards (“SFAS”) No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125)”; and the variable interest entity (“VIE”) framework under Financial Interpretation Number (“FIN”) 46(R) “Consolidation of Variable Interest Entities”. The applicable framework depends on the nature of the entity and Ambac Assurance’s relation to that entity.

The QSPE framework is applicable when an entity transfers (sells) financial assets to a SPE meeting certain criteria as defined in SFAS 140. These criteria are designed to ensure that the activities of the entity are essentially predetermined in their entirety at the inception of the vehicle; decision making is limited and restricted to certain events, and that the transferor of the financial assets cannot exercise control over the entity and the assets therein. Entities meeting these criteria are not consolidated by the transferor or other counterparties, as long as the entity does not have the unilateral ability to liquidate or to cause it to no longer meet the QSPE criteria. Ambac follows the QSPE model for its medium-term note issuance program and does not consolidate those SPEs.

When the SPE does not meet the QSPE criteria, consolidation is assessed pursuant to FIN 46(R). Under FIN 46(R), a VIE is defined as an entity that is not assessed for consolidation by determining

5

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

which party maintains a controlling financial interest. As such, a VIE (i) lacks enough equity investment at risk to permit the entity to finance its activities without additional subordinated financial support from other parties, (ii) equity owners lack the right to make significant decisions affecting the entity’s operations, and (iii) equity owners do not have an obligation to absorb or the right to receive the entity’s losses or returns.

FIN 46(R) requires a variable interest holder (e.g., an investor in the entity or a financial guarantor) to consolidate that VIE if that holder will absorb a majority of the expected losses of the VIE, receive a majority of the residual returns of the VIE, or both. Ambac determines whether it is the primary beneficiary of a VIE by first performing a qualitative analysis of the VIE that includes, among other factors, its capital structure, contractual terms, which variable interests create or absorb variability, related party relationships and the design of the VIE. When qualitative analysis is not conclusive, Ambac Assurance performs a quantitative analysis.

In April of 2006, the FASB issued FASB Staff Position (FSP) FIN 46(R)-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)”. FSP FIN 46(R)-6 requires that the analysis of VIEs, in accordance with FIN 46(R), be based on the design of the entity (referred to as a “by design” approach). This evaluation requires an analysis of the nature of risks in a VIE, determining the purpose for which the entity was created, and determining the variability the VIE was designed to create and pass along to its interest holders. Accordingly, Ambac Assurance elected to consider, in its consolidation evaluation, the facts and circumstances surrounding the design of transactions, including participation of all interested parties. This evaluation considers the nature of all subordinate variable interest holders within the design of the transaction. FSP FIN 46(R)-6 permitted retrospective application to the date of the initial application of FIN 46(R). Under this provision, Ambac Assurance elected to retrospectively apply the new guidance as of December 31, 2006. As a result of retrospectively applying FSP FIN 46(R)-6, Ambac Assurance de-consolidated three transactions where it previously had concluded it was the primary beneficiary. Previous reporting periods have also been adjusted to reflect the effects of this de-consolidation. All previously consolidated VIEs are bankruptcy remote special purpose financing entities created by the issuer of debt securities to facilitate the sale of notes guaranteed by Ambac Assurance. Ambac Assurance is not primarily liable for the debt obligations of these entities. Ambac Assurance would only be required to make payments on these debt obligations in the event that the issuer defaults on any principal or interest due. Additionally, Ambac Assurance’s creditors do not have rights with regard to the assets of these VIEs.

INVESTMENTS:

Ambac Assurance’s investment portfolio is accounted for on a trade-date basis and consists primarily of investments in fixed income securities that are considered available-for-sale as defined by SFAS 115 “Accounting for Certain Investments in Debt and Equity Securities”. Available-for-sale securities are reported in the financial statements at fair value with unrealized gains and losses, net of deferred taxes, reflected in Accumulated Other Comprehensive Income in Stockholder’s Equity and are computed using amortized cost as the basis. Ambac Assurance purchases certain securities which are considered trading securities as defined by SFAS 115. These securities are reported in the financial statements at fair value in “Other Investments”. Net gains and losses from sales and changes in fair

6

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

value are reported in “Other revenue” in the consolidated Statements of Operations. Fair value is based primarily on quotes obtained from independent market sources. When quotes are not available, valuation models are used to estimate fair value. These models include estimates, made by management, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. For purposes of computing amortized cost, premiums and discounts are accounted for using the interest method. For bonds purchased at a price below par value, discounts are accreted over the remaining term of the securities even if they are callable. For bonds purchased at a price above par value that have call features, premiums are amortized to the call date that produces the lowest yield, typically the first call date. For premium bonds that do not have call features, such premiums are amortized over the remaining terms of the securities. Premiums and discounts on mortgage-backed and asset-backed securities are adjusted for the effects of actual and anticipated prepayments on a retrospective basis. Short-term investments are carried at cost, which approximates fair value. Realized gains and losses on the sale of investments are determined on the basis of specific identification.

Ambac Assurance has a formal impairment review process for all securities in its investment portfolio. Ambac Assurance conducts a review each quarter to identify and evaluate investments that have indications of possible impairment. An investment in a debt security is impaired if its fair value falls below its amortized cost and the decline is considered “other than temporary.” If we believe a decline in the value of a particular investment is temporary, we record the decline as an unrealized loss; net of tax in Accumulated Other Comprehensive Income in Stockholders’ Equity on our Consolidated Balance Sheets. If we believe the decline is “other than temporary”, we write-down the carrying value of the investment and record a loss on our Consolidated Statements of Operations. Factors considered when assessing impairment include: (i) debt securities whose fair values have declined by 20% or more below amortized cost; (ii) debt securities whose market values have declined by 5% or more but less than 20% below amortized cost for a continuous period of at least six months; (iii) recent downgrades by rating agencies; (iv) the financial condition of the issuer; (v) whether scheduled interest payments are past due; and (vi) whether Ambac Assurance has the ability and intent to hold the security for a sufficient period of time to allow for anticipated recoveries in fair value. Ambac Assurance’s assessment of a decline in value includes management’s current judgment regarding facts and circumstances specific to a security and the factors noted above. If that judgment changes in the future, Ambac Assurance may ultimately record a loss after having originally concluded that the decline in value was temporary.

SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL:

Securities purchased under agreements to resell represent short-term collateralized financing transactions, and are recorded at their contracted amounts, plus accrued interest. Ambac Assurance takes possession of the collateral underlying those agreements and monitors its market value on a daily basis and obtains additional collateral as appropriate. At December 31, 2006 and 2005, collateral underlying securities purchased under agreements to resell had an average credit rating of triple-A and a weighted average maturity of less than 30 days.

7

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

DEFERRED ACQUISITION COSTS:

Financial guarantee insurance costs that vary with and are primarily related to the production of business, have been deferred. Ambac Assurance periodically conducts a study to determine the amount of operating costs that vary with and primarily relate to the acquisition of business and qualify for deferral. These costs include compensation of employees, marketing, and certain other underwriting expenses, net of reinsurance ceding commissions. Premium taxes and reinsurance commissions are deferred in their entirety. Costs associated with credit derivatives are expensed as incurred. The deferred acquisition costs are being amortized over the periods in which the related premiums are earned. Amortization of deferred acquisition costs is adjusted to reflect acceleration of premium revenue due to refundings or calls and to reflect changes in the estimated lives of certain insured obligations amounted to $38,221, $30,582 and $25,260 for 2006, 2005 and 2004, respectively.

LOANS:

Loans are reported at their outstanding principal balances. Interest income is accrued on the unpaid principal balance. A loan is considered impaired when, based on current events and the financial condition of the issuer, it is probable that Ambac Assurance will be unable to collect all principal and interest due according to the contractual terms of the loan agreement.

LOSSES AND LOSS EXPENSES:

Ambac Assurance’s financial guarantee insurance is a promise to pay scheduled interest and principal if the issuer of the insured obligation fails to meet its obligation. The loss reserve policy for financial guarantee insurance discussed in this footnote relates only to Ambac Assurance’s non-derivative insurance business. The policy for derivative contracts is discussed in the section entitled “Derivative Contracts Classified as Held for Trading Purposes”. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. In most instances, claim payments are forecasted in advance of issuer default as a result of active surveillance of the insured book of business and observation of deterioration in the obligor’s credit standing. Based upon Ambac Assurance’s experience, claim payments become probable and estimable once the issuer’s credit profile has migrated to certain impaired credit levels. The trustee, on behalf of the insured party, named beneficiary, or custodian has the right to make a claim under Ambac Assurance’s financial guarantee insurance policy at the first scheduled debt service date of the defaulted obligation. As discussed in the last paragraph of this section, the accounting for credit loss reserves is subject to change.

