EXHIBIT 99.01

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

(a wholly-owned subsidiary of Ambac Financial Group, Inc.)

Consolidated Financial Statements

December 31, 2002 and 2001

Independent Auditors’ Report

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, 2002 and 2001, 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, 2002. 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 auditing standards generally accepted in the United States of America. 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, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

/s/ KPMG LLP

KPMG LLP

New York, New York

January 21, 2003

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

December 31, 2002 and 2001

(Dollars in Thousands Except Share Data)

	2002		2001
ASSETS
Investments:
Fixed income securities, at fair value (amortized cost of $5,866,488 in 2002 and $4,955,542 in 2001)	$	6,223,062	$	5,083,039
Short-term investments, at cost (approximates fair value)		287,315		185,943
Other, at fair value		1,394		1,394
Total investments		6,511,771		5,270,376
Cash		15,876		33,678
Securities purchased under agreements to resell		57,753		—
Receivable for securities sold		230		281
Investment income due and accrued		80,825		73,456
Reinsurance recoverable on paid and unpaid losses		4,842		1,021
Prepaid reinsurance		296,126		267,655
Deferred acquisition costs		174,055		163,477
Derivative product assets		1,010,081		383,959
Other assets		43,821		44,332
Total assets	$	8,195,380	$	6,238,235
LIABILITIES AND STOCKHOLDER’S EQUITY
Liabilities:
Unearned premiums	$	2,137,460	$	1,790,084
Losses and loss adjustment expense reserve		172,137		151,114
Ceded reinsurance balances payable		16,930		10,146
Obligations under payment agreements		250,534		—
Deferred income taxes		232,269		147,642
Current income taxes		41,375		126,039
Note payable to affiliate		59,600		63,500
Payable for securities purchased		70,761		26,097
Derivative product liabilities		953,772		325,922
Other liabilities		178,479		120,968
Total liabilities		4,113,317		2,761,512
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, 2002 and December 31, 2001		82,000		82,000
Additional paid-in capital		920,146		928,094
Accumulated other comprehensive income		231,436		80,556
Retained earnings		2,848,481		2,386,073
Total stockholder’s equity		4,082,063		3,476,723
Total liabilities and stockholder’s equity	$	8,195,380	$	6,238,235

See accompanying Notes to Consolidated Financial Statements.

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations

(Dollars in Thousands)

	Years Ended December 31,
	2002			2001			2000
Revenues:
Financial Guarantee:
Gross premiums written	$	908,890		$	687,457		$	485,685
Ceded premiums written		(113,542	)		(95,534	)		(80,789	)
Net premiums written	$	795,348		$	591,923		$	404,896
Net premiums earned	$	477,592		$	383,042		$	314,507
Other credit enhancement fees		28,775			21,661			12,157
Net premiums earned and other credit enhancement fees		506,367			404,703			326,664
Net investment income		297,266			267,618			241,047
Net realized investment gains		40,918			2,124			681
Net unrealized losses on credit derivative contracts		(27,877	)		(3,588	)		(4,111	)
Other income		4,996			4,655			4,228
Financial Services		18,502			22,421			29,489
Total revenues		840,172			697,933			597,998
Expenses:
Financial Guarantee:
Losses and loss adjustment expenses		26,700			20,000			15,000
Underwriting and operating expenses		76,804			69,748			57,883
Interest expense		2,035			4,676			4,027
Financial Services		5,256			4,104			5,270
Total expenses		110,795			98,528			82,180
Income before income taxes		729,377			599,405			515,818
Income tax expense:
Current taxes		184,010			146,796			103,812
Deferred taxes		4,959			656			24,324
Total income taxes		188,969			147,452			128,136
Net income	$	540,408		$	451,953		$	387,682

See accompanying Notes to Consolidated Financial Statements.

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Stockholder’s Equity

(Dollars In Thousands)

	Years Ended December 31,
	2001					2002						2000
Retained Earnings:
Balance at January 1	$	2,386,073				$	2,002,120					$	1,674,238
Net income		540,408		$	540,408		451,953		$	451,953			387,682		$	387,682
Dividends declared – common stock		(78,000	)				(68,000	)					(59,800	)
Balance at December 31	$	2,848,481				$	2,386,073					$	2,002,120
Accumulated Other Comprehensive Income (Loss):
Balance at January 1	$	80,556				$	81,616					$	(92,049	)
Unrealized gains (losses) on securities, $229,078, $(787), and $269,460, pre-tax, in 2002, 2001 and 2000, respectively) (1)					148,701					(511	)					175,149
Foreign currency loss					2,179					(549	)					(1,484	)
Other comprehensive (loss) income		150,880			150,880		(1,060	)		(1,060	)		173,665			173,665
Total comprehensive income				$	691,288				$	450,893					$	561,347
Balance at December 31	$	231,436				$	80,556					$	81,616
Common Stock:
Balance at January 1 and December 31	$	82,000				$	82,000					$	82,000
Additional Paid-in Capital:
Balance at January 1	$	928,094				$	760,006					$	751,522
Capital contribution		—					176,193						—
Capital issuance costs		(8,453	)				(8,468	)					—
Exercise of stock options		505					363						8,484
Balance at December 31	$	920,146				$	928,094					$	760,006
Total Stockholder’s Equity at December 31	$	4,082,063				$	3,476,723					$	2,925,742

(1)  Disclosure of reclassification amount:	2002		2001			2000
Unrealized holding gains arising during period	$	174,295	$	2,924		$	177,873
Less: reclassification adjustment for net gains included in net income		25,394		3,435			2,724
Net unrealized (losses) gains on securities	$	148,901	$	(511	)	$	175,149

See accompanying Notes to Consolidated Financial Statements.

