424B5 1 d424b5.htm PROSPECTUS SUPPLEMENT Prospectus Supplement
Table of Contents

Filed Pursuant to Rule 424(b)(5)
Registration No. 333-131888

This prospectus supplement relates to an effective registration statement under the Securities Act of 1933, but it is not complete and may be changed. This is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED MARCH 5, 2008

PRELIMINARY PROSPECTUS SUPPLEMENT TO PROSPECTUS DATED JANUARY 16, 2008

Equity Units

(Initially Consisting of              Corporate Units)

LOGO

Ambac Financial Group, Inc.

 

 

This is an offering of Equity Units by Ambac Financial Group, Inc. (initially consisting of Corporate Units), which we refer to as the Equity Units Offering. Each Corporate Unit will have a stated amount of $50 and will consist of a purchase contract issued by us and, initially, a  1/20, or 5%, undivided beneficial ownership interest in a $1,000 principal amount senior note initially due February 15, 2021 issued by us.

   

The purchase contract will obligate you to purchase from us, and us to sell to you, on May 17, 2011, for $50 in cash, the following number of shares of our common stock, subject to anti-dilution adjustments:

 

   

if the applicable market value of our common stock, which will be determined by reference to the average of the volume weighted average prices per share of our common stock over the 20-trading day period ending on the third trading day prior to May 17, 2011, is greater than or equal to the threshold appreciation price of $            , the settlement rate will be                  shares of our common stock;

 

   

if the applicable market value is less than the threshold appreciation price, but greater than the reference price of $            , a number of shares of our common stock equal to $50 divided by the applicable market value; and

 

   

if the applicable market value is less than or equal to the reference price,              shares of our common stock.

 

 

   

We will also pay you quarterly contract adjustment payments at a rate of     % per year on the stated amount of $50 per Equity Unit, or $              per year, as described in this prospectus supplement.

 

   

The senior notes will initially bear interest at a rate of     % per year, payable quarterly. The senior notes will be remarketed as described in this prospectus supplement. If this remarketing is successful, the interest rate on the senior notes will be reset and thereafter interest will be payable semi-annually at the reset rate. In connection with a successful remarketing, we may elect to change the maturity date of the senior notes to an earlier date not earlier than May 17, 2013, as described in this prospectus supplement.

 

   

If there is a successful remarketing of the senior notes as described in this prospectus supplement, and you hold Corporate Units, the proceeds from the remarketing will be invested in a portfolio of treasury securities, the proceeds of which will, upon their maturity, be used to satisfy your payment obligations under the purchase contract, unless you have elected to settle with separate cash.

 

   

You can create Treasury Units from Corporate Units by substituting treasury securities for your undivided beneficial ownership interest in the senior notes or the applicable ownership interest in the Treasury portfolio comprising a part of the Corporate Units, and you can recreate Corporate Units by substituting the senior notes or the applicable ownership interest in the Treasury portfolio for the treasury securities comprising a part of the Treasury Units.

 

   

Your ownership interest in the senior notes, the applicable ownership interest in the Treasury portfolio or the treasury securities, as the case may be, will be pledged to us to secure your obligation under the related purchase contract.

 

   

As of the date of this prospectus supplement, purchase contracts may settle for more shares of our common stock than we currently have authorized and unissued. We have undertaken to use our commercially reasonable efforts to authorize as promptly as practicable a sufficient number of shares of our common stock with which to settle the purchase contracts. If sufficient shares for the settlement of all purchase contracts are not authorized at the time of settlement of any purchase contract, we will deliver, in lieu of shares of our common stock, shares of our Series A Preferred Stock, each of which will automatically convert into 100 shares of our common stock upon the occurrence of our having a sufficient number of shares of our common stock issuable upon settlement of all purchase contracts. If we do not have a sufficient number of authorized and unissued shares of common stock within 120 days after the date of the issuance of the Equity Units, we will be required to pay additional contract adjustment payments to holders of the Equity Units and additional dividends on any outstanding Series A Preferred Stock on the terms described in this prospectus supplement.

We intend to list the Corporate Units on the New York Stock Exchange or another national securities exchange. Prior to this offering, there has been no public market for the Corporate Units.

Our common stock is listed on the New York Stock Exchange under the symbol “ABK.” The closing price of our common stock on the New York Stock Exchange on March 4, 2008 was $10.72 per share.

We are making a concurrent offering of              shares of common stock pursuant to a separate prospectus supplement, which we refer to as the Common Stock Offering. The completion of this Equity Units Offering is contingent upon the completion of the Common Stock Offering.

Investing in our Equity Units involves a high degree of risk. You should not invest unless you can afford to lose your entire investment. See “ Risk Factors” beginning on page S-23 of this prospectus supplement to read about factors you should consider before buying our Equity Units. You should also consider the risk factors described in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, and in the other documents we incorporate herein by reference.

 

      

Price to

Public

    

Underwriting
Discounts and
Commissions(1)

    

Proceeds to Ambac
Financial Group, Inc.

Per Equity Unit

     $                      $                      $                

Total

     $                      $                      $                

 

(1) Included in this calculation of “Underwriting Discounts and Commissions” is the structuring fee paid to Credit Suisse Securities (USA) LLC equal to 1% of gross proceeds raised in any capital-raising transaction by the Company. See “Underwriting—Other Relationships” in this prospectus supplement for additional information.

We have granted the underwriters a 13-day option to purchase up to              additional Equity Units solely to cover over-allotments, if any.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities, or determined if this prospectus supplement or the accompanying prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Delivery of the Equity Units in book-entry form only will be made through the facilities of The Depository Trust Company on or about March     , 2008.

Joint Book Running Managers

 

Credit Suisse   Citi

 

Banc of America Securities LLC   UBS Securities LLC

 

 

Keefe, Bruyette & Woods

The date of this prospectus supplement is March     , 2008


Table of Contents

TABLE OF CONTENTS

 

PROSPECTUS SUPPLEMENT  
    Page

ABOUT THIS PROSPECTUS SUPPLEMENT

  S-ii

FORWARD-LOOKING STATEMENTS

  S-ii

PROSPECTUS SUPPLEMENT SUMMARY

  S-1

RISK FACTORS

  S-23

USE OF PROCEEDS

  S-43

CAPITALIZATION

  S-44

COMMON STOCK OFFERING

  S-45

PRICE RANGE OF COMMON STOCK AND DIVIDENDS

  S-46

DISCUSSION OF CERTAIN PORTFOLIO RISKS

  S-47

DESCRIPTION OF THE EQUITY UNITS

  S-58

DESCRIPTION OF THE PURCHASE CONTRACTS

  S-64

CERTAIN PROVISIONS OF THE PURCHASE CONTRACT AGREEMENT AND PLEDGE AGREEMENT

  S-84

DESCRIPTION OF OUR SENIOR NOTES

  S-88

DESCRIPTION OF OUR CAPITAL STOCK

  S-93

CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS

  S-98

UNDERWRITING

  S-107

WHERE YOU CAN FIND MORE INFORMATION

  S-114

LEGAL OPINIONS

  S-114

EXPERTS

  S-114
PROSPECTUS  
    Page

ABOUT THIS PROSPECTUS

  1

AMBAC FINANCIAL GROUP, INC.

  1

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

  3

USE OF PROCEEDS

  4

RATIO OF EARNINGS TO FIXED CHARGES

  5

DESCRIPTION OF SECURITIES

  6

Description of Capital Stock

  6

Description of Depositary Shares

  8

Description of Debt Securities

  11

Description of Warrants

  21

Description of Stock Purchase Contracts and Stock Purchase Units

  22

WHERE YOU CAN FIND MORE INFORMATION

  23

LEGAL OPINIONS

  24

EXPERTS

  25

 

 

OUR ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007 IS ATTACHED TO THIS PROSPECTUS SUPPLEMENT.

 

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ABOUT THIS PROSPECTUS SUPPLEMENT

This document consists of three parts. The first part is the prospectus supplement, which describes the specific terms of this offering. The second part is the prospectus, which describes more general information, some of which may not apply to this offering. The third part is our Annual Report on Form 10-K (the “Form 10-K”) for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for additional information and disclosure. You should read this prospectus supplement, the accompanying prospectus and the Form 10-K, together with the other documents identified under the heading “Where You Can Find More Information” on page S-114 of this prospectus supplement.

If the information set forth in this prospectus supplement differs in any way from the information set forth in the accompanying prospectus, you should rely on the information set forth in this prospectus supplement.

You should rely only on the information contained in or incorporated by reference in this prospectus supplement, the accompanying prospectus, the Form 10-K and any free writing prospectus with respect to this offering filed by us with the Securities and Exchange Commission (the “SEC”). This prospectus supplement may be used only for the purpose for which it has been prepared. No one is authorized to give information other than that contained in this prospectus supplement and in the documents referred to in this prospectus supplement and which are made available to the public. We have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it.

We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should not assume that the information appearing in this prospectus supplement, the accompanying prospectus, the Form 10-K, any free writing prospectus prepared by us or any document incorporated by reference is accurate as of any date other than the date of the applicable document. Our business, financial condition, results of operations and prospects may have changed since that date. Neither this prospectus supplement, the accompanying prospectus nor the Form 10-K constitutes an offer, or an invitation on our behalf or on behalf of the underwriters, to subscribe for and purchase any of the securities and may not be used for or in connection with an offer or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation.

FORWARD-LOOKING STATEMENTS

In this prospectus supplement and the accompanying prospectus, 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. Words such as “estimate,” “expect,” “project,” “plan,” “believe,” “anticipate,” “intend,” “planned,” “potential” and similar expressions, or future or conditional verbs such as “will,” “should,” “would,” “could,” and “may,” or the negative of those expressions or verbs, identify forward-looking statements. We caution readers that these statements are not guarantees of future performance. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, which, may by their nature be inherently uncertain and some of which may be outside our control. These statements may relate to plans and objectives with respect to the future, among other things which may change. We are alerting you to the possibility that our actual results may differ, possibly materially, from the expected objectives or anticipated results that may be suggested, expressed or implied by these forward-looking statements. Important factors that could cause our results to differ, possibly materially, from those indicated in the forward-looking statements include, among others, those discussed under “Risk Factors” in this prospectus supplement and those discussed under “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement.

 

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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 Ambac’s management’s current belief or opinions. Ambac’s actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among events, risks, uncertainties or factors that could cause actual results to differ materially are: (1) changes in the economic, credit, foreign currency or interest rate environment in the United States and abroad; (2) the level of activity within the national and worldwide credit markets; (3) competitive conditions and pricing levels; (4) legislative and regulatory developments; (5) changes in tax laws; (6) changes in our business plan, including changes resulting from our decision to discontinue writing new business in the financial services area, to significantly reduce new underwriting of structured finance business and to discontinue all new underwritings of structured finance business for six months; (7) the policies and actions of the United States and other governments; (8) changes in capital requirements whether resulting from downgrades in our insured portfolio or changes in rating agencies’ rating criteria or other reasons; (9) changes in Ambac’s and/or Ambac Assurance’s credit or financial strength ratings; (10) changes in accounting principles or practices relating to the financial guarantee industry or that may impact Ambac’s reported financial results; (11) inadequacy of reserves established for losses and loss expenses; (12) default by one or more of Ambac Assurance’s portfolio investments, insured issuers, counterparties or reinsurers; (13) credit risk throughout our business, including large single exposures to reinsurers; (14) market spreads and pricing on insured collateralized debt obligations (“CDOs”) and other derivative products insured or issued by Ambac; (15) credit risk related to residential mortgage securities and CDOs; (16) the risk that holders of debt securities or counterparties on credit default swaps (“CDS”) or other similar agreements seek to declare events of default or seek judicial relief or bring claims alleging violation or breach of covenants by Ambac or one of its subsidiaries; (17) the risk that our underwriting and risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss as a result of unforeseen risks; (18) the risk of volatility in income and earnings, including volatility due to the application of fair value accounting, or FAS 133, to the portion of our credit enhancement business which is executed in credit derivative form; (19) operational risks, including with respect to internal processes, risk models, systems and employees; (20) decline in market position; (21) the risk that market risks impact assets in our investment portfolio; (22) the risk of credit and liquidity risk due to unscheduled and unanticipated withdrawals on investment agreements; (23) changes in prepayment speeds on insured asset-backed securities, (“ABS”); (24) factors that may influence the amount of installment premiums paid to Ambac; (25) the risk that we may be required to raise additional capital, which could have a dilutive effect on our outstanding equity capital and/or future earnings; (26) our ability or inability to raise additional capital, including the risks that regulatory or other approvals for any plan to raise capital are not obtained, or that various conditions to such a plan, either imposed by third parties or imposed by Ambac or its Board of Directors, are not satisfied and thus potentially necessary capital raising transactions do not occur, or the risk that for other reasons the Company cannot accomplish any potentially necessary capital raising transactions, including the transactions contemplated hereby; (27) the risk that Ambac’s holding company structure and certain regulatory and other constraints, including adverse business performance, affect Ambac’s ability to pay dividends and make other payments; (28) the risk of litigation and regulatory inquiries or investigations, and the risk of adverse outcomes in connection therewith, which could have a material adverse effect on our business, operations, financial position, profitability or cash flows; (29) other factors discussed under “Risk Factors” in this prospectus supplement, described in the Risk Factors section in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and also disclosed from time to time by Ambac in its subsequent reports on Form 10-Q and Form 8-K, which are or will be available on the Ambac website at www.ambac.com and at the SEC’s website, www.sec.gov; and (30) other risks and uncertainties that have not been identified at this time. Readers are cautioned that forward-looking statements speak only as of the date they are made and that Ambac does not undertake to update forward-looking statements to reflect circumstances or events that arise after the date the statements are made. You are therefore advised to consult any further disclosures we make on related subjects in Ambac’s reports to the SEC.

 

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PROSPECTUS SUPPLEMENT SUMMARY

The following summary highlights selected information contained elsewhere in this prospectus supplement and may not contain all of the information that is important to you. We encourage you to read this prospectus supplement and the accompanying prospectus, together with the documents identified under the heading “Where You Can Find More Information” on page S-114 of this prospectus supplement, in their entirety. You should pay special attention to the “Risk Factors” section of this prospectus supplement. Unless otherwise mentioned or unless the context requires otherwise, all references in this prospectus supplement to “Ambac,” “we,” “us,” “our,” the “Company” or similar references mean Ambac Financial Group, Inc. and its subsidiaries.