The liability for losses and loss expenses consists of active credit and case basis credit reserves. Active credit reserves are for probable and estimable losses due to credit deterioration on insured credits that have not yet defaulted or been reported and are reflected on an undiscounted basis as of the reporting date. The establishment of reserves for exposures that have not yet defaulted is a common practice in the financial guarantee industry. However, Ambac Assurance is aware that there are differences in the specific methodologies applied by other financial guarantors in establishing such

8

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

reserves. Ambac Assurance’s active credit reserve is based on management’s on-going review of the non-derivative financial guarantee credit portfolio. Active surveillance of the insured portfolio enables Ambac Assurance’s Surveillance Group to track credit migration of insured obligations from period to period and prepare an adversely classified credit listing. The active credit reserve is established only for adversely classified credits. The criteria for an exposure to be included on the adversely classified credit listing includes the deterioration in an issuer’s financial condition, underperformance of the underlying collateral (for collateral dependent transactions such as mortgage-backed securitizations), problems with the servicer of the underlying collateral and other adverse economic events or trends. The servicer of the underlying collateral of an insured securitization transaction is a consideration in assessing credit quality because the servicer’s performance can directly impact the performance of the related issue. For example, a servicer of a mortgage-backed securitization that does not remain current in its collection efforts could cause an increase in the delinquency and potential default of the underlying obligation.

The active credit reserve is established through a process that begins with estimates of probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac Assurance’s internal system of credit ratings, which are analogous to the risk ratings of the major rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) the net par outstanding on the adversely classified credit. The loss severities and default information are based on rating agency information and are specific to each bond type and are established and approved by Ambac Assurance’s Portfolio Risk Management Committee. The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac Assurance. For certain adversely classified credit exposures, Ambac Assurance’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities applied to adversely classified credits can include various actions by Ambac Assurance. The most common actions include obtaining detailed appraisal information on collateral, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac Assurance uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical approach discussed above. Senior management meets at least quarterly with the Surveillance Group to review the status of their work to determine the adequacy of Ambac Assurance’s loss reserves and make any necessary adjustments. Active credit reserves were $172,644 and $197,607 at December 31, 2006 and 2005, respectively. The active credit reserves at December 31, 2006 and 2005 were comprised of 55 and 88 credits with net par outstanding of $3,830,759 and $6,319,724, respectively. Included in the calculation of active credit reserves at December 31, 2006 and 2005 was the consideration of $6,859 and $17,479, respectively, of reinsurance which would be due to Ambac Assurance from reinsurers, upon default of the insured obligation.

Case basis credit reserves are for losses on insured obligations that have defaulted. We believe our definition of case basis credit reserves differs from other financial guarantee industry participants. Upon the occurrence of a payment default, the related active credit reserve is transferred to case basis credit reserve. Additional provision for losses upon further credit deterioration of a case basis exposure are initially recorded through the active credit reserve and subsequently transferred to case basis credit

9

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

reserves. Our case reserves represent the present value of anticipated loss and loss expense payments expected over the estimated period of default. Loss and loss expenses consider anticipated defaulted debt service payments, estimated expenses associated with settling the claims and estimated recoveries under collateral and subrogation rights. The estimate does not consider future installment premium receipts, as the likelihood of such receipts is remote. Ambac Assurance discounts these estimated net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio.

Case basis credit reserves were $47,430 and $106,532 at December 31, 2006 and 2005, respectively. The discount rate applied to case basis credit reserves was 4.50% and 4.75% at December 31, 2006 and 2005, respectively. The case basis credit reserves at December 31, 2006 and 2005 were comprised of 7 and 10 credits, respectively, with net par outstanding of $668,440 and $838,975, respectively. Additionally, we have reinsurance recoverables on case basis credit reserves of $4,972 and $3,468 at December 31, 2006 and 2005, respectively.

Ambac Assurance provides information on the classification of its loss reserve between active credit reserve and case basis credit reserve for the purpose of disclosing the components of the total reserve that relate to exposures that have not yet defaulted and those that have defaulted. The total reserve (active credit and case basis) was $220,074 and $304,139 at December 31, 2006 and 2005, respectively. Due to the relatively small number and large size of certain insured obligations comprising the active and case basis credit reserves, improvements or further deterioration in any one credit may significantly impact our loss provision in a given period. The provision for losses and loss expenses in the accompanying Consolidated Statements of Operations represents the expense recorded to bring the total reserve to a level determined by management to be adequate for losses inherent in the non-derivative financial guarantee insurance portfolio. Ambac Assurance’s management believes that the reserves for losses and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.

Our liabilities for credit losses are based in part on the short-duration accounting guidance in SFAS No. 60, “Accounting and Reporting by Insurance Enterprises.” The trustee (on behalf of the insured party), named beneficiary or custodian has a right to a claim payment under the financial guarantee insurance policy at the date of the first scheduled debt service payment of a defaulted security in the amount equal to the payment shortfall. We believe a loss event occurs for financial guarantee insurance products at the time the issuers’ financial condition deteriorates to an impaired credit status rather than at the time the insured party has a right to a claim payment. Because of this belief and the ambiguities discussed below in the application of SFAS No. 60 to the financial guarantee industry, Ambac Assurance does not believe that SFAS No. 60 alone provides sufficient guidance. As a result, Ambac Assurance supplements the guidance in SFAS No. 60 with the guidance in SFAS No. 5, “Accounting for Contingencies,” which calls for a loss to be accrued if it is probable that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. Ambac Assurance also relies by analogy on EITF Issue No. 85-20, “Recognition of Fees for Guaranteeing a Loan,” which states that a guarantor should perform an ongoing assessment of the probability of loss to determine if a liability (and a loss) should be recognized under SFAS No. 5.

10

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

In management’s view, the accounting guidance noted above does not comprehensively address the attributes of financial guarantee insurance contracts, primarily due to the fact that SFAS No. 60 was developed prior to the maturity of the financial guarantee industry. Financial guarantee contracts have elements of long-duration insurance contracts in that they are generally irrevocable and extend over a period of time that may be 30 years or more but are considered and reported for regulatory purposes as property and casualty insurance, normally considered short-duration contracts. The short-duration and long-duration classifications have different methods of accounting for premium revenue, deferred acquisition costs and contract liability recognition.

Ambac Assurance is aware that there are certain differences regarding the measurement of liabilities for credit losses among participants in the financial guarantee industry. Difficulties applying the existing insurance accounting literature such as the classification of the insurance contracts as either short-duration or long-duration to the attributes of financial guarantee insurance, different measurement models and assumptions utilized, regulatory guidance provided to certain entities, and the existence of accounting literature providing guidance with respect to liability recognition for loan guarantees are the reasons for differences among the industry participants.

In January and February of 2005, the Securities and Exchange Commission staff discussed with the financial guarantee industry participants differences in loss reserve recognition practices among those participants. In June 2005, the Financial Accounting Standards Board (“FASB”) added a project to its agenda to consider the accounting by financial guarantee insurers for claims liability recognition, premium recognition and deferred acquisition costs. The proposed and final guidance are expected to be issued in 2007. When the FASB reaches a final resolution on this issue, Ambac Assurance and the rest of the financial guarantee industry may be required to change some aspects of their loss reserving policies and premium and expense recognition. Until a final standard is released, Ambac Assurance cannot predict how the FASB will resolve this issue and the resulting impact on our financial statements. Until the issue is resolved, Ambac Assurance intends to continue to apply its existing policy with respect to the establishment of both case and active credit reserves.

OBLIGATIONS UNDER PAYMENT AGREEMENTS:

Ambac Assurance has obligations under payment agreements that represent funds received from various investors and are used to purchase fixed income municipal investment securities. Obligations under payment agreements are recorded as liabilities on the Consolidated Balance Sheets at amortized cost. Interest expense is computed based upon daily outstanding liability balances, at rates and periods specified in the agreements. Net interest income related to proceeds received under these payment agreements is included as a component of Financial Services revenue. Under the terms of these payment agreements the investors have the contractual right to redeem their investment at any time, within five business days notice to Ambac Assurance.

NET PREMIUMS EARNED:

Gross premiums are received either upfront (typical of public finance obligations), or in installments (typical of structured finance obligations). Up-front insurance premiums written are received for an entire bond issue, which may contain several maturities; and are recorded as unearned

11

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

premiums. The premium is allocated to each bond maturity proportionately based on total principal amount guaranteed and is recognized as premiums on a straight-line basis over the term of each maturity. Installment insurance premiums written are recognized as premiums earned over each installment period, typically one year or less, on a straight-line basis. Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. When an issue insured by Ambac Assurance has been refunded or called, the remaining unrecognized premium (net of refunding credits, if any) is recognized at that time.

Premiums ceded to reinsurers reduce the amount of net premiums earned by Ambac Assurance from its financial guarantee insurance policies. For both up-front and installment premiums, ceded premiums written are primarily recognized in earnings in proportion to and at the same time the related gross premium revenue is recognized. Prepaid reinsurance represents the portion of premiums ceded to reinsurers relating to unearned premiums ceded under reinsurance contracts.