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Stockholder’s Equity

(Dollars In Thousands)

	Years Ended December 31,
	2002			2001			2000
Cash flows from operating activities:
Net income	$	540,408		$	451,953		$	387,682
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		2,881			2,881			2,925
Amortization of bond premium and discount		(4,685	)		(7,615	)		(5,507	)
Current income taxes		(84,664	)		94,731			(2,474	)
Deferred income taxes		4,557			1,079			24,667
Deferred acquisition costs		(10,578	)		(10,053	)		(18,100	)
Unearned premiums, net		318,905			208,783			89,944
Losses and loss adjustment expenses		17,202			18,739			10,379
Ceded reinsurance balances payable		6,784			(746	)		(4,136	)
Net realized investment gains		(40,918	)		(2,124	)		(681	)
Net unrealized losses on credit derivative contracts		27,877			3,588			4,111
Other, net		(4,228	)		(10,868	)		14,862
Net cash provided by operating activities		773,541			750,348			503,672
Cash flows from investing activities:
Proceeds from sales of bonds		1,228,101			505,688			638,613
Proceeds from matured bonds		316,822			239,669			119,592
Purchases of bonds		(2,363,358	)		(1,523,590	)		(1,135,069	)
Change in short-term investments		(101,372	)		32,562			(11,384	)
Securities purchased under agreements to resell		(6,003	)		25,016			(25,016	)
Other, net		(25,715	)		(6,645	)		(5,611	)
Net cash used in investing activities		(951,525	)		(727,300	)		(418,875	)
Cash flows from financing activities:
Dividends paid		(78,000	)		(68,000	)		(59,800	)
Capital issuance costs		(8,452	)		(8,468	)		—
Payment agreements		250,534			—			—
Long-term financing from affiliates		(3,900	)		63,500			—
Short-term financing from affiliates		—			—			(7,930	)
Net cash used in financing activities		160,182			(12,968	)		(67,730	)
Net cash flow		(17,802	)		10,080			17,067
Cash at January 1		33,678			23,598			6,531
Cash at December 31	$	15,876		$	33,678		$	23,598
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Income taxes	$	206,833		$	51,289		$	96,116
Interest expense on affiliate financings	$	1,139		$	229		$	15

Supplemental disclosure of non-cash financing activities:

Ambac Assurance received capital contributions from its parent company in November 2001 in the form of fixed income securities amounting to $176,193.

See accompanying Notes to Consolidated Financial Statements.

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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 ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, Fitch, Inc., and Rating and Investment Information, Inc. Insurance policies insured by Ambac Assurance guarantee payment when due of the principal of and interest on the obligation guaranteed. Ambac Assurance is a wholly owned subsidiary of Ambac Financial Group, Inc., 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 accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates. The significant accounting policies of Ambac Assurance are as described below:

CONSOLIDATION:

The accompanying consolidated financial statements include the accounts of Ambac Assurance and its subsidiaries. The following companies have been consolidated with these financial statements: Ambac Assurance UK Limited, Ambac Credit Products, LLC, Connie Lee Holdings, Inc., Ambac Private Holdings, LLC, Ambac Financial Services, L.P., Ambac Capital Services, LLC and Ambac Japan Co., Ltd. All significant intercompany balances have been eliminated.

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 and are carried at fair value. 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. Short-term investments are carried at cost, which approximates fair value. Unrealized gains and losses, net of deferred income taxes, are included as a component of “Accumulated Other Comprehensive Income” in stockholder’s equity and are computed using amortized cost as the basis. If management believes that an unrealized loss is “other than temporary”, the carrying value of the investment is reduced and a realized investment loss is recorded in the Consolidated Statement of Operations. 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. For bonds purchased at a price above par value which have call features, premiums are amortized to the most likely call dates as determined by management. For premium bonds that do not have call features, such

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

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. Realized gains and losses on the sale of investments are determined on the basis of specific identification.

SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL:

Securities purchased under agreements to resell are collateralized investment transactions, and are recorded at their contracted resale amounts, plus accrued interest. Ambac Assurance takes possession of the collateral underlying those agreements and monitors its market value on a daily basis and, when necessary, requires prompt transfer of additional collateral to reflect current market value. At December 31, 2002, 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.

DEFERRED ACQUISITION COSTS:

Certain financial guarantee costs incurred, primarily related to the production of business, have been deferred. These costs include direct and indirect expenses related to underwriting, marketing and policy issuance, rating agency fees and premium taxes, net of reinsurance ceding commissions. The deferred acquisition costs are being amortized over the periods in which the related premiums are earned, and such amortization amounted to $32,336, $28,203 and $22,472 for 2002, 2001 and 2000, respectively. Deferred acquisition costs, net of such amortization, amounted to $10,578, $10,053 and $18,100 for 2002, 2001 and 2000, respectively.

LOSSES AND LOSS ADJUSTMENT EXPENSE RESERVE:

The reserve for losses and loss adjustment expenses consists of the active credit reserve and case basis credit loss and loss adjustment expense reserves. The active credit reserve is established based upon probable debt service defaults from incurred losses, as a result of credit deterioration. Reserve amounts are reasonably estimated based on managements review of each credit. When defaults occur, case basis credit loss reserves are established in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default and estimated expenses associated with settling the claims, less estimated recoveries under salvage or subrogation rights. These reserves are discounted in accordance with discount rates prescribed or permitted by state regulatory authorities. During 2002, 2001 and 2000, paid losses were $11,143, $2,595, and $4,622, respectively. All or parts of case basis credit loss reserves are allocated from any active credit reserves available. During 2002, 2001 and 2000, salvage amounts received were $553, $1,333 and $0, respectively.