Ambac Financial Group, Inc.

Ambac, 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, or Ambac Assurance. Ambac Assurance is the successor to the founding financial guarantee insurance company, which wrote the first bond insurance policy in 1971. As an alternative to financial guarantee insurance, credit protection is provided by Ambac Credit Products, a subsidiary of Ambac Assurance, in credit derivative format. Through its financial services subsidiaries, Ambac has provided 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.

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 and to pay its operating expenses. Dividends from Ambac Assurance are subject to certain insurance regulatory restrictions. For more information, see “Insurance Regulatory Matters—Dividend Restrictions—Wisconsin” and “Management’s Discussion and Analysis—Liquidity and Capital Resources” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further information.

Our principal executive offices are located at One State Street Plaza, New York, New York 10004 and our telephone number is (212) 668-0340.

Recent Developments

Ratings Agencies

Currently, Ambac Assurance has triple-A financial strength ratings from Moody’s Investors Services, Inc. (“Moody’s”) and Standard and Poor’s Rating Services (“S&P”), and a double-A rating from Fitch Inc. (“Fitch”) (downgraded from triple-A on January 18, 2008). These ratings are an essential part of Ambac Assurance’s ability to provide credit enhancement and are essential to Ambac Assurance’s ability to compete in the financial guarantee business. See “Rating Agencies” in Part I, Item 1 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further information. Considering the high levels of delinquencies and defaults within residential mortgage loans, each of these rating agencies began a review of the capital adequacy of the financial guarantee industry in the fall of 2007. In late December 2007, following the rating agency reviews, Ambac Assurance’s triple-A rating was affirmed by both S&P (with “negative outlook”) and Moody’s; however, Fitch placed Ambac’s triple-A rating on “rating watch

 

 

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negative” and stated that Ambac Assurance had a modeled $1 billion capital shortfall. On January 16, 2008, Moody’s put Ambac Assurance’s triple-A rating on review for possible downgrade. On January 18, 2008, S&P placed Ambac Assurance’s triple-A financial strength rating on Credit Watch Negative. On January 18, 2008, Fitch downgraded Ambac Assurance’s insurance financial strength rating to double-A (“rating watch negative”). On February 25, 2008, S&P reaffirmed Ambac Assurance’s triple A rating, but kept it on Credit Watch Negative. On February 29, 2008, Moody’s publicly announced that it is continuing a review for possible downgrade that was initiated on January 16, 2008. Based on an updated assessment of Ambac Assurance’s mortgage risk, Moody’s believes that Ambac Assurance’s capital exceeds the minimum Aaa standard but falls below the Aaa target level. Moody’s further stated that Ambac is actively pursuing capital strengthening activities that, if successful, are expected to result in Ambac Assurance meeting Moody’s current estimate of the Aaa target level. There have been a number of recent developments with respect to ratings actions by the rating agencies. In light of the ongoing nature of ratings actions or announcements by the rating agencies, one should consult announcements by the rating agencies, the websites of the rating agencies and Ambac’s website for the then current publicly available information. These ratings actions have had a significant impact on Ambac Assurance’s ability to compete in the financial guarantee business. Please see Part I, Item 1 “Business—Business Segments—Financial Guarantee” and “Business—Business Segments—Competition” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further discussion as to its impact on the U.S. public finance, structured finance and international markets.

Currently, Ambac Financial Group’s long-term senior unsecured debt is rated “AA” by S&P (with “negative outlook”), “Aa2” by Moody’s (review for possible downgrade) and “A” by Fitch (“rating watch negative”).

As a result of the rating agency actions described above, as well as significant disruption in the capital markets and investor concern with respect to our financial position, we have been able to write only a limited amount of new financial guarantee business since November 2007, and we have written virtually no new business thus far in 2008.

Business Restructuring

In recent months, we have undertaken a review of all our business units. In conducting this review, we considered the risk exposure within each business (including our view of the probability of default, the potential loss given default and the relevant correlations), the risk adjusted returns over the course of an economic cycle and Ambac’s franchise value and competitive advantages.

As a result of this review, in connection with our efforts to raise capital and maintain our triple-A ratings from Moody’s and S&P, we expect to:

 

   

Execute all financial guarantee insurance business through Ambac Assurance Corporation and Ambac UK Limited;

 

   

Emphasize our public finance business (including municipal finance, healthcare and global utilities) and refocus our structured finance business (including the global infrastructure market, student loans, leasing and asset finance and structured insurance). Many of the above businesses will be subject to revised underwriting and risk management guidelines and reduced net retention limits;

 

   

Suspend underwriting all structured finance businesses (domestic and international) for six months in order to accumulate capital;

 

   

Discontinue underwriting certain structured finance businesses (domestic and international), including:

 

   

CDOs, collateralized loan obligations and other arbitrage-driven transactions,

 

 

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All mortgage-backed securities,

 

   

Whole business securitizations, including franchise fee securitizations and intellectual property royalty securitizations,

 

   

Auto loan and lease securitizations and rental car fleet securitizations,

 

   

Structured energy transactions,

 

   

Pooled aircraft securitizations,

 

   

Credit card receivables and small business loan securitizations, and

 

   

Emerging market transactions, including future flow transactions and other on-shore securitizations;

 

   

Discontinue the execution of credit enhancement transactions in CDS, total return swap or other derivative format;

 

   

Discontinue writing new Financial Services business; and

 

   

Focus on reducing single risk concentrations across our portfolio.

 

   

We also have reduced the quarterly dividend payable on our common shares to $0.01 per share.

The structured finance businesses that we are intending to discontinue were included in our historical net premiums earned, loss and loss expenses, mark-to-market on credit derivatives and credit enhancement production (“CEP”) as follows:

 

$ in millions    2005     2006     2007  
     Amount     % of
Total
    Amount    % of
Total
    Amount     % of
Total
 

Net Premiums Earned

   $ 341     39 %   $ 358    41 %   $ 359     39 %

Loss and Loss Expenses

     (9 )   6       36    (181 )     (293 )   114  

Mark-to-market gains (losses) on credit derivatives

     14     100       9    100       (6,004 )   100  

CEP

     412     33       475    37       492     35  

See “Discussion of Certain Portfolio Risks—Mark-to-Market Losses with Respect to Credit Derivatives” for further discussion.

Credit enhancement production, a non-GAAP measure, is used by management, equity analysts and investors as an indication of new business production in the period. Credit enhancement production, which Ambac reports as analytical data, is defined as gross (direct and assumed) up-front premiums plus the present value of estimated installment premiums on insurance policies and structured credit derivatives issued in the period. The discount rate used to measure the present value of estimated installment premiums was 7.0% in the first, second, third and fourth quarters of 2005, 5.1%, 5.6%, 6.0% and 5.4% in the first, second, third and fourth quarters of 2006, respectively, and 5.4%, 5.4%, 5.8% and 5.6% in the first, second, third and fourth quarters of 2007, respectively. The definition of credit enhancement production used by Ambac may differ from definitions of credit enhancement production (or similar terms) used by other public holding companies of financial guarantors. The following table reconciles credit enhancement production to gross premiums written calculated in accordance with GAAP:

 

$ in millions    2005     2006     2007  

Credit enhancement production

   $ 412     $ 475     $ 492  

Present value of estimated installment premiums written on insurance policies and structured credit derivatives issued in the period

     (410 )  

 

(472

)

 

 

(486

)

                        

Gross up-front premiums written

   $ 2     $ 3     $ 6  

Gross installment premiums written on insurance policies

     335       332       317  
                        

Gross premiums written

   $ 337     $ 335     $ 323  
                        

 

 

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Notwithstanding this business restructuring, management remains confident that Ambac Assurance’s claims paying ability is adequate to support policyholder liabilities.

This Equity Units Offering, along with the Common Stock Offering, is part of a capital raising strategy focused on maintaining Ambac Assurance’s triple-A financial strength rating from Moody’s and S&P. We do not anticipate that the completion of this offering and the Common Stock Offering will result in S&P or Moody’s assigning a “stable” outlook to our triple-A ratings nor Fitch upgrading our double-A financial strength rating to triple-A. In the event that we do not maintain our triple-A ratings from Moody’s and S&P, we believe that we can execute a significantly reduced business plan and operate with double-A ratings that will include Structured Finance, International and reinsurance across a variety of bond types; we would be unlikely to write a significant amount of business in Public Finance, however. In that circumstance, we expect to accumulate capital and position ourselves to regain our triple-A ratings. Ambac will continue to work closely with the regulators and the rating agencies to design and implement a strategy to address the credit issues within its portfolio and to preserve and grow the business franchise.

Certain First Quarter 2008 Financial Developments

The following information is based largely on our unaudited monthly financial data for and as of January 31, 2008. Certain of the following information, including, without limitation, the mark-to-market losses, is subject to adjustment based on various factors and developments, including, without limitation, changes in the fair market value of, among other items, our credit derivative portfolio.

 

   

Mark-to-market losses on credit derivatives and total return swaps are estimated to be approximately $650 million for the month of January 2008 reflecting wider credit spreads across nearly all asset classes, especially in CDO of ABS greater than 25% RMBS exposure which widened an average of 72 basis points, contributing $461 million to the January 2008 mark-to-market loss. Market conditions which give rise to such losses have continued into February 2008. If these conditions persist or worsen through the end of the first quarter, we would expect to incur a material net loss for the quarter. See “Discussion of Certain Portfolio Risks—Mark-to-Market Losses with Respect to Credit Derivatives” for further discussion.

 

   

Net unrealized losses in our investment portfolio increased from approximately $68 million as of December 31, 2007 to approximately $104 million as of January 31, 2008; this increase in net unrealized losses resulted from:

 

   

the increase in our net unrealized losses from approximately $287 million as of December 31, 2007 to approximately $439 million as of January 31, 2008 in that portion of our investment portfolio associated with our Financial Services business, which is offset in part by

 

   

an increase in net unrealized gains from approximately $219 million as of December 31, 2007 to approximately $335 million as of January 31, 2008 in that portion of our investment portfolio associated with our Financial Guarantee business.

 

   

Refunding activity in January 2008 occurred at a slower pace than we have experienced in prior quarters, amounting to approximately $3 million.

 

   

As a result of the rating agency actions described above, as well as significant disruption in the capital markets and investor concern with respect to our financial position, we have been able to write only a limited amount of new financial guarantee business since November 2007, and we have written virtually no new business thus far in 2008.

 

   

Our claim payments for January 2008 amounted to approximately $9 million.

 

   

There has been significant disruption in the municipal bond market, in which we are a major investor. Such disruption, if it continues, could require us to recognize additional unrealized losses, which could be material, with respect to our municipal bond investment portfolio.

 

 

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The Offering

What are Equity Units?

Equity Units may be either Corporate Units or Treasury Units as described below. The Equity Units offered will initially consist of      Corporate Units (or      Corporate Units if the underwriters exercise their over-allotment option in full), each with a stated amount of $50. You can create Treasury Units from the Corporate Units in the manner described below under “How can I create Treasury Units from Corporate Units?”.

What are the components of a Corporate Unit?

Each Corporate Unit initially consists of a purchase contract and a  1/20, or 5%, undivided beneficial ownership interest in $1,000 principal amount of our senior notes initially due February 15, 2021, which we refer to as the senior notes. The undivided beneficial ownership interest in our senior notes corresponds to $50 principal amount of our senior notes. The senior notes will be issued in minimum denominations of $1,000 and integral multiples of $1,000. Your undivided beneficial ownership interest in the senior note comprising part of each Corporate Unit is owned by you, but will be pledged to us through the collateral agent to secure your obligation under the related purchase contract. If the senior notes are successfully remarketed on or prior to February 15, 2011, as described in this prospectus supplement, the senior notes comprising part of the Corporate Units will be replaced by the Treasury portfolio described below under “What is the Treasury portfolio?”, and your applicable ownership interest in the Treasury portfolio will then be pledged to us through the collateral agent to secure your obligation under the related purchase contract.

What is a purchase contract?

Each purchase contract that is a component of an Equity Unit obligates the holder of the purchase contract to purchase, and obligates us to sell, on May 17, 2011, which we refer to as the purchase contract settlement date, for $50 in cash, a number of newly issued shares of our common stock equal to the settlement rate. Our obligation to deliver shares of common stock under the purchase contracts will be subject to the provisions set forth under “What happens if the Authorized Share Condition has not been satisfied?”.

The settlement rate will, subject to adjustment under the circumstances set forth in “Description of the Purchase Contracts—Anti-Dilution Adjustments,” be as follows:

 

   

if the applicable market value of our common stock is greater than or equal to $            , which we refer to as the threshold appreciation price,              shares of our common stock;

 

   

if the applicable market value of our common stock is less than the threshold appreciation price but greater than $            , which we refer to as the reference price, a number of shares of our common stock equal to $50 divided by the applicable market value; and

 

   

if the applicable market value of our common stock is less than or equal to the reference price,              shares of our common stock.

“Applicable market value” means the average of the volume weighted average price per share of our common stock (or exchange property units, as defined under “Description of the Purchase Contracts—Anti-Dilution Adjustments,” in which the purchase contracts will be settled following a reorganization event) on each of the 20 consecutive trading days ending on the third trading day immediately preceding the purchase contract settlement date, subject to anti-dilution adjustments under the circumstances set forth in “Description of the Purchase Contracts—Anti-Dilution Adjustments.” The reference price equals the price at which we offered our common stock in the concurrent Common Stock Offering on March     , 2008. The threshold appreciation price represents an approximately     % appreciation over the reference price.

 

 

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We will not issue any fractional shares of our common stock upon settlement of a purchase contract. Instead of a fractional share, you will receive an amount of cash equal to the applicable fraction multiplied by the applicable market value.

What happens if the Authorized Share Condition has not been satisfied?

The purchase contracts may be settled for more shares of common stock than we currently have available on reserve for issuance on the purchase contract settlement date or upon any earlier settlement date of a purchase contract. In order to provide for the authorization of a sufficient number of shares of our common stock with which to settle the purchase contracts in full, we have agreed in the Certificate of Designations governing our Series A Preferred Stock, the purchase contract agreement relating to the Equity Units and the underwriting agreement relating to the offering to use commercially reasonable efforts to satisfy the Authorized Share Condition (as defined below) as promptly as practicable following the issuance of the Equity Units.