DERIVATIVE PRODUCT REVENUE:

Ambac Assurance provides interest rate and currency swaps principally to states, municipalities and their authorities and asset-backed issuers in connection with their financings. Ambac Assurance also enters into total return swaps, which contain contractual provisions similar to credit default swaps, with various financial institutions. All interest rate, currency and total return swap revenues are accounted for as “Derivative Contracts Classified as Held for Trading Purposes,” which is discussed in the Derivative Contracts section below.

DERIVATIVE CONTRACTS CLASSIFIED AS HELD FOR TRADING PURPOSES:

SFAS 133 “Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS 138 and SFAS 149”, establishes accounting and reporting standards for derivative instruments. All derivatives, whether designed for hedging relationships or not, are required to be recorded on the Consolidated Balance Sheets at fair value. When available, quotes are obtained from independent market sources. However, when quotes are not available, Ambac Assurance uses internally developed valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. The valuation results from these models could differ materially from amounts that would actually be realized in the market. In accordance with the Emerging Issues Task Force (EITF) Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (EITF 02-3), recognition of a trading profit at inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating observable market data. Ambac Assurance defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. The deferral is recognized in income when the market data becomes observable or over the life of the transaction. The fair value

12

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

includes an adjustment for counterparty credit risk and other adjustments, as appropriate, to reflect liquidity and ongoing servicing costs.

All derivative contracts are recorded on the Consolidated Balance Sheets on a gross basis; assets and liabilities are netted by customer only when a legal right of set-off exists. Gross asset and gross liability balances for all derivatives are recorded as Derivative Assets or Derivative Liabilities on the Consolidated Balance Sheets.

Financial Guarantee Credit Derivatives:

Ambac Assurance, through its subsidiary Ambac Credit Products, enters into credit derivative transactions with various financial institutions. Management views these credit derivative transactions as an extension of its financial guarantee business, under which Ambac Assurance intends to hold its position for the entire term of the related contract. These credit derivative contracts are accounted for at fair value since they do not qualify for the financial guarantee scope exception under SFAS 133, as amended. Changes in fair value are recorded in the Consolidated Statement of Operations. The fee component is reflected in “Other Credit Enhancement Fees”, and the mark-to-market gains or losses associated with fair value changes are reflected in “Net Mark-to-Market Gains on Credit Derivative Contracts”.

Financial Services Derivative Products:

Ambac Assurance, through its subsidiary Ambac Financial Services, provides interest rate and currency swaps to states, municipalities and their authorities, asset-backed issuers and other entities in connection with their financings. Ambac Capital Services enters into total return swaps with professional counterparties. Total return swaps are primarily referenced to fixed income obligations, which meet Ambac Assurance’s credit underwriting criteria. These contracts are accounted on trade date at fair value. Changes in fair value are recorded as a component of “Derivative Product” revenue in the accompanying Consolidated Statements of Operations.

DEPRECIATION AND AMORTIZATION:

Depreciation of furniture and fixtures and electronic data processing equipment is provided over the estimated useful lives of the respective assets, ranging from three to five years, using the straight-line method. Amortization of leasehold improvements is charged over the lesser of ten years or the remaining term of the operating leases using the straight-line method.

PENSION, POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS:

Ambac Financial Group provides various pension, postretirement and postemployment benefits, including health and life benefits that cover substantially all employees who meet certain age and service requirements. Amounts related to the defined benefit pension plan and postretirement health benefits are charged to expenses based on actuarial determinations. These expenses are allocated for each of Ambac Financial Group’s subsidiaries based on a percentage of payroll. During 2006, the Compensation Committee of the Board of Directors of Ambac Financial Group approved an amendment to the Pension Plan that terminated the Plan effective December 31, 2006. Effective August 1, 2005, new employees were not eligible for postretirement benefits.

13

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

STOCK COMPENSATION PLANS:

The Ambac Financial Group 1997 Equity Plan (the “Equity Plan”) provides for the granting of stock options, stock appreciation rights, restricted stock units (“RSUs”), performance units and other awards that are valued or determined by reference to the Common Stock. Ambac Financial Group generally expects to deliver shares to employees under this plan from its treasury stock. Ambac Financial Group also maintains the Ambac 1997 Non-employee Directors Equity Plan, which provides awards of restricted stock units to non-employee members of Ambac Financial Group’s Board of Directors. The fair value of the stock option awards are attributed over the shorter of the derived vesting periods based on the output of the valuation model or the service period. RSU awards are attributed over the shorter of the vesting or service period.

Since January 1, 2003, Ambac Financial Group accounted for stock-based employee compensation in accordance with the fair-value method prescribed by SFAS No. 123 as amended by SFAS Statement 148, “Accounting for Stock-Based Compensation – Transition and Disclosure,” (“SFAS 148”), prospectively to all employee awards granted after January 1, 2003.

Effective January 1, 2006, Ambac Financial Group adopted SFAS No. 123-R, “Share-Based Payment”, (“SFAS No. 123-R”) by using the modified prospective approach to all employee awards granted after the effective date. Beginning with the effective date, SFAS 123-R requires entities to recognize compensation cost for all equity-classified awards after the effective date and for all awards granted to employees prior to the effective date of SFAS No. 123-R that remain unvested on the effective date using the fair-value measurement method and estimating forfeitures for all unvested awards. Key differences between SFAS No. 123-R and SFAS No. 123 are:

· SFAS No. 123-R provided clarification that the Black-Scholes-Merton model is not appropriate for stock options containing a market condition that affects vesting and the ability to exercise. Stock options granted prior to the adoption of SFAS 123-R were valued using the Black-Scholes-Merton model. Stock options granted in 2006 will vest on the earlier of Ambac Financial Group’s Common Stock achieving certain price targets (market conditions) or meeting the requisite service requirement, therefore, the fair value of each market condition award was estimated on the date of grant using a Monte Carlo simulation model.

· SFAS 123-R requires compensation expense be recognized for partially vested awards outstanding at its effective date. The expense related to the unvested award will be recognized for the remainder of the requisite service period. Certain market condition stock option grants previously accounted for under APB No. 25 were partially vested as of January 1, 2006. For 2006 approximately $770 of compensation expense is recorded for these partially vested awards.

· SFAS No.123-R requires the grant date expensing of share-based awards granted to retirement-eligible employees. This is consistent with how Ambac Financial Group recognized such awards under SFAS 123. Based on interpretative guidance under SFAS No. 123-R, Ambac Financial Group must elect to continue to expense awards to

14

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

retirement eligible employees on the grant date or accrue in the year prior to the grant date. Ambac Financial Group elected to accrue the estimated cost of future stock-compensation grants to retirement-eligible employees over the service period. Therefore, Ambac will accrue the estimated cost of such awards over the course of the fiscal year preceding the grant date ($8,286 is recognized in 2006).

Stock options and restricted stock unit expenses are allocated to each of Ambac Financial Group’s subsidiaries based on the actual number of stock options and restricted stock units granted to each subsidiary’s employees.

FOREIGN CURRENCY:

Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with SFAS Statement 52, “Foreign Currency Translation” (“SFAS 52”). Under SFAS 52, functional currency assets and liabilities are translated into U.S. dollars using exchange rates in effect at the balance sheet dates and the related translation adjustments are included as a component of “Accumulated Other Comprehensive Income”, net of any related taxes in Stockholder’s Equity. Functional currencies are generally the currencies of the local operating environment. Income statement accounts expressed in functional currencies are translated using average exchange rates.

Foreign currency transaction gains and losses of Ambac Assurance’s U.S. dollar functional currency subsidiaries, arising primarily from sales of long-term foreign denominated investment securities, short-term investment securities and cash denominated in foreign currencies, are reflected in net income. The Consolidated Statements of Operations include pre-tax gains from such foreign exchange items of $8,722, $7,089 and $6,596 for 2006, 2005 and 2004, respectively.

INCOME TAXES:

Pursuant to a tax sharing agreement, Ambac Assurance is included in Ambac Financial Group, Inc.’s consolidated Federal income tax return. The tax sharing agreement provides for the determination of tax expense or benefit based on the contribution of Ambac Assurance to Ambac Financial Group’s consolidated Federal income tax liability, computed substantially as if Ambac Assurance filed a separate Federal income tax return. The tax liability due is settled quarterly, with a final settlement taking place after the filing of the consolidated Federal income tax return. Ambac Assurance files its own state income tax returns.

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.