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

OBLIGATIONS UNDER PAYMENT AGREEMENTS:

Ambac Assurance has obligations under certain payment agreements that represent funds received from various investors and used by Ambac Assurance to purchase high credit quality fixed income municipal investment securities. Obligations under payment agreements are recorded as liabilities on the Consolidated Balance Sheets at the face value of the agreement. Interest expense is

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

computed based upon daily outstanding settled liabilities balances, at rates and periods specified in the agreements. Net interest income related to payment agreements is included as a component of Financial Services revenue. As of December 31, 2002 the interest rates on these obligations ranged from 0.95% to 1.92%. These payment agreements are directly secured by the related municipal investment securities. 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:

Up-front insurance premiums written are received for an entire bond issue. A bond issue may contain several maturities. The premium is allocated to each bond maturity proportionally, based on total principal amount guaranteed and is recognized on a straight-line basis over the term of each maturity. Installment insurance premiums written are recognized over each installment period, generally one year or less. 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.

FINANCIAL SERVICES REVENUE:

Ambac Assurance provides interest rate swaps principally to states, municipalities and municipal authorities in connection with their financings. Ambac Assurance also enters into total return swaps with various financial institutions. All interest rate swaps and total return swap revenues are accounted for as “Derivative Contracts Held for Trading Purposes,” which is discussed in the Derivatives section below.

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 remaining term of the operating leases, ranging from four to ten years, using the straight-line method.

POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS:

Ambac Financial Group, through its subsidiaries, provides various postretirement and postemployment benefits, including pension, and health and life benefits covering substantially all employees who meet certain age and service requirements. Ambac Assurance accounts for these benefits under the accrual method of accounting. Amounts related to the defined benefit pension plan and postretirement health benefits are charged based on actuarial determinations.

FOREIGN CURRENCY:

Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with FAS 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 recorded as a separate component of comprehensive income, net of any related taxes. 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 arising primarily from short-

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

term investment securities denominated in foreign currencies are reflected in net income. The Consolidated Statements of Operations include pre-tax gains (losses) from such foreign exchange items of $1,402, $(3,370) and $(3,748) for 2002, 2001 and 2000, 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.

STOCK COMPENSATION PLANS:

Ambac Assurance participates in Ambac Financial Group’s equity plan. Under this plan, awards are granted to eligible employees of Ambac Assurance in the form of incentive stock options or other stock-based awards. Other than the tax benefits derived from this plan, pursuant to the tax sharing agreement, no other recognition is given by Ambac Assurance.

DERIVATIVE CONTRACTS:

In June 1998 the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 133, “Accounting for Derivative Instruments and Certain Hedging Activities.” In June 2000 the FASB issued SFAS 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of SFAS 133.” SFAS 133 and SFAS 138 require all derivative instruments be recorded on the balance sheet at their respective fair values. SFAS 133 and SFAS 138 are effective for all fiscal quarters of all fiscal years beginning after June 30, 2000; Ambac Assurance adopted SFAS 133 and SFAS 138 on January 1, 2001. In accordance with the transition provisions of SFAS 133, Ambac Assurance determined that it did not have an effect on the consolidated financial statements.

All derivative instruments are recognized in the Consolidated Balance Sheets as either assets or liabilities depending on the rights or obligations under the contracts. All derivative instruments are measured at estimated fair value. The fair values of derivative instruments are determined by broker quotes or valuation models when broker quotes are not available. Valuation 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.

8

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Ambac Assurance, through its affiliate 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 Assurance, through its subsidiary Ambac Capital Services, enters into total return swaps with professional counterparties. Total return swaps are only used for fixed income obligations, which meet Ambac Assurance’s credit underwriting criteria. Ambac Assurance, through its subsidiary Ambac Credit Products, enters into structured credit derivative transactions with various financial institutions. Ambac Financial Services’ interest rate swaps and futures contracts, Ambac Capital Services’ total return swaps and Ambac Credit Products’ structured credit derivatives are classified as held for trading purposes. These contracts are recorded on trade date at fair value. Changes in fair value are recorded as a component of Financial Services income for interest rate swaps, total return swaps and futures contracts in the accompanying Consolidated Statements of Operations. The fee component of structured credit derivatives is reflected in Other Credit Enhancement Fees in the accompanying Consolidated Statements of Operations. The mark-to-market gain or loss associated with credit spread changes on structured credit derivatives is reflected in Net unrealized losses on credit derivative contracts in the accompanying Consolidated Statements of Operations.

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 Product Assets or Derivative Product Liabilities on the Consolidated Balance Sheets.

SPECIAL PURPOSE ENTITIES:

Ambac Financial Group has transferred third-party debt obligations to two special purpose entities. The business purpose of these entities is to provide some of our financial guarantee clients with funding for their debt obligations. These special purpose entities meet the characteristics of Qualifying Special Purpose Entities (“QSPEs”) in accordance with Statement of Financial Accounting Standards 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. The QSPEs are not consolidated in Ambac Financial Group’s consolidated 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 (i) purchasing assets from Ambac Financial Group, which are defined in the governing documents of the QSPEs, (ii) issuing Medium Term Notes (“MTNs”) to fund such purchase, (iii) executing derivative hedges and (iv) providing related administrative services. The QSPEs hold only passive debt obligations transferred to it by Ambac Financial Group, passive derivative financial instruments used for hedging purposes and cash collected from assets that it holds pending distribution to the MTN holders. The QSPEs do not hold equity or other types of securities that would allow for voting rights, significant influence or contractual options such as the right to unconditionally put or call a financial instrument. The legal documents that established the QSPEs or created the beneficial interests in the transferred assets do not permit the sale or other disposal of the transferred financial assets except for disposals in automatic response to the terms of such financial assets (this would include only issuer call provisions). These required disposals are outside the control of Ambac Financial Group, its affiliates and the QSPEs. Beneficial interest holders do not have the rights to put their beneficial interest back to the QSPEs.