If the Authorized Share Condition has not been satisfied by the time a purchase contract is settled (whether on the purchase contract settlement date or upon any earlier settlement date), your obligation to purchase our common stock, and our obligation to deliver such common stock, will be satisfied through the purchase and delivery of newly issued shares of our Series A Participating Preferred Stock, par value $0.01 per share, which we refer to as our Series A Preferred Stock, in lieu of shares of our common stock. Each share of our Series A Preferred Stock is intended to be the economic equivalent of holding 100 shares of our common stock. Accordingly, if at the time of settlement of a purchase contract the Authorized Share Condition has not been satisfied, we will issue, in lieu of the number of shares of our common stock that would otherwise be deliverable, a number of shares of our Series A Preferred Stock equal to the number of shares of our common stock that would otherwise be deliverable multiplied by  1/100. Fractional shares of Series A Preferred Stock may be issued down to  1/100th of a share and each such fractional interest is intended to be the economic equivalent of holding one share of our common stock. For a description of the Series A Preferred Stock, see “Description of Our Capital Stock—Preferred Stock—Series A Preferred Stock.”

If the Authorized Share Condition has not been satisfied by the 120th day after the issuance of the Equity Units, then from such date to, but excluding, the date on which the Authorized Share Condition is satisfied, (i) the quarterly contract adjustment payments payable by us to holders of the Equity Units on all outstanding purchase contracts will increase from     % per annum to a rate of     % per annum on the stated amount of $50 per Equity Unit and (ii) with respect to any Series A Preferred Stock that is outstanding, in addition to the dividends payable on our common stock (in which the holders of the outstanding Series A Preferred Stock are entitled to participate), dividends will accrue on shares of the Series of Preferred Stock in an amount per quarter equal to $             per share (which is equal to 2.5% (or 10% on an annualized basis) of the reference price of our common stock multiplied by 100) or, in respect of each  1/100th fractional interest in our Series A Preferred Stock, $             for each such fractional share.

Upon the satisfaction of the Authorized Share Condition, each share of Series A Preferred Stock will automatically convert into 100 shares of our common stock (and, therefore, each  1/100th fractional interest in our Series A Preferred Stock will automatically convert into one share of our common stock) in accordance with the terms of the Series A Preferred Stock. The conversion rate upon automatic conversion of the Series A Preferred Stock upon the satisfaction of the Authorized Share Condition will remain at the fixed rate set forth in the preceding sentence. Upon the occurrence of a stock split or combination in respect of our common stock, the number of outstanding shares of our Series A Preferred Stock held by each holder will be proportionately adjusted. In addition, upon the occurrence of a reorganization event pursuant to which our common stock is converted into the right to receive cash, securities or other property, each share of Series A Preferred Stock will automatically convert into the right to receive the amount of cash, securities or other property that a holder of 100 shares of our common stock has the right to receive pursuant to such event.

 

 

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Holders of outstanding Series A Preferred Stock will be entitled to participate in all dividends or distributions (including, but not limited to, regular quarterly dividends) paid or made in respect of our common stock, whether in the form of cash or securities or any other form of property or assets. Any such dividend or distribution will be payable or deliverable on the date fixed for the related payment or delivery of the dividend or distribution on our common stock to holders of record of our Series A Preferred Stock on the record date fixed for the related dividend or distribution to holders of our common stock. Any such payment or delivery will equal, in respect of each share of our Series A Preferred Stock, the amount of cash, securities or other property or assets that a holder of 100 shares of our common stock is entitled to receive. In addition, holders of Series A Preferred Stock will be entitled to receive the additional dividend described in the second preceding paragraph. Payment of the additional dividend amount will be made on February 15, May 15, August 15 and November 15 of each year to holders of record of Series A Preferred Stock as of the first day of the month in which the related payment is to be made. Dividends in respect of the Series A Preferred Stock are cumulative and will be payable when, as and if declared by our board of directors.

“Authorized Share Condition” means that we have a sufficient number of authorized and unissued shares of common stock on reserve and registered on a registration statement under the Securities Act for the settlement in all circumstances of all outstanding purchase contracts and the automatic conversion of all outstanding shares of Series A Preferred Stock into shares of common stock.

We have also agreed in the Certificate of Designations governing the Series A Preferred Stock, the purchase contract agreement relating to the Equity Units and the underwriting agreement relating to the offering that in the event that we authorize any additional shares of our common stock following the date of issuance of the Equity Units, such shares must first be used by us to satisfy the Authorized Share Condition and we will not apply or reserve such shares for any other purpose until the Authorized Share Condition has been satisfied.

What is a Treasury Unit?

A Treasury Unit is a unit created from a Corporate Unit (as described below) and consists of a purchase contract and a  1/20, or 5%, undivided beneficial interest in a zero-coupon U.S. Treasury security, with a principal amount at maturity of $1,000 that matures on February 15, 2011 (CUSIP No. 912820GC5), which we refer to as a Treasury security and the related maturity date as the Treasury security maturity date. On the Treasury security maturity date, the collateral agent will use all or a portion of the proceeds of the maturing Treasury security, which we refer to as the maturity proceeds, to purchase a new treasury security, which we refer to as a new treasury security, that matures on or prior to the purchase contract settlement date, and will promptly remit any excess of the maturity proceeds over the purchase price of the new treasury security to holders of the Treasury Units. The purchase contract together with such new treasury security shall constitute a Treasury Unit. The beneficial interest in the Treasury security or the new treasury security, as the case may be, that is a component of a Treasury Unit will be owned by you, but will be pledged to us through the collateral agent to secure your obligation under the related purchase contract.

How can I create Treasury Units from Corporate Units?

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units (as described below), each holder of Corporate Units will have the right, at any time on or prior to the second business day immediately preceding the purchase contract settlement date, to create Treasury Units by substituting Treasury securities or, following the Treasury security maturity date, new treasury securities for such holder’s ownership interest in the senior notes held by the collateral agent, in a total principal amount at maturity equal to the aggregate principal amount of the senior notes for which substitution is being made; provided, however, that holders may not create Treasury Units by making such substitutions during the period beginning on and including the business day immediately preceding February 4, 2011, which we refer to as the initial remarketing date, and ending on and including the payment date scheduled to occur on February 15, 2011. We refer to this period as the remarketing period. Because Treasury securities and new treasury securities are issued in integral multiples of $1,000, holders of Corporate Units may make this substitution only in integral multiples of 20 Corporate Units.

 

 

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If the Treasury portfolio has replaced the senior notes as a component of the Corporate Units (as described below), holders of Corporate Units will have the right, at any time on or prior to the second business day immediately preceding the purchase contract settlement date, to create Treasury Units by substituting new treasury securities for the applicable ownership interest in the Treasury portfolio as a component of the Corporate Unit, but holders of Corporate Units may make this substitution only in integral multiples of      Corporate Units.

Each of these substitutions will create Treasury Units, and the applicable senior notes or applicable ownership interest in the Treasury portfolio will be released to the holder and be separately tradable from the Treasury Units.

How can I recreate Corporate Units from Treasury Units?

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units (as described below), each holder of Treasury Units will have the right, at any time on or prior to the second business day immediately preceding the purchase contract settlement date, to recreate Corporate Units by substituting for the related Treasury securities or new treasury securities held by the collateral agent, senior notes having a principal amount equal to the aggregate principal amount at maturity of the Treasury securities or new treasury securities for which substitution is being made; provided, however, that holders may not recreate Corporate Units by making such substitutions during the remarketing period. Because Treasury securities and new treasury securities are issued in integral multiples of $1,000, holders of Treasury Units may make these substitutions only in integral multiples of 20 Treasury Units.

If the Treasury portfolio has replaced the senior notes as a component of the Corporate Units (as described below), holders of Treasury Units will have the right, at any time on or prior to the second business day immediately preceding the purchase contract settlement date, to recreate Corporate Units by substituting an applicable ownership interest in the Treasury portfolio for the new treasury securities as a component of the Treasury Units, but holders of Treasury Units may make this substitution only in integral multiples of      Treasury Units.

Each of these substitutions will recreate Corporate Units and the applicable Treasury securities or new treasury securities will be released to the holder and be separately tradable from the Corporate Units.

What payments am I entitled to as a holder of Corporate Units?

Each holder of Corporate Units will be entitled to receive quarterly cash distributions consisting of interest payments at the rate of     % per annum on the holder’s undivided beneficial ownership interest in the senior notes (or distributions on the applicable ownership interest in the Treasury portfolio if the Treasury portfolio has replaced the senior notes as a component of Corporate Units), and quarterly contract adjustment payments payable by us at the rate of     % per annum on the stated amount of $50 per Corporate Unit until the earliest of the termination of the purchase contracts, the purchase contract settlement date, the cash merger early settlement date (as described in “Description of the Purchase Contracts—Early Settlement Upon Cash Merger”) and the most recent quarterly payment date on or before any other early settlement of the related purchase contracts (in the case of early settlement other than upon a cash merger). In addition, if the Authorized Share Condition has not been satisfied by the 120th day following the issuance of the Equity Units as described above under “What happens if the Authorized Share Condition has not been satisfied?”, the contract adjustment payments will increase from     % per annum to     % per annum on the stated amount of $50 per Corporate Unit from such date to, but excluding, the date on which the Authorized Share Condition is satisfied, at which time, such contract adjustment payments shall return to     % per annum.

 

 

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What payments will I be entitled to if I convert my Corporate Units to Treasury Units?

Holders of Treasury Units will be entitled to receive quarterly contract adjustment payments payable by us at the rate of     % per annum on the stated amount of $50 per Treasury Unit; provided, however, that if the Authorized Share Condition has not been satisfied by the 120th day following the issuance of the Equity Units as described above under “What happens if the Authorized Share Condition has not been satisfied?”, contract adjustment payments will increase from     % per annum to     % per annum on the stated amount of $50 per Treasury Unit from such date to, but excluding, the date on which the Authorized Share Condition is satisfied, at which time, such contract adjustment payments shall return to     % per annum. Except as described above under “What is a Treasury Unit?” with respect to the remittance of excess maturity proceeds to holders of Treasury Units, there will be no distributions in respect of the Treasury securities or new treasury securities that are components of the Treasury Units but the holders of the Treasury Units will continue to receive the scheduled quarterly interest payments on the senior notes that were released to them when they created the Treasury Units as long as they continue to hold the senior notes.

Do we have the option to defer current payments?

No, we do not have the right to defer the payment of contract adjustment payments in respect of the Equity Units or the payment of interest on the senior notes.

What are the payment dates for the Equity Units?

The payments described above in respect of the Equity Units will be payable quarterly in arrears on February 15, May 15, August 15, and November 15 of each year, commencing May 15, 2008; provided, that if any of these days is not a business day, we will make the payment on the following business day, without adjustment; provided, however, that the final payment in respect of the Equity Units will be made on the purchase contract settlement date in lieu of May 15, 2011 and the amount payable on such date shall include amounts accrued to, but excluding, the purchase contract settlement date. We will make these payments to the persons in whose name the Equity Units are registered at the close of business on the first day of the month in which the applicable interest payment date falls.

What is remarketing?

Except as described below, the remarketing agent will attempt to remarket the senior notes held by Corporate Unit holders as part of Corporate Units on the initial remarketing date and any senior notes that are not part of Corporate Units but whose holders have elected to participate in the remarketing, and in the event such remarketing on this date is not successful, the remarketing agent will thereafter attempt to remarket those senior notes on each of the four succeeding business days until a successful remarketing occurs, in each case for settlement on the remarketing settlement date. The remarketing settlement date is February 15, 2011.

For each remarketing, the remarketing agent will be required to use its reasonable efforts to obtain a price for the remarketed senior notes that results in proceeds of at least 100% of the sum of the Treasury portfolio purchase price and the purchase price of any senior notes that are not part of Corporate Units but whose holders have elected to participate in the remarketing. See “If I am holding a senior note as a separate security from the Corporate Unit, can I still participate in a remarketing of the senior notes and do I also have a put right in the event that the final remarketing is not successful?”. To obtain that price, the remarketing agent, in consultation with the Company, may reset the interest rate on the senior notes. In connection with any remarketing, we, in consultation with the Remarketing Agent, may elect to modify the maturity date or redemption provisions of the senior notes, as described below. If the remarketing is successful, the reset interest rate, the modified maturity date, if any, and modified redemption provisions, if any, will apply to all the senior notes, even if they are not included in the remarketing.

A remarketing on any remarketing date will be considered successful and no further attempts to remarket will be made if the resulting proceeds are at least 100% of the sum of the Treasury portfolio purchase price and the purchase price of any senior notes that are not part of Corporate Units but whose holders have elected to participate in the remarketing (as described in “Description of the Purchase Contracts—Remarketing”).

 

 

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In the event of a successful remarketing of the senior notes on any remarketing date, the portion of the proceeds from the remarketing equal to the Treasury portfolio purchase price will be applied on the remarketing settlement date to purchase the Treasury portfolio. The Corporate Unit holder’s applicable ownership interest in the Treasury portfolio will be substituted for such holder’s ownership interest in the senior notes as a component of such holder’s Corporate Units and will be pledged to us through the collateral agent to secure such holder’s obligation under the purchase contracts that are a component of such holder’s Corporate Units. On or promptly following the remarketing settlement date, the remarketing agent will remit to the purchase contract agent any remaining portion of the proceeds for the benefit of the holders of the Corporate Units, the senior notes component of which were included in the remarketing. On the purchase contract settlement date, a portion of the proceeds from the Treasury portfolio equal to the principal amount of the senior notes that previously were a component of such holder’s Corporate Units will automatically be applied to satisfy the Corporate Unit holder’s obligation to purchase common stock under the purchase contracts that are a component of the holder’s Corporate Units, and a portion of the proceeds from the Treasury portfolio equal to the interest payment (assuming no reset of the interest rate) that would have been due on the senior notes on the purchase contract settlement date will be paid to the holders of the Corporate Units. We will separately pay a fee to the remarketing agent. Holders of senior notes that are remarketed will not be responsible for the payment of any remarketing fee in connection with the remarketing.

What happens if the senior notes are not successfully remarketed?

If the senior notes have not been successfully remarketed during the remarketing period, the interest rate on the senior notes will not be reset, and the holder of a Corporate Unit will have the right to put such holder’s beneficial interest in the senior note that comprises part of such Corporate Unit to us on the purchase contract settlement date at a put price equal to $50 per Corporate Unit, plus accrued and unpaid interest.