15

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

FUTURE APPLICATION OF ACCOUNTING STANDARDS:

On February 16, 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS 155 amends SFAS 133 and SFAS 140, and addresses issues raised in SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.” The primary objectives of SFAS 155 are: (i) with respect to SFAS 133, to address the accounting for beneficial interests in securitized financial assets and (ii) with respect to SFAS 140, eliminate a restriction on the passive derivative instruments that a QSPE may hold. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Ambac Assurance will adopt SFAS 155 on January 1, 2007 and is currently evaluating the implications of SFAS 155 on its financial statements.

In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48 “Accounting for Uncertainty in Income Taxes”, an interpretation of SFAS 109. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109 “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is applicable for fiscal years beginning after December 15, 2006. Ambac Assurance will adopt FIN 48 on January 1, 2007 and is currently evaluating the implication of this Interpretation on its financial statements.

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year. Ambac Assurance is currently evaluating the implications of SFAS 157 on its financial statements. In addition, SFAS 157 supersedes certain accounting guidance, which prohibited the recognition of day one gains on certain derivative transactions. With the adoption of SFAS 157, any remaining reserves for day one gains will be reflected as a cumulative effect adjustment to the opening balance of retained earnings.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS 159 permits reporting entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments and not to portions of instruments. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years that begin after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007 provided the entity also elects to apply the provisions of SFAS 157, which are described in the previous paragraph. This early adoption election must be made

16

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

within 120 days of the beginning of the fiscal year of adoption provided the entity has not yet issued interim period financial statements. Ambac Assurance is currently evaluating the implications of SFAS 159 on its financial statements.

The FASB is currently working on a number of amendments to the existing accounting standards governing financial guarantees and asset transfers. Upon completion of these standards, Ambac Assurance will need to reevaluate its accounting and disclosures.

RECLASSIFICATIONS:

Certain reclassifications have been made to prior years’ amounts to conform to the current year’s presentation.

3 CORRECTION OF PREMIUM REVENUE RECOGNITION

For contracts entered into prior to 2004, where installment premiums are billed and collected in arrears, Ambac Assurance recognized revenues for these installment paying financial guarantees when received rather than on an accrual basis. Ambac Assurance has determined that $10,555 of premium income, net of deferred acquisition costs and tax, should have been recorded as premium revenue in periods prior to 2004. This amount was not material to any of the noted periods and therefore is reported as an adjustment to beginning 2004 retained earnings. The impact of the adjustments decreased total assets by $677 and total liabilities by $11,232 at December 31, 2005. There was no effect on the previously reported liquidity or net operating cash flows for either 2004 or 2005. In 2006, the Company is recording financial guarantee premiums on an accrual basis of accounting.

17

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

4 INVESTMENTS

The amortized cost and fair value of investments at December 31, 2006 and 2005 were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
2006: Fixed income securities:
Municipal obligations	$	7,713,739	$	233,275	$	20,658	$	7,926,356
Corporate obligations		195,079		13,160		—		208,239
Foreign obligations		269,834		8,413		1,417		276,830
U.S. government obligations		163,077		22		2,948		160,151
U.S. agency obligations		405,841		90		5,536		400,395
Mortgage and asset-backed securities		922,402		2,115		18,568		905,949
Short-term		232,179		—		—		232,179
Other		12,845		584		32		13,397
	$	9,914,996	$	257,659	$	49,159	$	10,123,496
2005: Fixed income securities:
Municipal obligations	$	6,477,896	$	236,779	$	21,513	$	6,693,162
Corporate obligations		76,848		13,276		—		90,124
Foreign obligations		178,348		6,186		2,790		181,744
U.S. government obligations		170,335		1,022		1,006		170,351
U.S. agency obligations		559,648		886		4,931		555,603
Mortgage and asset-backed securities		1,088,172		2,644		17,968		1,072,848
Short-term		406,530		—		—		406,530
Other		13,025		434		151		13,308
	$	8,970,802	$	261,227	$	48,359	$	9,183,670

Foreign obligations consist primarily of government issued securities, which are denominated in either Pounds sterling, Euros or Australian dollars.

The amortized cost and estimated fair value of investments at December 31, 2006, by contractual maturity, were as follows:

	Amortized Cost		Estimated Fair Value
Due in one year or less	$	435,686	$	439,764
Due after one year through five years		1,465,464		1,474,388
Due after five years through ten years		2,522,641		2,545,972
Due after ten years		4,568,803		4,757,423
		8,992,594		9,217,547
Mortgage and asset-backed securities		922,402		905,949
	$	9,914,996	$	10,123,496

18

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

The following table shows the gross unrealized losses and fair values of Ambac Assurance’s investments, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2006 and 2005:

	Less Than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
2006: Fixed income securities
Municipal obligations	$	728,470	$	3,981	$	1,129,258	$	16,677	$	1,857,728	$	20,658
Foreign obligations		105,264		1,258		13,090		159		118,354		1,417
U.S. government obligations		28,132		174		111,720		2,774		139,852		2,948
U.S. agency obligations		288,335		3,277		108,404		2,259		396,739		5,536
Mortgage and asset-backed securities		158,570		1,779		646,370		16,789		804,940		18,568
Other		516		32		—		—		516		32
Total temporarily impaired securities	$	1,309,287	$	10,501	$	2,008,842	$	38,658	$	3,318,129	$	49,159
2005: Fixed income securities
Municipal obligations	$	1,335,894	$	13,839	$	278,752	$	7,674	$	1,614,646	$	21,513
Foreign obligations		52,208		1,194		14,228		1,596		66,436		2,790
U.S. government obligations		127,352		881		17,371		125		144,723		1,006
U.S. agency obligations		313,102		4,753		5,525		178		318,627		4,931
Mortgage and asset-backed securities		556,774		8,415		327,752		9,553		884,526		17,968
Other		199		3		538		148		737		151
Total temporarily impaired securities	$	2,385,529	$	29,085	$	644,166	$	19,274	$	3,029,695	$	48,359

At December 31, 2006 and 2005, there were 284 and 267 investments in fixed income securities where the aggregate amortized cost exceeded fair value by $49,159 or 1% and $48,359 or 2%, respectively. Management has determined that the unrealized losses in fixed income securities at December 31, 2006 are primarily attributable to the current interest rate environment and has concluded that these unrealized losses are temporary in nature based upon (a) no principal and interest payment defaults on these securities; (b) analysis of the creditworthiness of the issuer; and (c) Ambac Assurance’s ability and current intent to hold these securities until a recovery in fair value or maturity. There were no individual securities with material unrealized losses as of December 31, 2006 and 2005. Of the $10,501 and $29,085 that have been in a gross unrealized loss position for less than a year, 100% are rated investment grade for both 2006 and 2005. Of the $38,658 and $19,274 that have been in a gross unrealized loss position for a year or more, 100% and 99% are rated investment grade for 2006 and 2005, respectively. There were impairment write-downs of $119, $340, and $0 in 2006, 2005 and 2004, respectively.

19

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Securities carried at $6,389 and $6,583 at December 31, 2006 and 2005 respectively, were deposited by Ambac Assurance with governmental authorities or designated custodian banks as required by laws affecting insurance companies.

Ambac Assurance’s fixed income portfolio included securities covered by guarantees issued by Ambac Assurance (“insured securities”). The published ratings on these securities are triple-A by the major rating agencies as a result of the Ambac Assurance insurance policy. Rating agencies generally do not publish separate underlying ratings (those ratings excluding the Ambac Assurance insurance) because the insurance cannot be legally separated from the underlying security by the insurer. Ambac Assurance obtains underlying ratings through ongoing dialog with rating agencies. At December 31, 2006, one security with a carrying value of $32,689 representing less than 1% of the investment portfolio with an underlying rating of A- was insured by Ambac Assurance.

Net investment income of Ambac Assurance comprised the following:

	2006			2005			2004
Fixed income securities	$	417,339		$	374,224		$	355,672
Short-term investments		9,358			8,061			2,414
Loans		2,071			1,519			2,057
Total investment income		428,768			383,804			360,143
Investment expense		(4,900	)		(5,708	)		(4,881	)
Net investment income	$	423,868		$	378,096		$	355,262

Net realized investment gains were $7,085, $6,307 and $30,004 in 2006, 2005 and 2004, respectively. The following table details amounts included in net realized gains:

	2006			2005			2004
Gross realized gains on securities sold	$	3,867		$	11,926		$	40,346
Gross realized losses on securities sold		(2,839	)		(12,727	)		(15,996	)
Other than temporary impairment on securities		(119	)		(340	)		—
Foreign exchange gains on investments		6,176			7,448			5,654
Net realized gains	$	7,085		$	6,307		$	30,004

5 REINSURANCE

In the ordinary course of business, Ambac Assurance cedes exposures under various reinsurance contracts primarily designed to minimize losses from large risks and to protect capital and surplus. The effect of reinsurance on premiums written and earned was as follows:

	Year Ended December 31,
	2006						2005						2004
	Written			Earned			Written			Earned			Written			Earned
Direct	$	972,064		$	881,681		$	1,048,018		$	878,109		$	1,014,314		$	784,767
Assumed		36,297			34,279			52,447			36,478			36,425			37,746
Ceded		(103,446	)		(91,381	)		(99,673	)		(93,620	)		(70,946	)		(99,077	)
Net premiums	$	904,915		$	824,579		$	1,000,792		$	820,967		$	979,793		$	723,436

20

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Ambac Assurance pledged cash and fixed income securities to foreign insurers of $15,331, $13,556 and $15,086 at December 31, 2006, 2005 and 2004, respectively, related to business assumed from those insurers.