As of December 31, 2002, there have been 12 individual transactions processed through the QSPEs. In each case, Ambac Financial Group sells fixed income debt obligations issued by third parties to the

9

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

QSPEs. Ambac Financial Group receives cash consideration for all assets transferred to the QSPEs. Ambac Financial Group surrenders control over the transferred debt obligations. There are no agreements that entitle or obligate Ambac Financial Group to repurchase or redeem assets. The QSPEs are structured as bankruptcy remote entities. Ambac Financial Group management believes that the assets transferred represent a true sale and the assets held by the QSPEs are beyond the reach of Ambac Financial Group and its creditors, even in bankruptcy or other receivership. Legal counsel has concurred with management’s belief and has provided Ambac Financial Group true sale and non-substantive consolidation opinions. The purchase by the QSPEs is financed through the issuance of MTNs, which are collateralized by the purchased assets. Derivative contracts may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase debt obligations. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued and the derivative contracts used. As of December 31, 2002, Ambac Assurance had financial guarantee insurance policies issued for all assets owned, MTNs issued and derivative contracts used by the QSPEs.

Ambac Assurance’s exposure under these financial guarantee insurance policies is included in the disclosure in Note 10 “Guarantees in Force” to the consolidated financial statements. 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. To date, no losses have been recognized. Under the terms of an Administrative Agency Agreement, Ambac Financial Group provides some administrative services, primarily collecting amounts due on the obligations and making interest payments on the MTNs.

Assets sold to the QSPEs during 2002, 2001 and 2000 were $350,000, $793,438 and $159,937, respectively. No gains or losses were recognized on these sales. As of December 31, 2002, the estimated fair value of financial assets, MTN liabilities and derivative hedge liabilities were $1,347,287, $1,263,530 and $90,958, respectively. When market quotes are not available, estimated fair value is determined utilizing valuation models. These models include estimates, made by Ambac Financial Group 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. Ambac Assurance received gross premiums and other fees for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $19,255, $23,682 and $3,204 for the years ended December 31, 2002, 2001 and 2000, respectively. Ambac Financial Group received fees for providing administrative services amounting to $80, $302 and $180 for 2002, 2001 and 2000, respectively.

ACCOUNTING STANDARDS:

In January 2003, the FASB issued FAS Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). FIN 46 clarifies the consolidation rules to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 requires variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. Variable interest entities that effectively disperse risks will not be consolidated. FIN 46 requires disclosures for entities that have either a primary or significant variable interest in a variable interest entity. Ambac Assurance is required to adopt the consolidation provisions of FIN 46 on July 1, 2003. Based upon Ambac Assurance’s current assessment,

10

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

it does not have a significant variable interest in any Variable Interest Entity affected by this Interpretation.

RECLASSIFICATIONS:

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

3    INVESTMENTS

The amortized cost, gross unrealized gains and losses, and estimated fair value of investments in fixed income securities and short-term investments at December 31, 2002 and 2001 were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
2002
Municipal obligations	$	4,439,062	$	287,765	$	4,494	$	4,722,333
Corporate obligations		405,070		30,406		2,982		432,494
Foreign government obligations		108,071		12,562		33		120,600
U.S. government obligations		99,178		2,765		336		101,607
Mortgage and asset-backed securities (includes U.S. government agency obligations)		815,107		30,929		8		846,028
Short-term		287,315		—		—		287,315
	$	6,153,803	$	364,427	$	7,853	$	6,510,377
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
2001
Municipal obligations	$	3,439,356	$	129,826	$	28,887	$	3,540,295
Corporate obligations		644,216		22,762		10,777		656,201
Foreign government obligations		97,108		629		1,137		96,600
U.S. government obligations		51,182		3,582		—		54,764
Mortgage and asset-backed securities (includes U.S. government agency obligations)		723,680		13,018		1,519		735,179
Short-term		185,943		—		—		185,943
	$	5,141,485	$	169,817	$	42,320	$	5,268,982

11

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

The amortized cost and estimated fair value of fixed income securities and short-term investments at December 31, 2002, by contractual maturity, were as follows:

	Amortized Cost		Estimated Fair Value
2002
Due in one year or less	$	370,825	$	373,563
Due after one year through five years		473,878		506,523
Due after five years through ten years		762,045		821,410
Due after ten years		3,731,948		3,962,853
		5,338,696		5,664,349
Mortgage and asset-backed securities (includes U.S. government agency obligations)		815,107		846,028
	$	6,153,803	$	6,510,377

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.

Securities carried at $6,240 and $5,964 at December 31, 2002 and 2001 respectively, were deposited by Ambac Assurance with governmental authorities or designated custodian banks as required by laws affecting insurance companies.