A holder of a Corporate Unit will be deemed to have automatically exercised this put right with respect to the senior notes unless, on or prior to 11:00 a.m., New York City time, on the second business day immediately preceding the purchase contract settlement date, such holder provides a written notice of its intention to settle the related purchase contract with separate cash and on or prior to the business day immediately preceding the purchase contract settlement date delivers to the collateral agent $50 in cash. Unless a Corporate Unit holder has settled a purchase contract with separate cash on or prior to the purchase contract settlement date, the portion of the put price equal to the principal amount of senior notes corresponding to a Corporate Unit holder’s beneficial interest in a senior note put to us will be delivered to the collateral agent, who will apply such amount in satisfaction of such Corporate Unit holder’s obligations under the related purchase contract on the purchase contract settlement date and the remaining portion of the put price will be remitted to such holder. Corporate Unit holders may settle purchase contracts with cash only with respect to integral multiples of 20 Corporate Units, unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, in which case holders of Corporate Units may settle early only in integral multiples of              Corporate Units.

Do I have to participate in the remarketing?

You may elect not to participate in the remarketing and to retain the senior notes underlying your Corporate Units by creating Treasury Units or settling the related purchase contracts early, in each case, at any time on or prior to the second business day immediately prior to the initial remarketing date. Upon a successful remarketing, the interest rate on the senior notes may be reset as described below under “Description of our Senior Notes—Market Reset Rate,” the maturity date of the senior notes may be modified as described below under “Description of our Senior Notes—Modification of the Terms of the Senior Notes in Connection with a Successful Remarketing,” and the Company’s optional redemption right may be eliminated or modified to provide that it will arise at a later date as described below under “Description of our Senior Notes—Optional Redemption.” Your senior notes will become subject to such reset rate, modified maturity and optional redemption provisions whether or not you participate in remarketing.

 

 

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Are the senior notes redeemable at the option of the Company?

The senior notes are not redeemable at our option prior to May 17, 2013. At any time on or after May 17, 2013, the senior notes are redeemable, at our option, in whole but not in part, at a price equal to $1,000 per senior note, plus accrued and unpaid interest, if any, to the date of redemption. In connection with the remarketing of the senior notes, we may modify our right to call the senior notes for redemption, effective on and after the remarketing settlement date, to eliminate it in its entirety or to provide that the optional redemption right will arise at a later date. See “Description of our Senior Notes—Optional Redemption.”

What is the Treasury portfolio?

If there is a successful remarketing during the remarketing period, the senior notes included in the Corporate Units will be replaced by the Treasury portfolio. The Treasury portfolio is a portfolio of U.S. Treasury securities consisting of:

 

   

U.S. Treasury securities (or principal or interest strips thereof) that mature on or prior to May 17, 2011 in an aggregate amount at maturity equal to the principal amount of the senior notes that were formerly included in Corporate Units but that were remarketed, and

 

   

U.S. Treasury securities (or principal or interest strips thereof) that mature on or prior to May 17, 2011 in an aggregate amount at maturity equal to the aggregate interest that would have accrued from, and including, February 15, 2011 to, but excluding, May 17, 2011 (assuming no reset of the interest rate and that May 17, 2011 was an interest payment date in lieu of May 15, 2011) on the principal amount of the senior notes that were formerly included in the Corporate Units but that were remarketed.

If I am holding a senior note as a separate security from the Corporate Unit, can I still participate in a remarketing of the senior notes and do I also have a put right in the event that the final remarketing is not successful?

Holders of senior notes that are not part of the Corporate Units may elect, in the manner described in this prospectus supplement, to have their senior notes remarketed by the remarketing agent along with the senior notes included in the Corporate Units. See “Description of our Senior Notes—Optional Remarketing.” Such holders may also participate in any remarketing by recreating Corporate Units from their Treasury Units at any time on or prior to the second business day immediately prior to the initial remarketing date. In the event of a successful remarketing, each holder of a separate senior note that has been remarketed will receive the remarketing price per senior note (as defined in “Description of the Purchase Contracts—Remarketing”), which, for each senior note, is an amount in cash equal to the quotient of the Treasury portfolio purchase price divided by the number of senior notes denominated in integral multiples of $1,000 included in such remarketing that are held as components of Corporate Units.

Holders of senior notes that are not part of a Corporate Unit may exercise their put right if a successful remarketing has not occurred by providing written notice to the trustee at least two business days prior to the purchase contract settlement date. The put price will be paid to such holder on the purchase contract settlement date.

Besides participating in a remarketing, how else can I satisfy my obligation under the purchase contracts?

Holders of Corporate Units or Treasury Units may also satisfy their obligations, or their obligations will be terminated, under the purchase contracts as follows:

 

   

through early settlement as described below under “Can I settle the purchase contract early?” and under “What happens if there is early settlement upon a cash merger?”;

 

   

in the case of Corporate Units, through cash settlement as described under “Description of the Purchase Contract—Notice to Settle with Cash”, or through exercise of the put right as described under “What happens if the senior notes are not successfully remarketed?”;

 

 

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through the automatic application of the proceeds of the new treasury securities in the case of the Treasury Units; or

 

   

without any further action, upon the termination of the purchase contracts as a result of our bankruptcy, insolvency or reorganization.

If the holder of a Corporate Unit or Treasury Unit settles a purchase contract early (other than pursuant to the merger early settlement right), or if the holder’s purchase contract is terminated as a result of our bankruptcy, insolvency or reorganization, such holder will not be entitled to any accrued contract adjustment payments.

What interest payments will I receive on the senior notes?

Interest on the senior notes will be payable quarterly in arrears initially at the annual rate of     % per annum to, but excluding, the reset effective date, which will be the remarketing settlement date if the senior notes are successfully remarketed. Following a reset of the interest rate, interest will be payable semi-annually on the senior notes at the reset rate from and including the reset effective date to, but excluding, February 15, 2021, which maturity date may be modified to an earlier date in connection with a successful remarketing. If a successful remarketing of the senior notes does not occur, the interest rate will not be reset and the senior notes will continue to bear interest at the initial interest rate payable quarterly.

What are the interest payment dates on the senior notes?

The interest payment dates on the senior notes are February 15, May 15, August 15 and November 15 of each year, commencing on May 15, 2008 and ending on the maturity date of the senior notes. Following a successful remarketing, interest on the senior notes will be payable on a semi-annual basis on February 15 and August 15 of each year, commencing on August 15, 2011.

When will the interest rate on the senior notes be reset and what is the reset rate?

The interest rate on the senior notes will be reset on the date of a successful remarketing, and the reset rate will become effective on the reset effective date. The reset rate will be the interest rate determined by the remarketing agent, in consultation with us, as the rate the senior notes should bear in order for the senior notes included in the remarketing to have an approximate aggregate market value on the remarketing date of 100% of the sum of the Treasury portfolio purchase price and the purchase price of the senior notes that are not part of Corporate Units whose holders have elected to participate in the remarketing (determined in the manner described in “Description of the Purchase Contracts—Remarketing”). The interest rate on the senior notes will not be reset if there is not a successful remarketing. The reset rate may not exceed the maximum rate, if any, permitted by applicable law.

Which provisions will govern the senior notes following a successful remarketing?

The senior notes will continue to be governed by the indenture under which they were issued. However, the indenture’s provisions regarding the maturity date and redemption of the senior notes may be modified by us, in consultation with the remarketing agent, without any holder’s consent. As described under “Description of our Senior Notes—Modification of the Terms of the Senior Notes in Connection with a Successful Remarketing” and “Description of our Senior Notes— Optional Redemption,” in connection with any successful remarketing, we may elect, in consultation with the remarketing agent, (i) to change the stated maturity of the senior notes from February 15, 2021 to any earlier date, provided that the senior notes may not mature earlier than May 17, 2013; or (ii) to extend the earliest redemption date on which we may call the senior notes for redemption from May 17, 2013 to a later date or to eliminate the redemption provisions from the senior notes.

 

 

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Can I settle the purchase contract early?

You can settle a purchase contract at any time on or prior to the second business day immediately preceding the purchase contract settlement date by paying $50 cash, in which case                     shares of our common stock, subject to adjustment, will be issued to you pursuant to the purchase contract; provided, however, that a holder may not elect to settle the related purchase contract during the remarketing period. The number of shares you receive under this circumstance will be fixed and will not be computed on the basis of the applicable market value of our common stock on the early settlement date. You will not be entitled to any accrued and unpaid contract adjustment payment on purchase contracts that are settled early under these circumstances. Prior to the satisfaction of the Authorized Share Condition, any settlement (including early settlement) of the purchase contracts will be subject to the provisions described under “What happens if the Authorized Share Condition has not been satisfied?”.

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, holders of Corporate Units may settle early only in integral multiples of 20 Corporate Units. If the Treasury portfolio has replaced the senior notes as a component of Corporate Units, holders of the Corporate Units may settle early only in integral multiples of                      Corporate Units. Holders of Treasury Units may settle early only in integral multiples of 20 Treasury Units.

Your early settlement right is subject to the condition that, if required under the U.S. federal securities laws, we have a registration statement under the Securities Act of 1933, as amended (the “Securities Act”), in effect and a prospectus available covering the shares of common stock and other securities, if any, deliverable upon settlement of a purchase contract. We have agreed that, if required by U.S. federal securities laws, we will use our commercially reasonable efforts to have a registration statement in effect and a prospectus available covering those shares of common stock and other securities to be delivered in respect of the purchase contracts being settled.

What happens if there is early settlement upon a cash merger?

Prior to the purchase contract settlement date, if we are involved in a consolidation, acquisition or merger, or a sale of all or substantially all of our assets, in each case in which at least 10% of the consideration received by holders of our common stock consists of cash or cash equivalents, which we refer to as a cash merger, then following the cash merger, each holder of a purchase contract will have the right to accelerate and settle such contract early at the settlement rate described under “Description of the Purchase Contacts—Early Settlement Upon Cash Merger,” and receive, under certain circumstances, an additional make-whole number of shares, which we refer to as the make-whole shares, provided that at such time, if required under the U.S. federal securities laws, there is in effect a registration statement and a prospectus available covering the common stock and other securities, if any, to be delivered in respect of the purchase contracts being settled. We refer to this right as the “merger early settlement right.” The number of make-whole shares applicable to a merger early settlement will be determined by reference to the table set forth under “Description of the Purchase Contracts—Early Settlement Upon Cash Merger.”

We will provide each of the holders with a notice of the completion of a cash merger within five business days thereof. The notice will specify a date, which we refer to as the “cash merger early settlement date,” which shall be at least ten days after the date of the notice but no later than the earlier of (i) 20 days after the date of such notice and (ii) two business days prior to the purchase contract settlement date, by which each holder’s merger early settlement right must be exercised. The notice will set forth, among other things, the applicable settlement rate and the amount of the cash, securities and other consideration receivable by the holder upon settlement. To exercise the merger early settlement right, you must deliver to the purchase contract agent three business days before the cash merger early settlement date your Corporate Units or Treasury Units (by delivery of certificates if they are held in certificated form) and payment of the applicable purchase price in immediately available funds less the amount of any accrued and unpaid contract adjustment payments (unless such cash

 

 

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merger early settlement date occurs after the related record date for such contract adjustment payments, in which case the applicable purchase price shall not be reduced by the amount of any accrued and unpaid contract adjustment payments).

If you exercise the merger early settlement right, we will deliver to you on the cash merger early settlement date, in respect of each such Equity Unit so settled, the kind and amount of securities, cash or other property that you would have been entitled to receive in the cash merger as a holder of a number of shares of our common stock equal to the sum of the settlement rate described under “Description of the Purchase Contracts—Early Settlement Upon Cash Merger” and the make-whole shares. You will also receive the senior notes, applicable ownership interests in the Treasury portfolio, Treasury securities or new treasury securities underlying the Corporate Units or Treasury Units, as the case may be. If you do not elect to exercise your merger early settlement right, your Corporate Units or Treasury Units will remain outstanding and subject to normal settlement, without the make-whole shares, on the purchase contract settlement date with the securities, cash or other property holders of our common stock were entitled to receive in the cash merger. If required under the U.S. federal securities laws, there will be a registration statement in effect and a prospectus available covering the common stock and other securities, if any, to be delivered in respect of the purchase contracts being settled.

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, holders of Corporate Units may exercise the merger early settlement right only in integral multiples of 20 Corporate Units. If the Treasury portfolio has replaced the senior notes as a component of Corporate Units, holders of the Corporate Units may exercise the merger early settlement right only in integral multiples of      Corporate Units. A holder of Treasury Units may exercise the merger early settlement right only in integral multiples of 20 Treasury Units.

What is the ranking of the senior notes and the contract adjustment payments?

The senior notes will be our unsecured, unsubordinated obligations. The senior notes will rank equally in right of payment with our existing and future unsecured and unsubordinated indebtedness and will be senior in right of payment to any of our existing and future subordinated indebtedness. The contract adjustment payments are our unsecured, subordinated obligations and will be subordinated in right of payment to all of our existing and future senior indebtedness (as defined under “Description of the Equity Units—Ranking”) excluding indebtedness of variable interest entities which are required to be consolidated under the provisions of FIN 46. The senior notes and the contract adjustment payments will be effectively subordinated to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness. Additionally, the senior notes and contract adjustment payments will be effectively subordinated to all existing and future preferred stock and indebtedness, guarantees and other liabilities of our subsidiaries.

What are the principal United States federal income tax consequences related to Corporate Units, Treasury Units and senior notes?

Although the Internal Revenue Service (the “IRS”) has issued a Revenue Ruling addressing the treatment of units similar to the Equity Units, no statutory, judicial or administrative authority directly addresses the treatment of the Equity Units or instruments substantially identical to the Equity Units for United States federal income tax purposes. No assurance can be given that the conclusions in the Revenue Ruling would apply to the Equity Units.