The reinsurance of risk does not relieve Ambac Assurance of its original liability to its policyholders. In the event that any of Ambac Assurance’s reinsurers are unable to meet their obligations under reinsurance contracts, Ambac Assurance would nonetheless, be liable to its policyholders in the full amount of its policy.

To minimize exposure to significant losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of a rating downgrade of a reinsurer. For the years ended December 31, 2006, 2005 and 2004, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $3,904, $22,936 and $2,581, respectively. Reinsurance recoverables (payables) on paid losses and loss expenses as of December 31, 2006, 2005 and 2004 were ($1,051), $263 and $266, respectively.

Ambac Assurance’s reinsurance assets, including prepaid reinsurance and reinsurance recoverables on losses amounted to $319,419 at December 31, 2006. This credit exposure existed at December 31, 2006 with respect to reinsurance recoverables to the extent that any reinsurer may not be able to reimburse Ambac Assurance under the terms of these reinsurance arrangements. Ambac Assurance requires certain reinsurers to maintain bank letter of credits or establish trust accounts to cover liabilities ceded to such reinsurers under reinsurance contracts. The collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis. At December 31, 2006, approximately 60% of the reinsurance assets were collateralized. All of the balances with respect to the remaining reinsurers had financial strength ratings of AA or better as rated by Standard & Poor’s.

21

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

6 LOSSES AND LOSS EXPENSE RESERVE

As discussed in Note 2, Ambac Assurance’s liability for losses and loss expenses consists of case basis and active credit reserves. Following is a summary of the activity in the case basis credit and active credit reserve accounts and the components of the liability for loss and loss expense reserves:

	2006			2005			2004
Case basis credit loss and loss expense reserves:
Balance at January 1	$	106,532		$	133,254		$	57,233
Less: reinsurance recoverables		3,468			16,499			2,535
Net balance at January 1		103,064			116,755			54,698
Transfers from active credit reserves:
Current year		34,660			31,274			40,215
Prior years		10,307			41,776			40,765
Total transfers from active credit reserves		44,967			73,050			80,980
Paid (net of recoveries) related to:
Current year		32,895			2,755			214
Prior years		72,673			83,986			18,709
Total paid		105,568			86,741			18,923
Net balance at December 31		42,463			103,064			116,755
Less impact on foreign exchange gains on loss reserves		5			—			—
Plus reinsurance recoverables		4,972			3,468			16,499
Balance at December 31		47,430			106,532			133,254
Active credit reserve:
Balance at January 1		197,607			120,801			132,181
Provision for losses		20,004			149,856			69,600
Transfers to case reserves		(44,967	)		(73,050	)		(80,980	)
Balance at December 31		172,644			197,607			120,801
Total	$	220,074		$	304,139		$	254,055

During 2006, 2005 and 2004, gross losses paid were $126,183, $119,070 and $55,321, respectively. During 2006, 2005 and 2004, other recoveries (under subrogation rights) of losses were $16,711, $9,394 and $33,628, respectively.

The provision for losses and loss expenses represents the expense recorded to bring the total reserve (active credit and case basis credit) to a level determined by management to be adequate for losses inherent in the non-derivative financial guarantee insurance portfolio as of the reporting date. The provision for losses of $20,004 is the amount recorded as loss and loss expenses in the Consolidated Statements of Operations. The 2006 loss and loss expenses were primarily driven by provisions for losses for deteriorating public finance infrastructure and domestic health care credits, offset by a reduction in provisions of $41,253 for Hurricane Katrina credits. The decrease in the Hurricane Katrina reserves is primarily due to significant state and federal support provided to the

22

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

region in 2006, particularly the greater New Orleans area. Approximately $730 million of Katrina impacted credits remain in Ambac Assurance’s adversely classified credit portfolio. Ambac Assurance did not pay any Katrina related claims during 2006. Provisions are recognized through the active credit reserve based on the ongoing analysis of the portfolio as discussed in Note 2. Upon default of the underlying credit, the reserve is transferred from active credit reserves to case basis credit reserves. Additional provisions for losses upon further credit deterioration of a defaulted exposure are initially recorded in active credit reserve and subsequently transferred to case basis credit reserve.

Transfers from active credit reserves related to prior years were $10,307 and $41,776 for the years ended December 31, 2006 and 2005, respectively.

Continued deterioration in a previously impaired public finance infrastructure issue was experienced in 2006 offset by favorable development resulting from the final settlement of several credits (including the health care institution discussed below). Ambac Assurance believes the primary factor causing the deterioration is the highly competitive economic environment the issuer’s management is operating in. Ambac Assurance is closely surveilling the credit and is in frequent communication with the issuer’s management. A domestic health care institution, which defaulted in a year prior to 2005, continued to experience significant financial stress in 2005. An enhanced equipment trust that was impacted by a bankruptcy of a commercial airline in 2004, experienced additional losses in 2005 upon the settlement of the trust. In connection with the settlement of the trust, Ambac Assurance purchased three airplanes. In February 2006, Ambac Assurance sold these airplanes and recognized a realized gain of approximately $25,000 (included in “Other income” on our Consolidated Statement of Operations).

7 INCOME TAXES

The total effect of income taxes on income and stockholder’s equity for the years ended December 31, 2006 and 2005 was as follows:

	2006			2005
Total income taxes charged to income	$	335,697		$	264,939
Income taxes credited to stockholder’s equity:
Unrealized losses on investment securities		(1,490	)		(49,750	)
Exercise of stock options		(12,949	)		(10,359	)
Other		3,410			—
Total credited to stockholder’s equity		(11,029	)		(60,109	)
Total effect of income taxes	$	324,668		$	204,830

23

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

The tax provisions in the accompanying Consolidated Statements of Operations reflect effective tax rates differing from prevailing Federal corporate income tax rates. The following is a reconciliation of these differences:

	2006			%		2005			%		2004			%
Computed expected tax at statutory rate	$	427,558		35.0	%	$	358,070		35.0	%	$	364,417		35.0	%
Changes in expected tax resulting from:
Tax-exempt income		(94,045	)	(7.7	)		(84,760	)	(8.3	)		(79,564	)	(7.6	)
Addition to (release of) tax reserves		2,230		0.2			(9,000	)	(0.9	)		(8,250	)	(0.8	)
Other, net		(46	)	(0.0	)		629		0.1			(2,758	)	(0.3	)
Income tax expense	$	335,697		27.5	%	$	264,939		25.9	%	$	273,845		26.3	%

The addition to tax reserves in 2006 relates to the accrual of interest. The release of tax reserves in 2005 and 2004 relates to the expiration of the statute of limitations of an earlier tax year.

The tax effects of temporary differences that give rise to significant portions of the deferred tax liabilities and deferred tax assets at December 31, 2006 and 2005 are presented below:

	2006			2005
Deferred tax liabilities:
Contingency reserve	$	366,957		$	336,957
Unrealized gains on bonds		73,005			74,495
Deferred acquisition costs		91,840			80,120
Unearned premiums and credit fees		139,339			112,739
Other		12,902			8,560
Total deferred tax liabilities		684,043			612,871
Deferred tax assets:
Tax and loss bonds		331,371			301,371
Loss reserves		98,469			69,805
Compensation		37,989			27,313
Other		8,161			7,655
Sub-total deferred tax assets		475,990			406,144
Valuation allowance		—			—
Total deferred tax assets		475,990			406,144
Net deferred tax liabilities	$	(208,053	)	($	206,727	)

Ambac Assurance believes that no valuation allowance is necessary in connection with the deferred tax assets. It is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.

8 SPECIAL PURPOSE ENTITIES AND VARIABLE INTEREST ENTITIES

Ambac Financial Group has involvement with special purpose entities, including VIEs in the following ways. First, Ambac Assurance is a provider of financial guarantee insurance for various debt

24

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

obligations. Second, Ambac Financial Group has sponsored two special purpose entities that issue medium-term notes (“MTNs”) to fund the purchase of certain financial assets. As discussed in detail below, these Ambac Financial Group sponsored special purpose entities are considered QSPEs. Lastly, Ambac Assurance is an investor in asset-backed securities issued by VIEs, and, in one transaction, has a beneficial interest in a VIE that purchases fixed rate municipal bonds with proceeds from the issuance of floating rate short term beneficial interests as discussed in detail below.