Net investment income of Ambac Assurance comprised the following:

	2002			2001			2000
Fixed income securities	$	297,740		$	260,074		$	232,876
Short-term investments		2,801			9,995			9,904
Total investment income		300,541			270,069			242,780
Investment expense		(3,275	)		(2,451	)		(1,733	)
Net investment income	$	297,266		$	267,618		$	241,047

Net realized investment gains in 2002 were $40,918, compared to net realized investment gains of $2,124 and $681 in 2001 and 2000, respectively. The following table details amounts included in net realized gains:

	2002			2001			2000
Gross realized gains on securities sold	$	45,344		$	8,672		$	8,517
Gross realized losses on securities sold		(6,276	)		(3,388	)		(4,327	)
Foreign exchange gains (losses) on investments		1,850			(3,160	)		(3,509	)
Net realized gains	$	40,918		$	2,124		$	681

12

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

4    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,
	2002						2001						2000
	Written			Earned			Written			Earned			Written			Earned
Direct	$	875,928		$	521,177		$	636,574		$	414,700		$	442,714		$	338,139
Assumed		32,962			41,486			50,883			38,825			42,971			32,530
Ceded		(113,542	)		(85,071	)		(95,534	)		(70,483	)		(80,789	)		(56,162	)
Net premiums	$	795,348		$	477,592		$	591,923		$	383,042		$	404,896		$	314,507

The reinsurance of risk does not relieve the ceding insurer of its original liability to its policyholders. In the event that all or any of the reinsurers are unable to meet their obligations to Ambac Assurance under the existing reinsurance agreements, Ambac Assurance would be liable for such defaulted amounts. To minimize its exposure to significant losses from reinsurers, Ambac Assurance (i) evaluates the financial condition of its reinsurers; (ii) has collateral provisions in certain reinsurance contracts and (iii) has certain termination triggers that can be exercised by Ambac Assurance in the event of a rating downgrade of a reinsurer. Additionally, as of December 31, 2002, Ambac Assurance held bank letters of credit and collateral amounting to approximately $135,681 from its reinsurers to cover liabilities ceded under the aforementioned reinsurance contracts. For the years ended December 31, 2002, 2001 and 2000, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $1,334, $0 and $0, respectively. Reinsurance recoverables on paid losses and loss adjustment expenses as of December 31, 2002 and 2001 were $242 and $0, respectively. As of December 31, 2002, prepaid reinsurance of approximately $181,378 was associated with Ambac Assurance’s three largest reinsurers. Ambac pledged cash and fixed income securities to foreign insurers of $11,166 and $9,295 at December 31, 2002 and 2001, respectively, related to business assumed from those insurers.

5    LOSSES AND LOSS ADJUSTMENT EXPENSE RESERVE

As discussed in note 2, Ambac Assurance’s liability for losses and loss adjustment 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 adjustment expense reserves:

13

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

	2002			2001			2000
Case basis credit loss and loss adjustment expense reserves:
Balance at January 1	$	24,384		$	24,466		$	10,726
Less: reinsurance recoverables		1,021			1,011			—
Net Balance at January 1		23,363			23,455			10,726
Incurred related to:
Current year		36,365			38			16,000
Prior years		(1,480	)		1,131			1,350
Total incurred		34,885			1,169			17,350
Paid related to:
Current year		5,740			—			—
Prior years		3,516			1,261			4,621
Total paid		9,256			1,261			4,621
Net balance at December 31		48,992			23,363			23,455
Plus reinsurance recoverables		4,600			1,021			1,011
Balance at December 31		53,592			24,384			24,466
Active credit reserve:
Balance at January 1		126,730			107,899			110,249
Net provision for losses		26,700			20,000			15,000
Transfers to case reserves		(34,885	)		(1,169	)		(17,350	)
Balance at December 31		118,545			126,730			107,899
Total	$	172,137		$	151,114		$	132,365

6    COMMITMENTS AND CONTINGENCIES

Ambac Assurance 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
2003	$	5,316
2004		6,854
2005		6,868
2006		6,882
2007		6,131
All later years		88,523
	$	120,574

Rent expense for the aforementioned leases amounted to $6,377, $5,916 and $5,549 for the years ended December 31, 2002, 2001 and 2000, respectively.

7    INSURANCE REGULATORY

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

14

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

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. Based upon these restrictions, at December 31, 2002, the maximum amount that will be available during 2003 for payment of dividends by Ambac Assurance is approximately $223,000. Ambac Assurance paid cash dividends of $78,000, $68,000 and $59,800 on its common stock in 2002, 2001 and 2000, respectively.

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, 2002 and 2001, 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. Effective January 1, 2001, Wisconsin adopted the National Association of Insurance Commissioners’ statutory accounting practices (“NAIC SAP”) as a component of its prescribed accounting practices. The adoption of the NAIC SAP did not have a material effect on Ambac Assurance’s statutory capital. 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 release 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 $169,015, $183,269 and $154,175 for 2002, 2001 and 2000, respectively.

Statutory capital and surplus differs from stockholder’s equity determined under GAAP principally due to statutory accounting rules that treat loss reserves, premiums earned, policy acquisition costs, and deferred income taxes differently. The following is a reconciliation of consolidated stockholder’s equity presented on a GAAP basis for Ambac Assurance and its consolidated subsidiaries to statutory capital and surplus for Ambac Assurance:

15

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

	For the Years Ended December 31,
	2002			2001
Ambac Assurance Corporation GAAP stockholder’s equity	$	4,082,063		$	3,476,723
Mandatory contingency reserve		(1,508,898	)		(1,265,652	)
GAAP loss reserves		118,545			126,730
Unearned premium reserve		(376,957	)		(345,284	)
Deferred acquisition costs		(174,055	)		(163,477	)
Income taxes		271,570			178,191
Tax and loss bonds		191,139			128,371
Unrealized losses on investments		(360,469	)		(139,587	)
Other		(15,500	)		269
Statutory capital and surplus	$	2,227,438		$	1,996,284

Statutory net income was $486,246, $394,559 and $381,328 for 2002, 2001 and 2000, respectively.