An owner of Equity Units will be treated as owning the purchase contract and an undivided beneficial interest in the senior notes, the applicable ownership interest in the Treasury portfolio, Treasury securities or new treasury securities constituting the Equity Units, as applicable. By purchasing the Equity Units you will be deemed to have agreed to treat the Equity Units in that manner for all United States federal income tax purposes. In addition, as a holder of Corporate Units you will be deemed to have agreed to allocate $             to your undivided beneficial interest in the senior notes, which will establish your initial tax basis in your interest in each

 

 

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purchase contract as $             and your initial tax basis in your undivided beneficial interest in the senior notes as $            . Payments on the Equity Units will not be eligible for the 15% tax rate on qualified dividends. Because of the terms of the senior notes, we believe that the senior notes should be classified as contingent payment debt instruments subject to the “noncontingent bond method” for accruing original issue discount, as set forth in the applicable United States Treasury regulations. The effects of such method will be (i) to require you, regardless of your usual method of tax accounting, to accrue interest income with respect to the notes on a constant yield basis at an assumed yield; (ii) to require you to accrue interest income, which may be in excess of interest payments actually received for all accrual periods ending on or prior to February 15, 2011, and (iii) generally to result in ordinary rather than capital treatment of any gain or loss on the sale, exchange or other disposition of the senior notes.

If the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, a beneficial owner of Corporate Units will generally be required to include in gross income its allocable share of any interest payments made with respect to the applicable ownership interests in the Treasury portfolio and, if appropriate, original issue discount on the applicable ownership interests in the Treasury portfolio as it accrues on a constant yield to maturity basis, or, if appropriate, acquisition discount on the applicable ownership interests in the Treasury portfolio.

We intend to treat contract adjustment payments as taxable ordinary income to a U.S. Holder (as defined in this prospectus supplement under “Certain United States Federal Income Tax Consequences”) when received or accrued, in accordance with the U.S. Holder’s regular method of tax accounting. We intend to treat any contract adjustment payments paid to a Non-U.S. Holder (as defined in this prospectus supplement under “Certain United States Federal Income Tax Consequences”) as amounts generally subject to withholding tax at a 30% rate, unless an income tax treaty reduces or eliminates such tax.

FOR ADDITIONAL INFORMATION, SEE “CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES” IN THIS PROSPECTUS SUPPLEMENT, STARTING ON PAGE S-98.

What are the risks relating to the Equity Units?

See “Risk Factors” and other information included or incorporated by reference in this prospectus supplement and the accompanying prospectus for a discussion of factors you should carefully consider before deciding to invest in the Equity Units.

 

 

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The Offering—Explanatory Diagrams

The following diagrams demonstrate some of the key features of the purchase contracts, senior notes, Corporate Units and Treasury Units, and the transformation of Corporate Units into Treasury Units and senior notes.

The following diagrams assume that the senior notes are successfully remarketed and that the purchase contracts are settled on the purchase contract settlement date with shares of common stock.

Purchase Contract

Corporate Units and Treasury Units both include a purchase contract under which the holder agrees to purchase shares of our common stock on the purchase contract settlement date. In addition, these purchase contracts entitle the holder to unsecured contract adjustment payments as shown in the diagrams on the following pages.

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Notes:

 

(1)  

If the applicable market value of our common stock is less than or equal to the reference price of $            ,              shares of our common stock will be delivered to a holder of an Equity Unit. The number of shares of

 

 

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common stock to be so delivered is approximately equal to the quotient obtained by dividing the stated amount of $50 by the reference price.

(2)   If the applicable market value of our common stock is between the reference price and the threshold appreciation price of $            , the number of shares of our common stock to be delivered to a holder of an Equity Unit will be calculated by dividing the stated amount of $50 by the applicable market value.
(3)   If the applicable market value of our common stock is greater than or equal to the threshold appreciation price,              shares of our common stock will be delivered to a holder of an Equity Unit. The number of shares of common stock to be so delivered is approximately equal to the quotient obtained by dividing the stated amount of $50 by the threshold appreciation price of $            .
(4)   The reference price is the price at which we offered our common stock in the concurrent Common Stock Offering.
(5)   The threshold appreciation price represents an approximately     % appreciation over the reference price.
(6)   The “applicable market value” means the average of the volume weighted average prices per share of our common stock (or exchange property units, as defined under “Description of the Purchase Contracts—Anti-Dilution Adjustments,” in which the purchase contracts will be settled following a reorganization event) on each of the 20 consecutive trading days ending on the third trading day immediately preceding the purchase contract settlement date, subject to anti-dilution adjustments under the circumstances set forth in “Description of the Purchase Contracts—Anti-Dilution Adjustments.”
(7)   Until such time as the Authorized Share Condition has been satisfied, each purchase contract that is a component of an Equity Unit will be settled by the purchase by the holder of the purchase contract, and sale by us, of shares of our Series A Preferred Stock in lieu of shares of our common stock. The number of shares of our Series A Preferred Stock to be purchased by each holder of an Equity Unit will be based on a fixed ratio of one share of Series A Preferred Stock for every 100 shares of our common stock which would have otherwise been purchased. See “Description of the Purchase Contracts—Requirement for Authorized Share Condition.”

Corporate Units

A Corporate Unit consists of two components as described below:

LOGO

 

Notes:

 

(1)  

Until such time as the Authorized Share Condition has been satisfied, each purchase contract that is a component of an Equity Unit will be settled by the purchase by the holder of the purchase contract, and sale by us, of shares of our Series A Preferred Stock in lieu of shares of our common stock. The number of

 

 

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shares of our Series A Preferred Stock to be purchased by each holder of an Equity Unit will be based on a fixed ratio of one share of Series A Preferred Stock for every 100 shares of our common stock which would have otherwise been purchased. See “Description of the Purchase Contracts—Requirement for Authorized Share Condition.”

(2)

 

If the Authorized Share Condition has not been satisfied by the 120th day after the issuance of the Equity Units, quarterly contract adjustment payments payable by us to the holder will increase from     % per annum to a rate of     % per annum on the stated amount of $50 from such date to, but excluding, the date on which the Authorized Share Condition is satisfied, at which time, such contract adjustment payments shall return to     % per annum. See “Description of the Purchase Contracts—Contract Adjustment Payments.”

(3)

 

Each owner of a Corporate Unit owns an undivided beneficial ownership interest in a senior note and will be entitled to a  1/20, or 5%, of each interest payment paid in respect of a $1,000 principal amount senior note.

(4)

 

Senior notes will be issued in minimum denominations of $1,000. Each undivided beneficial ownership interest in senior notes represents a  1/20, or 5%, undivided beneficial ownership interest in a $1,000 principal amount senior note.

(5)   The senior notes are initially due on February 15, 2021, which maturity date may be modified to an earlier date in connection with a successful remarketing.

The holder of a Corporate Unit owns an undivided beneficial ownership interest in a senior note that forms a part of the Corporate Unit but will pledge it to us through the collateral agent to secure its obligation under the related purchase contract. Unless a successful remarketing occurs, the purchase contract is terminated as a result of our bankruptcy, insolvency or reorganization or the holder settles the purchase contract early, settles the purchase contract in cash or creates a Treasury Unit, the senior note will be used to satisfy the holder’s obligation under the related purchase contract.

Following the successful remarketing of the senior notes, the applicable ownership interest in the Treasury portfolio will replace the senior note as a component of the Corporate Unit and the reset rate on the senior notes would be effective three business days following the successful remarketing. In connection with any remarketing, we may elect, in consultation with the remarketing agent, to modify the maturity date and redemption provisions of the senior notes, as described under “Description of our Senior Notes,” and the remarketing agent, in consultation with us, may reset the interest rate.

Treasury Units

A Treasury Unit consists of two components as described below:

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Notes:

 

(1)   Until such time as the Authorized Share Condition has been satisfied, each purchase contract that is a component of an Equity Unit will be settled by the purchase by the holder of the purchase contract, and sale by us, of shares of our Series A Preferred Stock in lieu of shares of our common stock. The number of shares of our Series A Preferred Stock to be purchased by each holder of an Equity Unit will be based on a fixed ratio of one share of Series A Preferred Stock for every 100 shares of our common stock which would have otherwise been purchased. See “Description of the Purchase Contracts—Requirement for Authorized Share Condition.”

(2)

 

If the Authorized Share Condition has not been satisfied by the 120th day after the issuance of the Equity Units, quarterly contract adjustment payments payable by us to the holder will increase from     % per annum to a rate of     % per annum on the stated amount of $50 from such date to, but excluding, the date on which the Authorized Share Condition is satisfied, at which time, such contract adjustment payments shall return to     % per annum. See “Description of the Purchase Contracts—Contract Adjustment Payments.”

(3)

 

Each holder of a Treasury Unit owns a  1/20 , or 5%, undivided beneficial ownership interest in a Treasury security with a principal amount at maturity of $1,000 that matures on February 15, 2011. On such date, the collateral agent will use all or a portion of the proceeds of the maturing Treasury security to purchase a new treasury security that matures on or prior to the purchase contract settlement date. Such new treasury security together with the purchase contract constitutes a Treasury Unit.

The holder of a Treasury Unit owns a beneficial ownership interest in the Treasury security or new treasury that forms a part of the Treasury Unit but will pledge it to us through the collateral agent to secure its obligations under the related purchase contract. Unless the purchase contract is terminated as a result of our bankruptcy, insolvency or reorganization or the holder elects to settle early or recreates a Corporate Unit, the Treasury security or new treasury will be used to satisfy the holder’s obligation under the related purchase contract.

Treasury Units can only be created with integral multiples of 20 Corporate Units.

Senior Notes

The senior notes have the terms described below:

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Notes:

 

(1)   The senior notes are initially due on February 15, 2021, which maturity date may be modified to an earlier date in connection with a successful remarketing.

 

 

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Transforming Corporate Units into Treasury Units and Senior Notes

 

   

To create a Treasury Unit, a holder separates a Corporate Unit into its components—the purchase contract and the senior note, and then combines the purchase contract with a Treasury security or new treasury security.

 

   

The Treasury security or new treasury security together with the purchase contract constitutes a Treasury Unit. The senior note, which is no longer a component of the Corporate Unit, is released to the holder and is tradable as a separate security.

 

   

A holder owns a beneficial interest in the Treasury security or new treasury security that forms a part of the Treasury Unit but will pledge it to us through the collateral agent to secure its obligation under the related purchase contract.

LOGO

 

Notes:

 

(1)   Until such time as the Authorized Share Condition has been satisfied, each purchase contract that is a component of an Equity Unit will be settled by the purchase by the holder of the purchase contract, and sale by us, of shares of our Series A Preferred Stock in lieu of shares of our common stock. The number of shares of our Series A Preferred Stock to be purchased by each holder of an Equity Unit will be based on a fixed ratio of one share of Series A Preferred Stock for every 100 shares of our common stock which would have otherwise been purchased. See “Description of the Purchase Contracts—Requirement for Authorized Share Condition.”

(2)

 

If the Authorized Share Condition has not been satisfied by the 120th day after the issuance of the Equity Units, quarterly contract adjustment payments payable by us to the holder will increase from     % per annum to a rate of     % per annum on the stated amount of $50 from such date to, but excluding, the date on which the Authorized Share Condition is satisfied, at which time, such contract adjustment payments shall return to     % per annum. See “Description of the Purchase Contracts—Contract Adjustment Payments.”

(3)   The senior notes are initially due on February 15, 2021, which maturity date may be modified to an earlier date in connection with a successful remarketing.

(4)

 

Each holder of a Treasury Unit owns a  1/20 , or 5%, undivided beneficial ownership interest in a Treasury security with a principal amount at maturity of $1,000 that matures on February 15, 2011. On such date, the collateral agent will use all or a portion of the proceeds of the maturing Treasury security to purchase a new treasury security that matures on or prior to the purchase contract settlement date. Such new treasury security together the purchase contract constitutes a Treasury Unit.

 

 

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Following the successful remarketing of the senior notes, the applicable ownership interest in the Treasury portfolio, rather than the senior note, will be released to the holder upon the transformation of a Corporate Unit into a Treasury Unit and will be tradable separately.

The holder can also transform Treasury Units and senior notes (or, following a successful remarketing of the senior notes, the applicable ownership interest in the Treasury portfolio) into Corporate Units. Following that transformation, the Treasury security or new treasury security, which will no longer be a component of the Treasury Unit, will be released to the holder and will be tradable as a separate security.

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, the transformation of Corporate Units into Treasury Units requires integral multiples of 20 Corporate Units, and the transformation of Treasury Units into Corporate Units requires integral multiples of 20 Treasury Units. If the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, the transformation of Corporate Units into Treasury Units requires integral multiples of      Corporate Units, and the transformation of Treasury Units into Corporate Units also requires integral multiples of      Treasury Units.

 

 

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Summary Financial Information

The following summary consolidated statement of operations data for the years ended December 31, 2005, 2006 and 2007, and the consolidated balance sheet data as of December 31, 2006 and 2007, have been derived from our audited consolidated financial statements incorporated by reference in this prospectus supplement and included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement. The following summary consolidated statement of operations data for the years ended December 31, 2003 and 2004, and the consolidated balance sheet data as of December 31, 2003, 2004 and 2005 have been derived from our audited consolidated financial statements not included or incorporated by reference in this prospectus supplement. This information is only a summary and should be read together with the consolidated financial statements, the related notes and other financial information incorporated by reference in this prospectus supplement.