Financial Guarantees:

Ambac Assurance provides financial guarantees in respect of debt obligations of special purpose entities, including VIEs. Ambac Assurance’s primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structure provides certain financial protection to Ambac Assurance. This financial protection can take several forms; however, the most common are over-collateralization, first loss and excess spread. In the case of over-collateralization, (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by Ambac Assurance), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the structured finance obligations that have been guaranteed by Ambac Assurance. In the case of first loss, the financial guarantee insurance policy only covers a senior layer of losses on debt issued by special purpose entities, including VIEs. The first loss with respect to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate interest cash flows that are in excess of the interest payments on the related debt; such excess cash flow is applied to redeem debt, thus creating over-collateralization.

Qualified Special Purpose Entities:

Ambac Financial Group has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with SFAS 140. QSPEs are not subject to the requirements of FIN 46(R) and accordingly are not consolidated in Ambac Financial Group’s or Ambac Assurance’s financial statements. The QSPEs are legal entities that are demonstrably distinct from Ambac Financial Group. Ambac Financial Group, its affiliates or its agents cannot unilaterally dissolve the QSPEs. The QSPEs permitted activities are limited to those outlined below.

As of December 31, 2006, there have been 15 individual transactions processed through the QSPEs of which 10 are outstanding. In each case, Ambac Financial Group sold fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPE and the absence of any agreement or obligation for Ambac Financial Group to repurchase or redeem assets of the QSPE. Additionally, Ambac Financial Group’s creditors do not have any rights with regards to the assets of the QSPEs. The purchase by the QSPE is financed through the issuance of MTNs, which are collateralized by the purchased assets. Derivative contracts (interest rate and currency swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are

25

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

contractually limited to purchasing assets from Ambac Financial Group, issuing MTNs to fund such purchase, executing derivative hedges and related administrative services. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued or both. As of December 31, 2006, Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the QSPEs.

Ambac’s exposures under these financial guarantee insurance policies as of December 31, 2006 and December 31, 2005 are included in the disclosure in Note 12 “Guarantees in Force”. Pursuant to the terms of Ambac Assurance’s insurance policy, insurance premiums are paid to Ambac Assurance by the QSPEs and are earned in a manner consistent with other insurance policies, over the risk period. Any losses incurred would be included in Ambac Assurance’s Consolidated Statements of Operations. Under the terms of an Administrative Agency Agreement, Ambac Financial Group provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.

Assets sold to the QSPEs during 2006, 2005 and 2004 were $450,000, $0 and $195,000, respectively. No gains or losses were recognized on the sale. As of December 31, 2006, the estimated fair value of financial assets, MTN liabilities and derivative hedge liabilities of the QSPEs was $2,013,730, $2,053,512 and $6,021, respectively. When market quotes are not available, fair values are based on internal valuation models, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $5,022, $5,713 and $6,042 for the years ended December 31, 2006, 2005 and 2004, respectively. Ambac Financial Group also received fees for providing other services amounting to $328, $321 and $450 for 2006, 2005 and 2004, respectively.

VIE Beneficial Interest:

Ambac Assurance owns a beneficial interest in a special purpose entity that meets the definition of a VIE. This entity has issued floating rate beneficial interests to investors and invested the proceeds in fixed rate municipal debt securities. These beneficial interests are directly secured by the related municipal debt securities. Ambac Assurance is the primary beneficiary of this entity as a result of its beneficial interest. The fixed rate municipal debt securities, which are reported as Investments in fixed income securities, at fair value on the Consolidated Balance Sheets, were $258,976 and $258,806 as of December 31, 2006 and 2005, respectively. The beneficial interests issued to third parties, reported as Obligations under payment agreements on the Consolidated Balance Sheets, were $248,415 and $248,760 as of December 31, 2006 and 2005, respectively. Under the terms of these beneficial interests, the investors have the contractual right to redeem their investment at any time, with five business days notice. As of December 31, 2006 and 2005, the interest rates on these beneficial interests ranged from 2.95% to 4.01% and from 1.49% to 3.55%, respectively.

26

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

9 RETIREMENT PLANS

Pensions and Postretirement Health Care and Other Benefits:

Ambac Financial Group has a defined benefit pension plan covering substantially all employees of Ambac Assurance. The benefits are based on years of service and the employee’s average highest salary during five consecutive years of employment within the last ten years of employment. During 2006, the Compensation Committee of the Board of Directors of Ambac Financial Group approved an amendment to the Pension Plan that terminated the Plan effective December 31, 2006. Benefits under the Plan will cease to accrue as of December 31, 2006. Management’s current intention is to settle the Plan’s obligations in 2007. No funding contribution was made to the plan in 2006. In 2007, the Compensation Committee replaced this benefit with an increased matching contribution to Ambac Financial Group’s defined contribution plan.

Pension expense recorded by Ambac Assurance amounted to $1,748, $1,319 and $864 in 2006, 2005 and 2004, respectively.

Ambac Financial Group provides postretirement and postemployment benefits, including health and life benefits covering substantially all employees who meet certain age and service requirements. Effective August 1, 2005, new employees were not eligible for postretirement benefits. All plans are contributory. None of the plans are currently funded. Postretirement and postemployment benefits expense recorded by Ambac Assurance was $1,060, $894 and $479 in 2006, 2005 and 2004, respectively.

Savings Incentive Plan:

Substantially all employees of Ambac Financial Group are covered by a defined contribution plan (the “Savings Incentive Plan”). Ambac Financial Group makes an employer matching contribution of 50% of the employee’s contributions up to 6% of such participants’ base compensation, subject to limits set by the Internal Revenue Code. Effective January 1, 2007, the Compensation Committee of the Board of Directors approved an increase to the matching contribution from 50% to 100% of the employees contribution up to 6%. Ambac Financial Group may also make a Basic Profit Sharing contribution of 3% of base compensation and a Supplemental Profit Sharing contribution of an additional 3% of base compensation to eligible employees. The total cost of the Savings Incentive Plan to Ambac Assurance was $3,588, $3,204 and $3,247 in 2006, 2005 and 2004, respectively.

10 STOCK COMPENSATION

Stock Options:

Stock options awarded to eligible employees are exercisable and expire as specified at the time of grant. Such options are awarded based on the closing fair market value of the Common Stock as traded on the New York Stock Exchange on the grant date and have a term of seven years from the date of the grant. All employee stock option agreements provide that vesting is accelerated in certain circumstances, such as upon retirement, permanent disability or death. Total stock option expense for Ambac Assurance amounted to $14,667, $9,621 and $11,510 in 2006, 2005 and 2004, respectively. The net income effect from stock options for 2006, 2005 and 2004 were $5,463, $3,552 and $3,769, respectively.

27

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

RSUs:

RSUs are granted to all eligible employees based upon the performance of Ambac Financial Group, the performance of the employee’s department and the performance of the employee. Officers at the level of Managing Director and above, can, in lieu of the first twenty-five percent of their cash bonus, receive RSUs. These RSUs are granted at a twenty-five percent discount to the fair market value of Ambac Financial Group common stock on the date of grant. These employees can elect to defer more than twenty-five percent of their cash bonus in the form of RSUs, however, the aforementioned discount does not apply. RSUs do not have a vesting period in excess of four years. Typically, RSU agreements provide that vesting is accelerated in certain circumstances, such as retirement, permanent disability or death. The cost of the program for Ambac Assurance for the years ended December 31, 2006, 2005 and 2004 amounted to $20,866, $17,533 and $10,787, respectively. The net income effect from RSUs for 2006, 2005 and 2004 were $8,632, $7,097 and $4,326, respectively.

11 COMMITMENTS AND CONTINGENCIES

Ambac Assurance is responsible for leases on the rental of office space. The lease agreements, which expire through September 2019, contain provisions for scheduled periodic rent increases and are accounted for as operating leases. An estimate of future minimum net lease payments in each of the next five years ending December 31, and the periods thereafter, is as follows:

	Amount
2007	$	9,260
2008		9,338
2009		9,497
2010		9,944
2011		9,967
All later years		72,489
	$	120,495

Rent expense for the aforementioned leases amounted to $9,966, $10,018 and $8,507 for the years ended December 31, 2006, 2005 and 2004, respectively.

A subsidiary of Ambac Financial Group provides a $360,000 liquidity facility to a reinsurance company which acts as reinsurer with respect to a portfolio of life insurance policies. The liquidity facility, which is guaranteed by Ambac Assurance, provides temporary funding in the event that the reinsurance company’s capital is insufficient to make payments under the reinsurance agreement. The reinsurance company is required to repay all amounts drawn under the liquidity facility. No amounts have been drawn under this facility at December 31, 2006.