8    INCOME TAXES

The total effect of income taxes on income and stockholder’s equity for the years ended December 31, 2002 and 2001 was as follows:

	2002			2001
Total income taxes charged to income	$	188,969		$	147,452
Income taxes (credited) charged to stockholder’s equity:
Unrealized gains (losses) on bonds		80,177			(275	)
Exercise of stock options		(505	)		(363	)
Total charged (credited) to stockholder’s equity		79,672			(638	)
Total effect of income taxes	$	268,641		$	146,814

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:

	2002			%		2001			%		2000			%
Computed expected tax at statutory rate	$	255,282		35.0	%	$	209,792		35.0	%	$	180,536		35.0	%
Reductions in expected tax resulting from:
Tax-exempt interest		(63,065	)	(8.6	)		(59,644	)	(10.0	)		(50,479	)	(9.8	)
Other, net		(3,248	)	(0.5	)		(2,696	)	(0.4	)		(1,921	)	(0.4	)
Income tax expense	$	188,969		25.9	%	$	147,452		24.6	%	$	128,136		24.8	%

16

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

The tax effects of temporary differences that give rise to significant portions of the deferred tax liabilities and deferred tax assets at December 31, 2002 and 2001 are presented below:

	2002		2001
Deferred tax liabilities:
Contingency reserve	$	226,957	$	163,957
Unrealized gains on bonds		124,801		44,624
Deferred acquisition costs		60,110		56,783
Unearned premiums and credit fees		55,500		57,516
Other		7,984		6,099
Total deferred tax liabilities		475,352		328,979
Deferred tax assets:
Tax and loss bonds		191,371		128,371
Loss reserves		40,535		42,903
Compensation		7,047		5,859
Other		4,130		4,204
Sub-total deferred tax assets		243,083		181,337
Valuation allowance		—		—
Total deferred tax assets		243,083		181,337
Net deferred tax liabilities	$	232,269	$	147,642

Ambac Assurance believes that no valuation allowance is necessary in connection with the deferred tax assets.

9    EMPLOYEE BENEFITS

Pensions:

Ambac Financial Group has a defined benefit pension plan covering substantially all employees of Ambac. The benefits are based on years of service and the employee’s highest salary during five consecutive years of employment within the last ten years of employment. Ambac Financial Group’s funding policy is to contribute annually the maximum amount that can be deducted for Federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service-to-date but also for those expected to be earned in the future.

The table below sets forth a reconciliation of the beginning and ending projected benefit obligation, beginning and ending balances of the fair value of plan assets, and the funded status of the plan as of December 31, 2002 and 2001:

17

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

	2002			2001
Change in Projected Benefit Obligation:
Projected benefit obligation at beginning of year	$	14,360		$	12,669
Service cost		1,397			1,031
Interest cost		922			853
Actuarial loss (gain)		1,605			(189	)
Benefits paid		(254	)		(254	)
Other		—			250
Projected benefit obligation at end of year	$	18,030		$	14,360
Change in Plan Assets:
Fair value of plan assets at beginning of year	$	12,831		$	11,957
Actual return on plan assets		(1,556	)		(872	)
Ambac Financial Group contributions		1,500			2,000
Benefits paid		(254	)		(254	)
Fair value of plan assets at end of year	$	12,521		$	12,831
Funded status	$	(5,509	)	$	(1,529	)
Unrecognized loss (gain)		5,512			1,132
Unrecognized prior service cost		(249	)		(379	)
Pension liability	$	(246	)	$	(776	)

Ambac Financial Group’s net pension costs for the years ended December 31, 2002, 2001 and 2000 included the following components:

	2002			2001			2000
Service cost	$	1,397		$	1,031		$	892
Interest cost on expected benefit obligation		992			853			829
Expected return on plan assets		(1,289	)		(1,286	)		(1,056	)
Amortization of unrecognized transition asset		—			—			—
Amortization of prior service cost		(131	)		(151	)		(151	)
Recognized net actuarial (gain) loss		—			(78	)		(12	)
Net periodic pension cost	$	969		$	369		$	502

Pension expense is allocated to each of Ambac Financial Group’s subsidiaries based on percentage of payroll. Pension expense recorded by Ambac Assurance amounted to $812, $281 and $375 in 2002, 2001 and 2000, respectively.

The discount rate used in the determination of the actuarial present value for the projected benefit obligation was 6.5% and 7.0% for 2002 and 2001, respectively. The expected long-term rate of return on assets was 8.75% and 9.25% for 2002 and 2001, respectively. The rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation was 4.5% for both 2002 and 2001.

Substantially all employees of Ambac Financial Group and its subsidiaries are covered by a defined contribution plan (the “Savings Incentive Plan”), for which contributions and costs are determined as 6% of each eligible employee’s eligible base salary, plus a matching company contribution of 50% on contributions up to 6% of base salary made by eligible employees to the Savings Incentive

18

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Plan. The total cost of the Savings Incentive Plan to Ambac Assurance was $2,019, $2,188 and $1,940 in 2002, 2001 and 2000, respectively.

    Annual Incentive Program:

Ambac Financial Group has an annual incentive program that provides for awards to key officers and employees based upon predetermined criteria. Ambac Assurance’s cost of the program for the years ended December 31, 2002, 2001 and 2000 amounted to $30,190, $24,927 and $21,055, respectively.

    Postretirement Health Care and Other Benefits:

Ambac Financial Group provides certain medical and life insurance benefits for retired employees and eligible dependents. All plans are contributory. None of the plans are currently funded.

Ambac Assurance’s postretirement benefits expense was $73, $113 and $328 in 2002, 2001 and 2000, respectively. Ambac Financial Group’s unfunded accumulated postretirement benefit obligation was $961, and the related accrued postretirement liability was $2,425 as of December 31, 2002.