 

    Years Ended December 31,  
(Dollars in millions, except per share amounts)   2003     2004     2005     2006     2007  

Statement of Operations Data Highlights

         

Gross premiums written

  $ 1,143.7     $ 1,048.3     $ 1,096.0     $ 996.7     $ 1,031.4  

Net premiums earned and other credit enhancement fees

    667.3       764.5       866.4       871.4       917.9  

Net investment income

    321.1       355.3       378.1       423.9       465.0  

Net mark-to-market gains (losses) on credit derivative contracts

    —         17.7       13.6       9.1       (6,004.4 )

Interest income from investment and payment agreements

    212.0       198.8       270.3       391.7       445.3  

Financial services—other revenue

    20.6       26.4       15.8       16.6       6.9  

Total revenue

    1,272.2       1,401.6       1,614.1       1,832.1       (4,214.9 )

Losses and loss expenses

    53.4       69.6       149.9       20.0       256.1  

Financial guarantee underwriting and operating expenses

    92.0       106.6       117.7       133.7       139.3  

Interest expense from investment and payment agreements

    196.3       168.9       239.3       359.9       420.0  

Financial services—other expenses

    12.1       14.7       13.7       12.4       12.2  

Interest expense

    54.2       54.3       55.9       75.3       85.7  

Net income

    618.9       724.6       751.0       875.9       (3,248.2 )

Net income (loss) per share:

         

Basic

    5.81       6.61       6.94       8.22       (31.56 )

Diluted

    5.66       6.53       6.87       8.15       (31.56 )

Return on equity

    15.7 %     15.6 %     14.4 %     15.1 %     (76.7 )%

Cash dividends declared per common share

    0.420       0.470       0.550       0.660       0.780  
    As of December 31,  
    2003     2004     2005     2006     2007  

Balance Sheet Data

         

Total investments, at fair value

  $ 13,776.3     $ 14,422.3     $ 15,591.9     $ 17,433.6     $ 18,395.7  

Prepaid reinsurance

    325.5       297.3       303.4       315.5       489.0  

Total assets

    16,557.1       17,672.5       18,545.9       20,267.8       23,565.0  

Unearned premiums

    2,531.8       2,765.2       2,941.0       3,037.5       3,123.9  

Losses and loss expense reserve

    189.4       254.1       304.1       220.1       484.3  

Derivative liabilities

    946.2       1,213.5       807.5       667.1       6,685.5  

Obligations under investment, investment repurchase and payment agreements

    7,076.4       7,080.7       7,252.8       8,356.9       8,706.4  

Long-term debt

    791.8       791.8       1,191.7       991.8       1,669.9  

Total stockholders’ equity

    4,265.1       5,035.0       5,388.2       6,189.6       2,279.9  

 

 

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RISK FACTORS

Your investment in the Equity Units will involve significant risks described below. In consultation with your own financial and legal advisors, you should carefully consider the information included in or incorporated by reference in this prospectus supplement and the accompanying prospectus, and pay special attention to the following discussion of risks relating to the Equity Units before deciding whether an investment in the securities offered hereby is suitable for you. The Equity Units will not be an appropriate investment for you if you are not knowledgeable about significant features of the securities offered hereby or financial matters in general. You should not purchase the Equity Units unless you understand, and know that you can bear, these investment risks.

Risks relating to the Equity Units

Because we may not have enough shares of common stock authorized and unissued to accommodate the settlement in full of the purchase contracts, we may be required to issue shares of Series A Preferred Stock upon settlement, instead of common stock.

As described under “Description of the Purchase Contracts—Requirement for Authorized Share Condition,” the purchase contracts may be settled for more shares of common stock than we currently have available on reserve for issuance on the purchase contract settlement date. If at the time of settlement of a purchase contract the Authorized Share Condition has not been satisfied, we will issue shares of a newly created series of our preferred stock, the Series A Preferred Stock, instead of shares of our common stock. While each share of our Series A Preferred Stock is intended to be the economic equivalent of holding 100 shares of our common stock, the actual market value of a share of Series A Preferred Stock may be substantially less than the market value of 100 shares of our common stock. In addition, if there is a decrease in the market value of our common stock, the market value of our Series A Preferred Stock will also likely decrease. There currently is not and may never be a trading market for the Series A Preferred Stock that we may be required to issue upon settlement of the purchase contracts. A market is not expected to be made in the Series A Preferred Stock after it is issued, if at all, and no one is obligated to undertake market-making activity in the Series A Preferred Stock, and any market that may develop could be discontinued at any time without notice. In addition, any market-making activity will be subject to the limits imposed by applicable securities laws. As a result, a market for the Series A Preferred Stock may not develop or, if one does develop, it may not be maintained and if maintained, sufficient to provide adequate liquidity for the Series A Preferred Stock. If an active market for the Series A Preferred Stock fails to develop, be sustained or to have a sufficient float to provide adequate liquidity to the holders, the value of the Series A Preferred Stock could be significantly less than the market value of the corresponding number of shares of common stock. If shares of the Series A Preferred Stock are separately traded to a sufficient extent that applicable exchange listing requirements are met, we may endeavor, but are not obligated, to list the Series A Preferred Stock on the same exchange as the common stock.

You will bear the entire risk that the market value of our common stock may decline.

As a holder of Equity Units you will have a beneficial ownership interest in the related senior notes, Treasury securities, new treasury securities or an applicable ownership interest in the Treasury portfolio, as the case may be; you will also have an obligation to buy shares of our common stock pursuant to the purchase contract that is a part of the Equity Units. On May 17, 2011, unless you have paid cash to satisfy your obligation under the purchase contract or the purchase contracts are terminated due to our bankruptcy, insolvency or reorganization or settled early, (i) in the case of Corporate Units, either (x) the proceeds from the applicable ownership interest in the Treasury portfolio when paid at maturity or (y) the put price paid upon the automatic put of the senior notes to us, or (ii) in the case of Treasury Units, the proceeds from the applicable ownership interest in the related Treasury securities or new treasury securities when paid at maturity, will automatically be used to purchase a specified number of shares of our common stock on your behalf.

The number of shares of our common stock that you will receive upon the settlement of a purchase contract is not fixed but instead will depend on the average of the volume weighted average price per share of our

 

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common stock (or exchange property units, as defined under “Description of the Purchase Contracts—Anti-Dilution Adjustments,” in which the purchase contracts will be settled following a reorganization event) on each of the 20 consecutive trading days ending on the third trading day immediately preceding May 17, 2011, which we refer to as the applicable market value, subject to anti-dilution adjustments under the circumstances set forth in “Description of the Purchase Contracts—Anti-Dilution Adjustments.” There can be no assurance that the market value of our common stock on the purchase contract settlement date will not be less than the price paid by you for the Corporate Units. If the applicable market value of the common stock is less than the reference price $            , the market value of the common stock issued to you pursuant to each purchase contract on May 17, 2011 (assuming that the market value on that date is the same as the applicable market value of the common stock) will be less than the effective price per share paid by you on the date of issuance of the Corporate Units in this offering (assuming you purchased the Corporate Units for $50 each). Accordingly, you will bear the entire risk that the market value of the common stock may decline, and that the decline could be substantial and could result in a loss of all or a portion of your investment.

In addition, because the number of shares delivered to you on the purchase contract settlement date will be based upon the applicable market value, which is in turn calculated on the basis of the average of the volume weighted average price per share of our common stock on each of the 20 consecutive trading days ending on the third trading day immediately preceding the purchase contract settlement date, the shares of common stock you receive on the purchase contract settlement date may be worth less than the shares of common stock you would have received had the applicable market value been equal to the volume weighted average price per share of our common stock on the purchase contract settlement date. Moreover, to the extent that the shares of common stock are delivered after the purchase contract settlement date, you will bear the risk of a decline in the value of that common stock between the purchase contract settlement date and the applicable stock purchase date.

You will receive only a portion of any appreciation in our common stock price and only if the appreciation of common stock exceeds a specified threshold, and the opportunity for equity appreciation provided by an investment in Equity Units is less than that provided by a direct investment in our common stock.

There can be no assurance that the market price of our common stock will appreciate. Moreover, the opportunity for equity appreciation afforded by investing in Equity Units will generally be less than if you had invested directly in our common stock. This opportunity is less because the market value of the common stock to be received by you pursuant to a purchase contract on May 17, 2011 (assuming that the market value on that date is the same as the applicable market value of the common stock and no reorganization event has occurred) will only exceed the effective price per share paid by you for the common stock on the date of issuance of the Corporate Units (assuming you purchased Corporate Units for $50 each) if the applicable market value of the common stock exceeds the threshold appreciation price (which represents an appreciation of approximately     % over the reference price of $            ). In other words, your purchase contract will not entitle you to participate in any appreciation in the market value of our common stock unless the applicable market value of our common stock, determined in connection with the purchase contract settlement, is greater than the threshold appreciation price of $            . If the applicable market value of our common stock exceeds the reference price but falls below the threshold appreciation price, you will realize no equity appreciation on the common stock for the period during which you own the purchase contract, and if the applicable market value is less than the reference price, you will realize a loss on your investment (assuming you purchased Equity Units for $50 each). Furthermore, if the applicable market value of our common stock equals or exceeds the threshold appreciation price, you would receive on the purchase contract settlement date only approximately     % (the percentage equal to the reference price divided by the threshold appreciation price) of the value of the shares of common stock that you would have received had you invested $50 to purchase common stock at the reference price of $            per share on the date of issuance of the Equity Units.

 

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The senior notes and the contract adjustment payments are effectively subordinated to any existing or future preferred stock and indebtedness or other liabilities of our subsidiaries, and the contract adjustment payments are subordinated to our existing and future senior indebtedness.

The senior notes and the contract adjustment payments will be effectively subordinated to any existing or future preferred stock and indebtedness, guarantees and other liabilities, including trade payables, of our subsidiaries. As of December 31, 2007, our subsidiaries had total indebtedness and other liabilities (excluding policyholder reserves, intercompany liabilities and liabilities owed to us and debt related to variable interest entities consolidated under the provisions of FIN 46) of approximately $15.9 billion and had guaranteed approximately $0 of indebtedness outstanding as of that date (excluding financial guarantee contracts). The senior notes and the contract adjustment payments will be effectively subordinated to any of our secured indebtedness to the extent of the value of the asset securing such indebtedness.

The contract adjustment payments are also subordinated to our existing and future senior indebtedness (as defined under “Description of the Equity Units—Ranking”). As of December 31, 2007, we had $1.0 billion of senior indebtedness outstanding.

At December 31, 2007, on a pro forma basis after giving effect to the offering (excluding any exercise of the underwriters’ over-allotment option) and the use of proceeds hereof, we would have had $1.9 billion of indebtedness, $1.0 billion of which ranks pari passu to the senior notes.

The trading price of our common stock, the general level of interest rates and our credit quality will directly affect the trading prices for the Corporate Units and Treasury Units.

The trading prices of Corporate Units and Treasury Units in the secondary market will be directly affected by the trading prices of our common stock, the general level of interest rates and our credit quality, as well as by a number of other factors. It is impossible to predict whether the price of the common stock or interest rates will rise or fall or whether our credit quality will deteriorate. Trading prices of the common stock will be influenced by our operating results and prospects and by economic, financial and other factors. In addition, general market conditions, including the level of, and fluctuations in, the trading prices of stocks generally, and sales of substantial amounts of common stock by us in the market after the offering of the Equity Units, or the perception that such sales could occur, could affect the market price of our common stock. Fluctuations in interest rates may give rise to arbitrage opportunities based upon changes in the relative value of the common stock underlying the purchase contracts and of the other components of the Equity Units. Any such arbitrage could, in turn, affect the trading prices of the Corporate Units, Treasury Units, senior notes and our common stock.

If you hold Equity Units, you will not be entitled to any rights with respect to our common stock, but you will be subject to all changes made with respect to our common stock.

If you hold Equity Units, you will not be entitled to any rights with respect to our common stock (including, without limitation, voting rights and rights to receive any dividends or other distributions on the common stock), but you will be subject to all changes affecting the common stock. You will only be entitled to exercise rights and receive any dividends or other distributions with respect to the common stock if and when we deliver shares of common stock in settlement of your purchase contract on May 17, 2011, or as a result of early settlement, as the case may be, and the applicable record date, if any, for the exercise of those rights or the receipt of those dividends or distributions occurs on or after that date. For example, in the event that an amendment is proposed to our certificate of incorporation or by-laws requiring stockholder approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to delivery of the common stock, you will not be entitled to vote on the amendment, although you will nevertheless be subject to any changes in the powers, preferences or special rights of our common stock.

 

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The delivery of make-whole shares upon a merger early settlement may not adequately compensate you.

If a cash merger (as defined below under “Description of the Purchase Contracts—Early Settlement Upon Cash Merger”) occurs and you exercise your merger early settlement right, you will be entitled to receive additional value in the form of make-whole shares unless the price paid per share of our common stock in the cash merger is in excess of $            , subject to adjustment. A description of how the make-whole shares will be determined is set forth under “Description of the Purchase Contracts—Early Settlement Upon Cash Merger—Calculation of Make-Whole Shares.” Although the make-whole shares are designed to compensate you for the lost value of your Equity Units as a result of the cash merger, this feature may not adequately compensate you for such loss.

The Equity Units provide limited settlement rate adjustments, and an event could occur that adversely affects the value of the Equity Units or our common stock but that does not result in an adjustment to the settlement rate.

The number of shares of common stock that you are entitled to receive on May 17, 2011, or as a result of early settlement of a purchase contract, is subject to adjustment for certain events arising from stock splits and combinations, stock dividends, cash dividends and certain other acts. See “Description of the Purchase Contracts—Anti-Dilution Adjustments.” We will not adjust the number of shares of common stock that you are to receive on May 17, 2011, or as a result of early settlement of a purchase contract, for other events, including employee stock option grants, ordinary dividends, offerings of common stock by us for cash or in connection with acquisitions. There can be no assurance that an event that adversely affects the value of the Equity Units or our common stock, but does not result in an adjustment to the settlement rate, will not occur. Further, we are not restricted from issuing additional common stock during the term of the purchase contracts and have no obligation to consider your interests for any reason. If we issue additional shares of common stock, it may materially and adversely affect the trading price of our common stock and the Equity Units.

Upon a successful remarketing of the senior notes, the interest rate on your senior notes may be reset and the maturity date of your senior notes may be modified even if you elect not to participate in the remarketing.

In connection with a remarketing, we and the remarketing agent may change the interest rate on and maturity date and redemption provisions of the senior notes, as described under “Description of our Senior Notes—Modification of the Terms of the Senior Notes in Connection with a Successful Remarketing” and “Description of our Senior Notes—Market Reset Rate.” If the remarketing is successful, the reset interest rate, the modified maturity date, if any, and the modified redemption provisions, if any, will apply to all the senior notes, even if they are not included in the remarketing. Moreover, holders of senior notes must elect whether to participate in the remarketing before knowing what the reset interest rate on, modified maturity date or modified redemption provisions of the senior notes will be. You may determine that the reset interest rate, modified maturity date or modified redemption provision is not favorable to you. In addition, following a successful remarketing, interest on the senior notes will be payable on a semi-annual basis.

Our Corporate Units, Treasury Units and senior notes have no prior public market, and we cannot assure you that an active trading market will develop.