28

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

12 GUARANTEES IN FORCE

The par amount of financial guarantees outstanding, for non-affiliates, were $567,578,000 and $523,247,000 at December 31, 2006 and 2005, respectively. The par amount of financial guarantees outstanding, for non-affiliates, net of reinsurance, were $519,043,000 and $479,085,000 at December 31, 2006 and 2005, respectively. As of December 31, 2006 and 2005, the guarantee portfolio was diversified by type of guaranteed bond as shown in the following table:

	Net Par Amount Outstanding (1)
(Dollars in Millions)	2006		2005
Public Finance:
Lease and tax-backed revenue	$	89,042	$	82,584
General obligation		62,834		57,982
Utility revenue		38,313		36,877
Health care revenue		27,849		26,994
Transportation revenue		24,979		23,718
Higher education		22,068		20,203
Housing revenue		10,996		10,152
Other		6,181		5,556
Total Public Finance		282,262		264,066
Structured Finance:
Mortgage-backed and home equity		46,239		48,869
Pooled debt obligations		40,568		25,746
Asset-backed and conduits		34,815		32,505
Student loan		18,404		16,538
Investor-owned utilities		17,345		16,398
Other		5,212		4,296
Total Structured Finance		162,583		144,352
International Finance:
Pooled debt obligations		19,978		23,427
Asset-backed and conduits		17,863		15,356
Mortgage-backed and home equity		11,951		14,627
Investor-owned and public utilities		10,531		8,052
Sovereign/sub-sovereign		6,344		3,585
Transportation revenue		6,303		4,951
Other		1,228		669
Total International Finance		74,198		70,667
	$	519,043	$	479,085

(1) Included in the above exposures are credit derivatives. Total credit derivative net par outstanding amounted to $55,460 and $43,712 at December 31, 2006 and 2005, respectively.

29

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

As of December 31, 2006 and 2005, the International Finance guarantee portfolio is shown in the following table by location of risk:

	Net Par Amount Outstanding
(Dollars in Millions)	2006		2005
United Kingdom	$	27,253	$	22,761
Australia		6,126		5,139
Germany		5,852		5,895
Japan		4,391		4,274
Italy		2,167		1,843
Internationally diversified		19,180		22,874
Other international		9,229		7,881
Total International Finance	$	74,198	$	70,667

Internationally diversified obligations represent pools of geographically diversified exposures which includes significant components of domestic exposure.

Gross financial guarantees in force (principal and interest) was $887,448,000 and $801,085,000 at December 31, 2006 and 2005, respectively. Net financial guarantees in force (after giving effect to reinsurance) was $802,694,000 and $726,612,000 as of December 31, 2006 and 2005, respectively.

In the United States, California and New York were the states with the highest aggregate net par amounts in force, accounting for 10.6% and 6.6% of the total at December 31, 2006. No other state accounted for more than five percent. The highest single insured risk represented 0.5% of the aggregate net par amount guaranteed.

In connection with its financial guarantee business, Ambac Assurance has outstanding commitments to provide guarantees of $25,551,000 at December 31, 2006. These commitments relate to potential future debt issuances or increases in funding levels for existing insurance or credit derivative transactions. Commitments relating to future debt issuances generally have fixed termination dates and are contingent on the satisfaction of all conditions set forth in the contract. Since these commitments may expire unused or be reduced or cancelled at the counterparty’s request, the total commitment amount does not necessarily reflect actual future guaranteed amounts.

13 FAIR VALUES OF FINANCIAL INSTRUMENTS

The following fair value amounts were determined by using independent market information when available, and valuation models when market quotes were not available. In cases where specific market quotes are unavailable, interpreting market data and estimating fair values require considerable judgment by management. Accordingly, the estimates presented are not necessarily indicative of the amount Ambac Assurance could realize in a current market exchange. The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Investments:  The fair values of fixed income investments are based primarily on quoted market prices received from a nationally recognized pricing service or dealer quotes. When quotes are not available, fair values are estimated based upon internal valuation models.

30

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Short-term investments and cash:  The fair values of short-term investments and cash approximates amortized cost.

Other investments:  The fair value of other investments, primarily mutual funds, are based on quoted market prices received from a nationally recognized pricing service.

Securities purchased under agreements to resell:  The fair value of securities purchased under agreements to resell approximates carrying value.

Investment income due and accrued:  The fair value of investment income due and accrued approximates carrying value.

Loans:  The fair value of loans approximates carrying value.

Derivative contracts:  The fair values of interest rate swaps, currency swaps, total return swaps and credit derivative transactions are determined by market quotes or valuation models when market quotes are not available.

Obligations under payment agreements:  The fair value of payment agreements approximates carrying value.

Liability for net financial guarantees written:  The fair value of the liability for financial guarantees written is based on the estimated cost to reinsure those exposures at current market rates, which amount consists of the current unearned premium reserve less prepaid reinsurance plus the present value of estimated future installment premiums, less an estimated ceding commission thereon. The estimate of the amounts and timing of the future installment premiums is based on contractual premium rates, debt service schedules and expected run-off scenarios.

The carrying amount and estimated fair value of financial instruments are presented below:

	As of December 31,
	2006				2005
(Dollars in Millions)	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets:
Fixed income securities	$	9,878	$	9,878	$	8,764	$	8,764
Short-term investments		232		232		407		407
Other investments		13		13		13		13
Cash		24		24		20		20
Securities purchased under agreements to resell		95		95		97		97
Investment income due and accrued		132		132		113		113
Derivative assets		1,019		1,019		980		980
Loans		11		11		22		22
Financial liabilities:
Obligations under payments agreements		248		248		249		249
Derivative liabilities		920		920		880		880
Liability for net financial guarantees written		2,733		3,515		2,649		3,322

31

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

14 INSURANCE REGULATORY

Ambac Assurance is subject to insurance regulatory requirements of the States of Wisconsin and New York, and the other jurisdictions in which it is licensed to conduct business.

Ambac Assurance’s ability to pay dividends is generally restricted by law and subject to approval by the Office of the Commissioner of Insurance of the State of Wisconsin. Wisconsin insurance law restricts the payment of dividends in any 12-month period without regulatory approval to the lesser of (a) 10% of policyholders’ surplus as of the preceding December 31 and (b) the greater of (i) statutory net income for the calendar year preceding the date of dividend, minus realized capital gains for that calendar year and (ii) the aggregate of statutory net income for three calendar years preceding the date of the dividend, minus realized capital gains for those calendar years and minus dividends paid or credited within the first two of the three preceding calendar years. Additionally, no quarterly dividend may exceed the dividend paid in the corresponding quarter of the preceding year by more than 15% without notifying the Wisconsin Insurance Commissioner 30 days in advance of payment. Based upon these restrictions, at December 31, 2006, the maximum amount that will be available during 2007 for payment of dividends by Ambac Assurance is approximately $370,000. Ambac Assurance paid cash dividends of $136,000, $353,400 and $103,600 on its common stock in 2006, 2005 and 2004, respectively. The 2005 amounts required regulatory approval since it exceeded the statutorily prescribed threshold.

The New York Financial Guarantee Insurance Law establishes single risk limits applicable to obligations insured by Ambac Assurance. Such limits are specific to the type of insured obligation (for example, municipal or asset-backed). The limits compare the insured net par outstanding and average annual debt service, net of reinsurance and collateral, for a single risk to the insurer’s qualified statutory capital, which is defined as the sum of the insurer’s policyholders’ surplus and contingency reserves. As of December 31, 2006 and 2005, Ambac Assurance and its subsidiaries were in compliance with these regulatory requirements.

Ambac Assurance’s statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by the Wisconsin Insurance Department. Wisconsin has adopted the National Association of Insurance Commissioners’ statutory accounting practices (“NAIC SAP”) as a component of its prescribed accounting practices. Wisconsin’s accounting practice for changes to the contingency reserve differ from those practices of NAIC SAP. Under NAIC SAP, contributions to and releases from the contingency reserve are recorded via a direct charge or credit to surplus. Under the Wisconsin Administrative Code, contributions to and release from the contingency reserve are to be recorded through underwriting income. Ambac Assurance received permission of the Wisconsin Insurance Commissioner to record contributions to and releases from the contingency reserve in accordance with NAIC SAP. Statutory surplus is the same using each of these accounting practices. Statutory net income is higher than if Ambac Assurance had reported the net contributions in accordance with the Wisconsin Administrative Code by $322,786, $265,536 and $235,881 for 2006, 2005 and 2004, respectively.

32

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Statutory capital and surplus was $3,696,876 and $3,327,484 at December 31, 2006 and 2005, respectively. Qualified statutory capital was $6,370,991 and 5,648,813 at December 31, 2006 and 2005, respectively. Statutory net income for Ambac Assurance was $788,989, $707,402 and $693,176 for 2006, 2005 and 2004, respectively. Statutory capital and surplus differs from stockholders’ equity determined under GAAP principally due to statutory accounting rules that treat loss reserves, premiums earned, policy acquisition costs, and deferred income taxes differently.