The assumed health care cost trend rates range from 10.0% in 2003, decreasing ratably to 6.0% in 2009. Increasing the assumed health care cost trend rate by one percentage point in each future year would increase Ambac Financial Group’s accumulated postretirement benefit obligation at December 31, 2002 by $175 and Ambac Financial Group’s 2002 benefit expense by $55. The discount rate used to measure the accumulated postretirement benefit obligation and 2002 expense was 6.5%.

10    GUARANTEES IN FORCE

The par amount of financial guarantees outstanding, for non-affiliates, were $423,454,000 and $357,219,000 at December 31, 2002 and 2001, respectively. The par amount of financial guarantees outstanding, for non-affiliates, net of reinsurance, were $379,211,000 and $318,043,000 at December 31, 2002 and 2001, respectively. As of December 31, 2002 and 2001, the guarantee portfolio was diversified by type of guaranteed bond as shown in the following table:

19

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

	Net Par Amount Outstanding
(Dollars in Millions)	2002		2001
Public Finance:
Lease and tax-backed revenue	$	60,118	$	52,102
General obligation		41,359		39,664
Utility revenue		33,289		29,513
Health care revenue		20,675		19,003
Transportation revenue		15,218		13,000
Higher education		14,138		11,854
Housing revenue		8,345		7,476
Student loans		7,629		7,249
Other		5,723		5,103
Total Public Finance		206,494		184,964
Structured Finance:
Mortgage-backed and home equity		49,262		42,723
Asset-backed and conduits		25,977		20,687
Investor-owned utilities		14,285		11,642
Pooled debt obligations (1)		9,178		7,068
Other		6,290		6,612
Total Structured Finance		104,992		88,732
International Finance:
Pooled debt obligations (1)		45,697		27,206
Asset-backed and conduits		9,232		6,185
Mortgage-backed and home equity		4,828		2,602
Investor-owned and public utilities		3,680		2,878
Sovereign/sub-sovereign		1,916		1,299
Other		2,372		4,177
Total International Finance		67,725		44,347
	$	379,211	$	318,043

(1) Pooled debt obligations include $43,701 and $26,123 of structured credit derivatives at December 31, 2002 and December 31, 2001, respectively.

As of December 31, 2002 and 2001, the International Finance guarantee portfolio is shown in the following table by location of risk:

	Net Par Amount Outstanding
(Dollars in Millions)	2002		2001
Germany	$	10,556	$	5,804
United Kingdom		9,289		6,531
Australia		2,486		1,623
Japan		2,393		1,167
France		1,001		1,155
Mexico		668		654
Internationally diversified		36,454		23,312
Other international		4,878		4,101
Total International Finance	$	67,725	$	44,347

Internationally diversified includes pooled debt obligations. Such obligations represent pools of geographically diversified exposures which includes components of domestic exposure.

20

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Direct financial guarantees in force (principal and interest) were $632,194,000 and $542,458,000 at December 31, 2002 and 2001, respectively. Net financial guarantees in force (after giving effect to reinsurance) were $557,422,000 and $476,190,000 as of December 31, 2002 and 2001, respectively.

In the United States, California and New York were the states with the highest aggregate net par amounts in force, accounting for 8.8% and 5.6% of the total at December 31, 2002. No other state accounted for more than five percent. The highest single insured risk represented less than 1% of aggregate net par amount insured.

11    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 market 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.

Short-term investments, other investments and cash: The fair values of short-term investments, other investments and cash are assumed to approximate amortized cost.

Securities purchased under agreements to resell: The fair value of securities purchased under agreements to resell is assumed to approximate carrying value.

Investment income due and accrued: The fair value of investment income due and accrued is assumed to approximate carrying value.

Derivative contracts held for trading purposes: The fair values of interest rate swaps, total return swaps and structured credit derivative transactions, as discussed in Note 2, are based on quoted dealer prices, current settlement values, or valuation models.

Obligations under payment agreements: The fair value of payment agreements is assumed to approximate carrying value.

Note payable to affiliate: The fair value of the note payable is assumed to equal 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 an estimated ceding commission thereon.

21

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Other financial guarantee insurance policies have been written on an installment basis, where the future premiums to be received by Ambac Assurance are determined based on the outstanding exposure at the time the premiums are due. The fair value of Ambac Assurance’s liability under its installment premium policies is measured using the present value of estimated future installment premiums, less an estimated ceding commission. 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. This measure is used as an estimate of the cost to reinsure Ambac Assurance’s liability under these policies.

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

	As of December 31,
	2002				2001
(Dollars in Millions)	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Financial assets:
Fixed income securities	$	6,223	$	6,223	$	5,083	$	5,083
Short-term investments		287		287		186		186
Other investments		1		1		1		1
Cash		16		16		34		34
Securities purchased under agreements to resell		58		58		—		—
Investment income due and accrued		81		81		73		73
Derivative product assets:
Trading purposes		1,010		1,010		384		384
Financial liabilities:
Obligations under payments agreements		250		250		—		—
Note payable to affiliate		60		60		64		64
Derivative product liabilities:
Trading purposes		954		954		326		326
Liability for financial guarantees written:
Gross (up-front)		2,137		1,496		1,790		1,253
Net (up-front)		1,841		1,289		1,522		1,065
Gross installment premiums		—		1,110		—		818
Net installment premiums		—		940		—		691

12    LONG-TERM DEBT AND LINES OF CREDIT

At December 31, 2002, Ambac Private Holdings had an unsecured note payable to an affiliate, Ambac Investments, Inc. with a carrying value of $59,600 and a maturity date of October 30, 2006. This note pays interest quarterly at 0.2% below three month LIBOR, currently at 1.20%.