It is not possible to predict how, if at all, Corporate Units, Treasury Units or senior notes will trade in the secondary market or whether the market will be liquid or illiquid. Our Corporate Units, Treasury Units and senior notes are newly issued securities and there is currently no secondary market for any of our Corporate Units, Treasury Units or senior notes. Although we intend to list the Corporate Units on the New York Stock Exchange or another national securities exchange, an active trading market might not develop or continue. If the Treasury Units or the senior notes are separately traded to a sufficient extent that applicable exchange listing requirements are met, we may endeavor, but are not obligated, to list the Treasury Units or the senior notes on the same exchange as the Corporate Units. However, an active trading market in those securities also may not develop and

 

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we may not be successful in effecting any such listing. In addition, if you were to substitute Treasury securities or new treasury securities for senior notes or applicable ownership interest in the Treasury portfolio, thereby converting your Corporate Units into Treasury Units, or senior notes or applicable ownership interests in the Treasury portfolio for Treasury securities or new treasury securities, thereby converting your Treasury Units to Corporate Units, the liquidity of Corporate Units or Treasury Units could be adversely affected by the resultant reduction in the number of outstanding Corporate Units or Treasury Units, as the case may be. If the Corporate Units are listed on a securities exchange, we cannot assure you that the Corporate Units will not be delisted or that trading in the Corporate Units will not be suspended as a result of a holder’s or holders’ election to create Treasury Units by substituting collateral, which could cause the number of Corporate Units to fall below the requirement for listing securities on such exchange. Likewise, if Treasury Units were listed on a securities exchange, we cannot assure you that the Treasury Units would not be delisted or that trading in the Treasury Units would not be suspended as a result of a similar election to create Corporate Units by substituting collateral, which could cause the number of Treasury Units to fall below the requirement for listing on such exchange.

Your rights to the pledged securities will be subject to our security interest and may be affected by a bankruptcy proceeding.

Although holders of Equity Units will have a beneficial ownership interest in the related senior notes, Treasury securities, new treasury securities or Treasury portfolio, as applicable, those interests will be pledged to us through the collateral agent to secure your obligations under the related purchase contracts. Thus, your rights to the pledged securities will be subject to our security interest. In addition, notwithstanding the automatic termination of the purchase contracts in the event that Ambac Financial Group, Inc. becomes the subject of a case under the U.S. Bankruptcy Code, the delivery of the pledged securities to you may be delayed by the imposition of the automatic stay under Section 362 of the Bankruptcy Code or by exercise of the bankruptcy court’s power under Section 105(a) of the Bankruptcy Code. Moreover, claims arising out of the senior notes, like all other claims in bankruptcy proceedings, will be subject to the equitable jurisdiction and powers of the bankruptcy court. For example, a party in interest in the bankruptcy proceeding might argue that the holders of senior notes should be treated as equity holders, rather than creditors, in the bankruptcy proceeding.

The purchase contract agreement will not be qualified under the Trust Indenture Act and the obligations of the purchase contract agent are limited.

The purchase contract agreement between us and the purchase contract agent will not be qualified as an indenture under the Trust Indenture Act of 1939, and the purchase contract agent will not be required to qualify as a trustee under the Trust Indenture Act. Thus, you will not have the benefit of the protection of the Trust Indenture Act with respect to the purchase contract agreement or the purchase contract agent. The senior notes constituting a part of the Corporate Units will be issued pursuant to an indenture, which has been or will be qualified under the Trust Indenture Act. Accordingly, if you hold Corporate Units, you will have the benefit of the protections of the Trust Indenture Act only to the extent applicable to the senior notes included in the Corporate Units. The protections generally afforded the holder of a security issued under an indenture that has been qualified under the Trust Indenture Act include:

 

   

disqualification of the indenture trustee for “conflicting interests,” as defined under the Trust Indenture Act;

 

   

provisions preventing a trustee that is also a creditor of the issuer from improving its own credit position at the expense of the security holders immediately prior to or after a default under such indenture; and

 

   

the requirement that the indenture trustee deliver reports at least annually with respect to certain matters concerning the indenture trustee and the securities.

 

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You may not be able to exercise your rights to settle a purchase contract prior to the purchase contract settlement date unless a registration statement under the Securities Act is in effect and a prospectus is available covering the shares of common stock or other securities, if any, deliverable upon early settlement of a purchase contract.

The early settlement rights under the purchase contracts are subject to the condition that, if required under the U.S. federal securities laws, we have a registration statement under the Securities Act in effect and an available prospectus covering the shares of common stock and other securities, if any, deliverable upon settlement of a purchase contract. Although we have agreed to use our commercially reasonable efforts to have such a registration statement in effect and a prospectus available if so required under the U.S. federal securities laws, any failure or inability to maintain an effective registration statement or to have available a prospectus covering the common stock and any such other securities, including as a result of pending corporate events or announcements that prevent the delivery of a current prospectus, may prevent or delay an early settlement.

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 and other liabilities and to make capital investment in our subsidiaries. As a result, we will be largely dependent on dividends from Ambac Assurance to pay the principal of and interest on the senior notes offered hereby and to make contract adjustment payments. However, as separate legal entities, neither Ambac Assurance nor any of our other subsidiaries has any obligation, contingent or otherwise, to make such funds available to us or to make any payments under the stock purchase contracts or senior notes. In addition, 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 adversely affect our ability to make payments on the stock purchase contracts or to repay our debt, including the senior notes, or could have a material adverse effect on our operations. See “Insurance Regulatory Matters—Wisconsin Dividend Restrictions” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is incorporated by reference in this prospectus supplement for further information.

Our subsidiaries generated approximately 100% of our consolidated revenues in 2007 and held approximately 100% of our consolidated assets as of December 31, 2007.

You will be required to accrue original issue discount on the senior notes for United States federal income tax purposes.

For United States federal income tax purposes, you may be required to accrue interest income on the senior notes in excess of the stated interest on the senior notes and will generally be required to treat any gain on a disposition of the notes as ordinary income instead of capital. Because of the terms of the senior notes, the senior notes should be classified as contingent payment debt instruments subject to the “noncontingent bond method” for accruing original issue discount for United States federal income tax purposes. Assuming that the senior notes are so treated, you will be required to accrue original issue discount on the senior notes in your gross income based upon an assumed yield on a constant yield-to-maturity basis, regardless of your usual method of tax accounting. For all accrual periods ending on or prior to February 15, 2011, the original issue discount that accrues on the senior notes may exceed the stated interest payments on the senior notes. In addition, any gain on the disposition of a senior note before the date that is six months after the date of a successful remarketing generally will be treated as ordinary interest income; thus, the ability to offset this interest income with a loss, if any, on a purchase contract may be limited. For additional tax-related risks relating to the purchase, ownership and disposition of the senior notes, see “Certain United States Federal Income Tax Consequences—Senior Notes” in this prospectus supplement.

 

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You may have to pay taxes with respect to constructive distributions on our common stock or Series A Preferred Stock.

The number of shares of common stock or Series A Preferred Stock, as applicable, that you are entitled to receive on the purchase contract settlement date or as a result of early settlement of a purchase contract, is subject to adjustment for certain events arising from stock splits and combinations, stock dividends, certain cash dividends and certain other actions by us that modify our capital structure. See “Description of the Purchase Contracts—Anti-Dilution Adjustments.” If the settlement rate is adjusted as a result of a distribution that is taxable to our common stock holders or Series A Preferred Stock holders, as applicable, such as a quarterly cash dividend, you would be deemed to receive a “constructive distribution” of our stock and may be required to include an amount in income for United States federal income tax purposes, notwithstanding the fact that you do not actually receive such distribution. In addition, Non-U.S. Holders of Equity Units may, in certain circumstances, be deemed to have received a distribution subject to United States federal withholding tax. See “Certain United States Federal Income Tax Consequences” in this prospectus supplement.

The IRS could disagree with our U.S. federal income tax characterization of the Equity Units.

It is a condition to the closing of the Equity Units Offering that Wachtell, Lipton, Rosen & Katz, special tax counsel to the Company, deliver its opinion to the Company that, for United States federal income tax purposes, the senior notes and the purchase contracts will be treated as separate securities, and the senior notes will be treated as our debt instruments. However, because opinions of counsel are not binding upon the IRS or any court, the IRS may challenge such conclusion and a court may sustain such a challenge. If the IRS were to successfully challenge our characterization of the Equity Units, the IRS’s recharacterization could adversely affect the amount, timing or character of the income, gain or loss you recognize with respect to our Equity Units. You are urged to consult your own tax advisors concerning the tax consequences of an investment in our Equity Units.

We likely will experience an ownership change under Section 382 of the Internal Revenue Code.

In connection with the Common Stock Offering, the Equity Units Offering and/or other transactions in our shares from time to time, we likely will experience an “ownership change” within the meaning of Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). In general terms, an ownership change would result from transactions increasing the aggregate ownership of certain stockholders in our stock by more than 50 percentage points over a testing period (generally three years). If an ownership change were to occur, our ability to use certain tax attributes, including certain built-in losses, credits, deductions or tax basis and/or our ability to continue to reflect the associated tax benefits as assets on our balance sheet, may be limited. We have concluded that these limitations are unlikely to have any material tax or accounting consequences. However, this conclusion is based on a variety of assumptions, including our estimates regarding the amounts and timing of certain deductions and future earnings, any of which could be incorrect. Accordingly, there can be no assurance that these limitations would not have an adverse effect on our results of operations or that such adverse effect would not be material.

Risks Relating to Our Business and Industry

There can be no assurance that we will maintain our financial strength ratings, even if we are successful in raising capital through this Equity Units offering and the concurrent Common Stock Offering.

This Equity Units offering and the concurrent Common Stock Offering are part of a capital raising strategy focused on maintaining Ambac Assurance’s triple-A financial strength ratings from Moody’s and S&P. While we expect that the additional capital raised from these offerings will enable us to maintain such ratings at the present time, we do not anticipate that the completion of this offering or the Common Stock Offering will result in S&P or Moody’s assigning a “Stable” outlook to our triple-A ratings nor Fitch upgrading our double-A financial strength rating to triple-A. Furthermore, there are various factors, including those discussed in the second following risk factor and elsewhere in this “Risk Factors” section, that could result in our financial strength and

 

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other ratings being downgraded or being subject to downgrade in the future. Accordingly, there can be no assurance that we will not seek to raise capital, including through additional issuance of equity, in the future.

There have been a number of recent developments with respect to ratings actions by the rating agencies. In light of the ongoing nature of ratings actions or announcements by the rating agencies, investors should consult announcements by the rating agencies, the websites of the rating agencies and Ambac’s website for the then-current publicly available information.

As a result of market conditions, rating agency actions and investor concern with respect to our financial position, our ability to write new business has been severely limited since November 2007, and we have written virtually no new business thus far in 2008.

In January and February 2008, we booked only a de minimis amount of new business. There can be no assurance that our business will improve or return to normal (or better) levels or, if they do improve, as to the timing of such improvements or return to normal levels.

The placement of our financial strength rating on negative credit watch by S&P and on review for possible downgrade by Moody’s and the downgrade by Fitch has had a material adverse effect on our competitive position and our ability to write new business. A further downgrade of the financial strength rating of Ambac Assurance would materially adversely affect our business and prospects and, consequently, our results of operations and financial condition.

Ambac Assurance’s ability to attract new business and to compete with other triple A-rated financial guarantors has, to date, been highly dependent on the triple-A financial strength ratings assigned to it by the rating agencies. Historically, our insurance companies have held triple-A financial strength ratings from Moody’s, S&P and Fitch. 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.

In the fall of 2007, each of the major rating agencies began a review of the capital adequacy of the financial guaranty industry. In late December, following the rating agency reviews, Ambac’s triple-A rating was affirmed by both S&P (with “negative outlook”) and Moody’s; however, Fitch placed Ambac’s AAA ratings on rating watch negative and stated that Ambac had a modeled $1 billion capital shortfall. On January 16, 2008, Moody’s put Ambac’s Aaa rating on review for possible downgrade. On January 18, 2008, Fitch downgraded Ambac’s insurance financial strength rating to AA, Credit Watch Negative. In addition, on January 18, 2008, S&P put Ambac’s AAA rating on Credit Watch Negative. On February 25, 2008, S&P reaffirmed Ambac Assurance’s triple-A rating, but kept it on Credit Watch Negative. On February 29, 2008, Moody’s publicly announced that it was continuing a review for possible downgrade that was initiated on January 16, 2008. To the extent that Ambac is unable to raise sufficient capital over the near term in relation to its increased capital needs, or is unable to satisfy other rating agency criteria, the ratings assigned to it and to Ambac Assurance by the rating agencies could be lowered. There can be no assurance that the proceeds of this Equity Units Offering and the Common Stock Offering will be sufficient to obtain or maintain triple-A ratings. Furthermore, there can be no assurance that Ambac Assurance will not be required by any of the rating agencies to raise additional capital in order to maintain ratings in the future, nor can there be any assurance that we will be able to raise any such additional capital in the future. In addition, failure to replace our interim CEO with a permanent CEO on a timely basis could have an adverse effect on our ratings.

If Ambac Assurance’s ratings were reduced to double-A by S&P and Moody’s, there is no assurance that we could successfully execute the reduced double-A business plan as we envision; failure to do so may eliminate the possibility of a ratings upgrade and could result in further ratings downgrades. In addition, further adverse ratings

 

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action by Fitch could have an adverse effect on our business and operations. We believe downgrades below a double-A rating by the major rating agencies would, if our competitors were not similarly downgraded, further and materially reduce our ability to write new business.

As a result of the rating agency actions described above, as well as significant disruption in the capital markets and investor concern with respect to our financial position, we have been able to write only a limited amount of new financial guarantee business since November 2007 and we have written virtually no new business thus far in 2008. Any further downgrade in our financial strength ratings could have a material adverse effect on our long-term competitive position and our prospects for future business. See Part I, Item 1, “Business—Rating Agencies” and Part II, Item 7, “Management’s Discussion and Analysis—Credit Ratings and Collateral” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further information.

A downgrade of the financial strength rating of Ambac Assurance would result in significant collateral-posting obligations in respect of investment agreements and interest rate swap and currency swap transactions, and/or withdrawals or terminations of such transactions.

Most investment agreements and interest rate swap and currency swap transactions provide certain remedies to the counterparty in the event of a downgrade of Ambac Assurance’s financial strength rating, typically to A1 by Moody’s or A+ by S&P. In most cases, we are required to post collateral or otherwise enhance our credit to the A1 or A+ rating level. These collateral-posting obligations could have a material adverse effect on our liquidity. Additionally, it is likely that Ambac Assurance would need to lend or contribute investment assets or cash to the Financial Services businesses in order to satisfy these collateral-posting obligations. Any such loans or contributions would be subject to the prior consent of the Office of the Commissioner of the State of Wisconsin; there can be no assurance that we would obtain such consent. If we fail to post collateral as required or if Ambac Assurance’s financial strength rating is downgraded below A3 by Moody’s or A+ by S&P, counterparties are entitled to terminate the transactions. Upon such terminations, we could liquidate securities with unrealized mark-to-market losses which could have a material adverse effect on our liquidity and lead to further downgrades. See Part II, Item 7, “Management’s Discussion and Analysis—Credit Ratings and Collateral” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further information.