15 LINES OF CREDIT

On July 28, 2005, Ambac Financial Group and Ambac Assurance, as borrowers, entered into a $400,000 five year unsecured, committed revolving credit facility (the “Credit Facility”) with a group of highly rated banks (the “Banks”). The Credit Facility was amended on July 28, 2006 to extend the final maturity date from July 28, 2010 to July 28, 2011. The Credit Facility provides for borrowings by Ambac Financial Group and Ambac Assurance on a revolving basis up to an aggregate of $400,000 at any one time outstanding, which maximum amount may, at Ambac Financial Group’s and Ambac Assurance’s request and subject to the terms and conditions of the facility, be increased up to $500,000.

Ambac Financial Group and/or Ambac Assurance may borrow under the Credit Facility for general corporate purposes, including the payment of claims. Subject to the terms and conditions thereof, Ambac Financial Group and/or Ambac Assurance may borrow under the Credit Facility until the final maturity date. Loans may be denominated in U. S. Dollars or certain other currencies at the option of Ambac Financial Group and/or Ambac Assurance. Ambac Financial Group and/or Ambac Assurance has the option of selecting either (i) a Base Rate, a fluctuating rate equal to the higher of Citibank’s Base Rate and the Federal Funds Rate plus 0.5%, plus the Applicable Margin (as defined in the Credit Facility) or (ii) a Eurocurrency Rate, a periodic fixed rate equal to LIBOR plus the Applicable Margin. There are no outstanding loans under the Credit Facility. Neither Ambac Financial Group nor Ambac Assurance have previously incurred any borrowing under this or prior similar facilities.

The Credit Facility contains customary representations, warranties and covenants for this type of financing, including two financial covenants requiring Ambac Financial Group to: (i) maintain as of the end of each fiscal quarter a debt-to-capital ratio, excluding debt consolidated under FIN 46, of not more than 30%, and (ii) maintain at all times total stockholders’ equity equal to or greater than $2,800,000. The stockholders’ equity financial covenant will increase annually, in an amount equal to 15% of Ambac Financial Group’s prior fiscal year’s net income and 15% of the net proceeds of any future equity issuances. As a result, the stockholders’ equity financial covenant will increase to $2,930,000 for 2007. The Credit Facility also provides for certain events of default with corresponding grace periods, including failure to pay any principal or interest when due, failure to comply with covenants, any material representation or warranty made by Ambac Financial Group or Ambac Assurance proving to be false in any material respect, certain bankruptcy, insolvency or receivership events affecting Ambac Financial Group or Ambac Assurance, defaults relating to other indebtedness, imposition of certain judgments and a change in ownership of Ambac Financial Group and/or Ambac Assurance. Ambac Financial Group and Ambac Assurance are in full compliance with the terms and conditions of the Credit Facility.

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Ambac Assurance has a series of perpetual put options on its own preferred stock. The counterparty to these put options are trusts established by a major investment bank. The trusts were created as a vehicle for providing capital support to Ambac Assurance by allowing it to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put option were exercised, Ambac Assurance would receive up to $800,000 in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose, including the payment of claims. The preferred stock would give investors the rights of an equity investor in Ambac Assurance. Such rights are subordinate to insurance claims, as well as to the general unsecured creditors of Ambac Assurance. Dividend payments on the preferred stock are cumulative, subject to certain limited exceptions, only if Ambac Assurance pays dividends on its common stock. Each trust is restricted to holding high-quality short-term commercial paper investments to ensure that it can meet its obligations under the put option. To fund these investments, each trust has issued its own auction market perpetual securities. Each trust is rated AA/Aa2 by Standard & Poor’s and Moody’s, respectively. During 2006 and 2005, Ambac Assurance incurred fees related to these perpetual put options of $3,497 and $5,035, respectively. Put option fees are recorded in adjusted paid-in capital in the Consolidated Balance Sheets.

15 RELATED PARTY TRANSACTIONS

During 2006 and 2005, Ambac Assurance guaranteed the timely payment of principal and interest on obligations under investment agreements and investment repurchase agreements issued by its affiliates. As of December 31, 2006 and 2005, the principal amount of investment agreements and investment repurchase agreements insured was $7,558,072 and $6,470,998, respectively, including accrued interest. The guarantees are collateralized by investment securities, accrued interest receivable, securities purchased under agreements to resell, cash and cash equivalents and other financial assets, which as of December 31, 2006 and 2005, had an aggregate fair value of $7,727,706 and $6,649,413, respectively. Certain investment agreements may be terminated at fair value. During 2006 and 2005, Ambac Assurance recorded gross premiums written of $8,383 and $3,481, and net premiums earned of $9,646 and $3,682, respectively, related to these agreements.

During 2006 and 2005, several interest rate swap transactions were executed between Ambac Financial Services and its affiliates (other than Ambac Assurance). As of December 31, 2006 and 2005, these contracts had an outstanding notional amount of approximately $2,666,261 and $2,068,000, respectively. As of December 31, 2006 and 2005, Ambac Financial Services recorded net liabilities of $253,332 and $72,291, respectively, related to these transactions.

In 2006 and 2005, Ambac Assurance received capital contributions totaling none and $199,110, respectively, from Ambac Financial Group, Inc.

16 SEGMENT INFORMATION

Ambac Assurance has two reportable segments, as follows: (1) financial guarantee, which provides financial guarantees (including credit derivatives) for public finance and structured finance obligations

34

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

and (2) financial services, which provides payment agreements, interest rate, currency and total return swaps.

Ambac Assurance’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different marketing strategies, personnel skill sets and technology.

The accounting policies of the segments are described in Note 2 “Significant Accounting Policies”. Intersegment revenues include the premiums earned under those agreements. Ambac Assurance guarantees swap obligations and receives dividends from its Financial Services subsidiaries. Such premiums are determined as if they were premiums to third parties, that is, at current market prices. In 2006 and 2005, Financial Guarantee intersegment revenues include dividends of $41,600 and $2,500, respectively, from the Financial Services segment.

35

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

The following table is a summary of the financial information by reportable segment as of and for the years ended December 31, 2006, 2005 and 2004:

	Financial Guarantee		Financial Services			Intersegment Eliminations			Total Consolidated
2006:
Revenues:
External customers	$	1,356,012	$	33,716		$	—		$	1,389,728
Intersegment		48,092		—			(48,092	)		—
Total revenues	$	1,404,104	$	33,716		$	(48,092	)	$	1,389,728
Income before income taxes:
External customers	$	1,202,218	$	19,377		$	—		$	1,221,595
Intersegment		50,788		(9,188	)		(41,600	)		—
Total income before income taxes	$	1,253,006	$	10,189		$	(41,600	)	$	1,221,595
Identifiable assets	$	10,690,560	$	1,371,003		$	—		$	12,061,563
2005:
Revenues:
External customers	$	1,273,570	$	30,200		$	—		$	1,303,770
Intersegment		5,005		—			(5,005	)		—
Total revenues	$	1,278,575	$	30,200		$	(5,005	)	$	1,303,770
Income before income taxes:
External customers	$	1,006,013	$	17,043		$	—		$	1,023,056
Intersegment		7,321		(4,821	)		(2,500	)		—
Total income before income taxes	$	1,013,334	$	12,222		$	(2,500	)	$	1,023,056
Identifiable assets	$	9,727,311	$	1,340,415		$	—		$	11,067,726
2004:
Revenues:
External customers	$	1,180,518	$	47,627		$	—		$	1,228,145
Intersegment		20,018		—			(20,018	)		—
Total revenues	$	1,200,536	$	47,627		$	(20,018	)	$	1,228,145
Income before income taxes:
External customers	$	1,004,204	$	36,986		$	—		$	1,041,190
Intersegment		21,804		(4,146	)		(17,658	)		—
Total income before income taxes	$	1,026,008	$	32,840		$	(17,658	)	$	1,041,190
Identifiable assets	$	9,009,435	$	1,616,425		$	—		$	10,625,860

36

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands, Except Share Amounts)

The following table summarizes gross premiums written and net premiums earned and other credit enhancement fees included in the financial guarantee segment, by location of risk for the years ended December 31, 2006, 2005 and 2004.

	2006		2005		2004
Gross premiums written:
United States	$	720,991	$	871,191	$	820,632
United Kingdom		143,872		81,492		110,225
Other international		143,498		147,782		119,882
Total:	$	1,008,361	$	1,100,465	$	1,050,739
Net premiums earned and other credit enhancement fees:
United States	$	655,465	$	654,856	$	558,877
United Kingdom		77,781		64,335		60,731
Other international		147,783		150,905		151,154
Total:	$	881,029	$	870,096	$	770,762

Internationally diversified includes significant components of domestic exposure.

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