22

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

Ambac Financial Group and Ambac Assurance have a revolving credit facility with six major international banks for $300,000, which expires in July 2003 and provides a two-year term loan provision. The facility is available for general corporate purposes, including the payment of claims. As of December 31, 2002 and 2001, no amounts were outstanding under this credit facility. This facility’s financial covenants require that Ambac Financial Group: (i) maintain as of the end of each fiscal quarter a debt to capital ratio of not more than 30% and (ii) maintain at all times total stockholders’ equity equal to or greater than $1.75 billion.

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, the preferred stock holdings of Ambac Assurance 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. If 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. Dividend payments on the preferred stock are cumulative 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 preferred stock. Ambac Assurance pays a floating put option fee. Each trust is rated AA/Aa2 by Standard & Poor’s and Moody’s respectively.

13    RELATED PARTY TRANSACTIONS

During 2002 and 2001, 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, 2002 and 2001, the aggregate amount of investment agreements and investment repurchase agreements insured was $6,266,847 and $4,831,601, respectively, including accrued interest. These 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, 2002 and 2001, had a fair value of $6,461,770 and $4,924,367, respectively, in the aggregate. During 2002 and 2001, Ambac Assurance recorded gross premiums written of $4,858 and $4,162, and net premiums earned of $6,058 and $4,309, respectively, related to these agreements.

During 2002 and 2001, several interest rate swap transactions were executed between Ambac Financial Services and its affiliates (other than Ambac Assurance). As of December 31, 2002 and 2001, these contracts had an outstanding notional amount of approximately $1,013,000 and $986,000, respectively. As of December 31, 2002 and 2001, Ambac Financial Services recorded a liability of $8,673 and an asset of $4,909, respectively, related to these transactions.

In 2001, Ambac Assurance received a capital contribution in the form of fixed income securities amounting to $176,193 from Ambac Financial Group.

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

14    SEGMENT INFORMATION

Ambac Assurance has two reportable segments, as follows: (1) financial guarantee, which provides financial guarantees (including structured credit derivatives) for public finance and structured finance obligations; and (2) financial services, which provides payment agreements, interest rate 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”. Pursuant to insurance and indemnity agreements between Ambac Financial Services and Ambac Assurance, Ambac Financial Services’ payment obligations under its swap agreements are guaranteed by Ambac Assurance. Additionally, the payment obligations of Ambac Financial Services’ counterparties, under their swap agreements with Ambac Financial Services, are guaranteed by Ambac Assurance pursuant to insurance and indemnity agreements. Intersegment revenues include the premiums earned under those agreements. Such premiums are determined as if they were premiums to third parties, that is, at current market prices.

The following table is a summary of the financial information by reportable segment as of and for the years ended December 31, 2002, 2001 and 2000:

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

	Financial Guarantee		Financial Services			Intersegment Eliminations			Total Consolidated
2002:
Revenues:
External customers	$	821,670	$	18,502		$	—		$	840,172
Intersegment		1,329		—			(1,329	)		—
Total revenues	$	822,999	$	18,502		$	(1,329	)	$	840,172
Income before income taxes:
External customers	$	716,131	$	13,246		$	—		$	729,377
Intersegment		1,329		(1,329	)		—			—
Total income before income taxes	$	717,460	$	11,917		$	—		$	729,377
Identifiable assets	$	7,035,850	$	1,159,530		$	—		$	8,195,380
2001:
Revenues:
External customers	$	675,512	$	22,421		$	—		$	697,933
Intersegment		697		—			(697	)		—
Total revenues	$	676,209	$	22,421		$	(697	)	$	697,933
Income before income taxes:
External customers	$	581,088	$	18,317		$	—		$	599,405
Intersegment		697		(697	)		—			—
Total income before income taxes	$	581,785	$	17,620		$	—		$	599,405
Identifiable assets	$	5,960,900	$	277,335		$	—		$	6,238,235
2000:
Revenues:
External customers	$	568,509	$	29,489		$	—		$	597,998
Intersegment		582		—			(582	)		—
Total revenues	$	569,091	$	29,489		$	(582	)	$	597,998
Income before income taxes:
External customers	$	491,599	$	24,219		$	—		$	515,818
Intersegment		582		(582	)		—			—
Total income before income taxes	$	492,181	$	23,637		$	—		$	515,818
Identifiable assets	$	4,870,075	$	192,564		$	—		$	5,062,639

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AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Dollar Amounts in Thousands)

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, 2002, 2001 and 2000.

	2002		2001		2000
Gross premiums written:
United States	$	770,883	$	539,886	$	375,872
United Kingdom		39,248		40,650		19,325
Japan		22,033		12,204		7,655
Mexico		16,513		16,285		16,232
Australia		9,379		7,308		27,647
Germany		1,207		483		418
France		884		856		970
Internationally diversified		16,841		30,615		14,754
Other international		31,902		39,170		22,812
Total:	$	908,890	$	687,457	$	485,685
Net premiums earned and other credit enhancement fees:
United States	$	387,714	$	322,788	$	267,676
United Kingdom		20,040		11,043		7,138
Japan		17,941		8,939		6,252
Mexico		7,720		7,540		7,461
Australia		4,945		3,761		3,058
Germany		4,808		2,092		1,052
France		1,174		1,116		1,133
Internationally diversified		40,926		33,706		24,434
Other international		21,099		13,718		8,460
Total:	$	506,367	$	404,703	$	326,664

Internationally diversified includes components of domestic exposure.

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