Ultimate actual claim payments on our CDO of ABS, CDO-squared and other credit derivative exposures could materially exceed on a present value basis our current disclosed estimates of impairment.

For the year ended December 31, 2007, Ambac reported a total of $6.0 billion of mark-to-market losses on credit derivative exposures, including estimated credit impairment of approximately $1.1 billion related to certain collateralized debt obligations of asset-backed securities (“CDO of ABS”) backed primarily by mezzanine level subprime residential mortgage-backed securities (“Subprime MBS”) and “CDO squared” transactions which are backed by CDO of ABS transactions comprised of Subprime MBS that have recently been internally downgraded to below investment grade. See “Discussion of Certain Portfolio Risks—Mark-to-Market Losses with Respect to Credit Derivatives” for further discussion. An estimate for credit impairment has been established because it is management’s expectation that Ambac will have to make claim payments on these exposures in the future. Such credit impairment estimates 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 of the CDOs. The purpose of credit impairment estimates is to capture management’s expectation about future claims and not to reflect management’s expectations about stressed or “worst case” outcomes. Credit impairment estimates are only established when management has observed significant credit deterioration, in most cases when the underlying credit is considered below investment grade. We do not estimate impairment for performing credits. Many factors will affect ultimate performance or impairment of our credit derivative exposures, including volatility in the capital markets, conditions in the residential housing and residential mortgage markets and downgrades by the rating agencies of mortgage-backed securities within our CDO of ABS exposures.

 

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Accordingly, there can be no assurance that the actual payments we are ultimately required to make in respect of our CDO of ABS, CDO squared and other credit derivative exposures will not materially exceed our current disclosed estimates.

Uncertainty with respect to the ultimate performance of certain of our credit derivative exposures may result in substantial changes to our impairment estimates. Correspondingly, such changes would affect our financial position possibly materially and adversely.

Various third-party market participants, including several underwriters in this offering and in the concurrent Equity Units Offering, have made estimates of our losses, estimates of credit impairments and mark-to-market losses that in some cases materially exceed the amounts we have reported.

Various third-party securities analysts and other market participants have made estimates of our loss and credit impairment amounts under various scenarios. In light of various factors, including, without limitation, the volatility in the capital markets, the limited liquidity for certain classes of securities and the various assumptions about the future that are inherent in making such estimates, including estimates regarding the performance of RMBS and the housing market more generally, these third-party estimates vary widely. We have been informed by certain of the underwriters in this offering and the concurrent Common Stock Offering that their estimates of our losses and mark-to-market losses, which include estimates of our credit impairment, materially exceed the corresponding amounts shown in the stress cases of S&P discussed below in “Discussion of Certain Portfolio Risks—Rating Agency Perspective on Stress Testing Ambac’s Capital Adequacy,” and, in some cases, materially exceed the sum of the mark-to-market losses we have reported plus the amount of our loss reserve estimates. In the event that our ultimate losses and credit impairments approach some of these third-party estimates, such losses and credit impairments would have a materially adverse effect on our performance and financial position. In addition, we can provide no assurance that we would be able to maintain our triple-A ratings from Moody’s and S&P or our double-A from Fitch if our losses and credit impairments approached or exceeded these third-party estimates, even if such actual losses and credit impairments were less than the stress losses currently modeled by those rating agencies; we can also provide no assurance regarding at what level our financial strength would be if such a downgrade were to occur.

Loss reserves may not be adequate to cover potential losses; changes in loss reserves may result in further volatility of net income and earnings.

Loss reserves established with respect to our non-derivative 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. Loss reserves are only established when management has observed significant credit deterioration, in most cases, when the underlying credit is considered below investment grade. We do not record loss reserves for performing credits. Furthermore, the objective of establishing loss reserve estimates is not to reflect the worst possible outcome. As such, there can be no assurance that the actual losses in our financial guarantee insurance portfolio will not exceed our loss reserves. A further description of our accounting for loss and loss expenses can be found in Note 2 of the notes to our consolidated financial statements included in Item 8 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement.

Uncertainty with respect to the ultimate performance of certain of our insured exposures may result in substantial changes in loss reserves. Correspondingly, such changes to loss reserves would affect our reported earnings.

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

Recent reviews by each of Moody’s, S&P and Fitch stemming from the uncertainties relating to ultimate losses in the mortgage market have resulted in an increase in the level of capital the agencies require Ambac Assurance to hold against insured Residential Mortgage Backed Securities (“RMBS”) and CDOs of asset-backed

 

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securities (“ABS”). Such actions have resulted in a downgrade of Ambac Assurance’s financial strength rating by Fitch from AAA to AA and a change in outlook to Credit Watch Negative and Review for Possible Downgrade from S&P and Moody’s respectively. See Part I, Item 1, “Business Rating Agencies” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for additional details regarding rating agency actions. As a result of the actions taken by each of the agencies, Ambac is exploring methods for enhancing its capital base. Additional changes in the rating agencies capital models and rating methodology, whether resulting from further losses or uncertainty in the mortgage market or other factors, could require us to hold more capital against specified credit risks in our insured portfolio. These requirements could place incremental stress on our rating and force us to raise additional capital, which could result in lower returns on equity.

Changes in the rating agencies’ capital models and rating methodology with respect to financial guarantee insurers could also impose limitations on the areas and amount of new financial guarantee business in which we engage.

In addition, changes in the rating agencies’ capital models or rating methodology applied to issuers could adversely affect our business results and prospects. For example, ratings agencies could begin to rate municipal bond issuers on the significantly less stringent rating scales currently applied to rate corporate bonds. In such case many municipal issuers whose bonds might have been lower rated on the municipal scale might receive a triple-A rating on the corporate scale, possibly adversely affecting the demand for, and pricing of, financial guarantee insurance for such bonds.

Also, even in the absence of changes in the ratings agencies’ capital models or rating methodology applied to municipal issuers, investors and other market participants could come to view non-triple-A rated municipal bonds as having the same financial strength as triple-A rated corporate bonds, therefore possibly adversely affecting the demand for, and pricing of, financial guarantee insurance for such bonds.

Collectively, changes in the rating agencies’ rating methodology may result in a downgrade of Ambac Assurance’s financial strength rating despite meeting the agencies’ currently prescribed capital metrics for a triple-A rating.

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

Our long-term senior unsecured debt is rated “AA” by S&P and “Aa2” by Moody’s. On December 14, 2007, Moody’s affirmed our long-term senior debt rating. On December 19, 2007, S&P affirmed our long-term senior unsecured debt rating with a negative outlook. On December 21, 2007, Fitch placed our AA long-term senior unsecured debt rating on “rating watch negative.” On January 16, 2008, Moody’s placed our long-term senior unsecured debt rating on review for possible downgrade. On January 18, 2008, Fitch downgraded our AA long-term senior unsecured debt rating to A, and AA- subordinated debt rating to A-. On January 18, 2007, S&P placed our AA long-term senior unsecured debt rating on Credit Watch Negative. On February 25, 2008, S&P affirmed our long-term senior unsecured debt rating, which remains on Credit Watch Negative. On February 29, 2008, Moody’s stated that it is continuing its review for possible downgrade.

Our access to external sources of financing, as well as the cost of that financing, could be adversely affected by a deterioration of our long-term debt ratings. Long-term debt ratings are influenced by a number of factors, including, but not limited to: financial leverage on an absolute basis or relative to our 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 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.

 

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Our holding company structure and certain regulatory and other constraints, including adverse business performance, 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, among other things, pay dividends on our capital stock, pay principal and interest on our indebtedness, pay our operating expenses and make capital investment in our subsidiaries. Wisconsin insurance regulations restrict the amount of dividends that may be paid by Ambac Assurance without the consent of the regulator. Adverse business circumstances or changes in regulatory policy could impact Ambac Assurance’s ability to pay us dividends in an amount sufficient for us to pay dividends on our capital stock. Ambac Assurance reported a reduction in policyholders’ surplus of $380.7 million on a statutory basis for the year ended December 31, 2007. Because of the regulatory tests applicable to the payment of extraordinary dividends, the amount of dividends that may be paid by Ambac Assurance to us without regulatory consent would be reduced as a result of this reduction in policyholders’ surplus. The amount of dividends that we expect Ambac Assurance to pay to us in 2008 does not constitute an extraordinary dividend and therefore no regulatory consent would be required for the payment of such non-extraordinary dividends. Further, 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 and/or raise capital or otherwise have a material adverse effect on our operations. See Part I, Item 1 “Business—Insurance Regulatory Dividend Restrictions—Wisconsin” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further information.

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

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, fraud or other reasons. These credit risks could cause increased losses and loss reserves, estimates of credit impairments 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 whether or not Ambac Assurance is downgraded by the rating agencies; and we could experience losses and decreases in the value of our investment portfolio and, therefore, our financial strength. See “Discussion of Certain Portfolio Risks—Mark-to-Market Losses with Respect to Credit Derivatives” for further discussion. 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.

As of December 31, 2007, we have credit exposure to our reinsurance counterparties through reinsurance contracts of approximately $88.1 billion or 14% of our gross par outstanding. No single reinsurance counterparty represents more than 16% of the $88.1 billion in par ceded, except for Assured Guaranty Re Limited to which we have reinsured $34.6 billion of par. In the event that we are required to make claim payments on policies that have been reinsured, we are at risk that such counterparties will fail to fulfill their payment obligations to us. In addition, downgrades to the credit ratings of our reinsurance counterparties may result in the reduction of rating agency capital credit provided by those reinsurance contracts, and could therefore result in a downgrade of our own credit ratings. The ratings agencies currently are reviewing the monoline financial guaranty reinsurers. For additional information on our reinsurers, see Item 7A, “Risk Management—Credit Risk” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement. Finally, a material deterioration in the capital levels of our reinsurance counterparties could reduce the amount of statutory capital relief provided by our reinsurance arrangements, and could result in our failure to meet our own statutory capital requirements. See the table included in “Quantitative and Qualitative Disclosures About Market Risk—Credit Risk” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is

 

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attached to this prospectus supplement, for additional information on the financial strength ratings of Ambac’s reinsurers as well as the amount of amounts due from such reinsurers that are not secured by collateral.

We are subject to credit risk and other risks related to RMBS and CDOs of ABS.

We have insured, and written credit default swaps (“CDS”), with respect to, RMBS (including transactions composed of second lien mortgage products, Home Equity Line of Credit (“HELOCs”) and closed end second mortgage loans) and CDOs of ABS and are thus exposed to credit risk associated with those asset classes. Performance of these transactions can be adversely affected by general economic conditions, including recession, rising unemployment rates, declining house prices, increasing foreclosure rates and unavailability of consumer credit; mortgage product attributes, such as interest rate adjustments and balloon payment obligations; borrower and/or originator fraud; financial difficulty experienced by mortgage servicers; and, particularly in the case of CDOs of ABS, transaction-specific factors such as the lack of control of the underlying collateral security which can result in a senior creditor determining to liquidate underlying assets to the disadvantage of mezzanine and subordinated creditors and disputes between creditors with respect to the interpretation of legal documents governing the particular transaction.

Transactions within Ambac Assurance’s insured RMBS and CDO portfolios also may be downgraded, placed on watch or subject to other actions by the three rating agencies that have granted Ambac Assurance its claims-paying ratings. Such ratings or other actions could require Ambac Assurance to maintain a material amount of additional capital to support the exposures it has insured. This could require us to:

 

   

Raise additional capital, if available, on terms and conditions that may be unfavorable;

 

   

Curtail the production of new business; or pay to reinsure or otherwise transfer certain of its risk exposure.

RMBS and CDOs of ABS exposures which we have written in the form of CDS are subject to FAS 133, which requires that these transactions be recorded at fair value. Changes in estimated fair values relative to our credit derivative book have caused decreases in the value of such credit derivative transactions; those changes in value are reported in our financial statements and have therefore affected our reported earnings. Similarly, further decreases or increases in estimated fair values in the future can affect our reported earnings. Changes in the estimated fair values of these CDS can be caused by general market conditions, perception of credit risk generally and events affecting particular credit derivative transactions (including those described above) and actual impairment.

While further deterioration in performance of the subprime mortgage sector is generally expected, the extent and duration of any future continued deterioration of the credit markets is unknown, as is the impact, if any, on potential claim payments and ultimate losses of the securities within Ambac Assurance’s portfolio. In addition, there can be no assurance that any of the governmental or private sector initiatives designed to address such credit deterioration in the markets will be implemented, and there is no way to know the effect that any such initiatives could have on the credit performance over time of the actual securities that Ambac Assurance insures.

In addition, there can be no assurance that we would be successful, or that we would not be delayed, in enforcing the subordination provisions, credit enhancements or other contractual provisions of the RMBS and CDOs of ABS that Ambac Assurance insures in the event of litigation or the bankruptcy of other transaction parties. Many of the subordination provisions, credit enhancements and other contractual provisions of the RMBS and CDOs of ABS that Ambac Assurance insures are untested in the market and, therefore, it is uncertain how such subordination provisions, credit enhancements and other contractual provisions will be interpreted in the event of an action for enforcement.

 

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Our recently announced intention to suspend or discontinue our activities and to revise our underwriting criteria in the structured finance sector and to discontinue our activities in Financial Services will adversely affect our business results and future earnings relative to historical levels.

As described more fully above in “Prospectus Supplement Summary—Recent Developments,” in connection with our efforts to raise capital and maintain our triple-A ratings from Moody’s and S&P, we expect to make a number of changes to our businesses. As a result, certain businesses in which we currently operate will be suspended or discontinued, and other businesses de-emphasized or subject to new limitations. These changes will result in decreased revenues, credit enhancement production and net income relative to historical levels and decreased cash flow to meet our obligations. There can be no assurance that these changes will be deemed sufficient by the rating agencies to maintain our ratings or that we will be able to replace the loss of business production with our on-going businesses. Further, these changes could lead to certain disruptions in our on-going businesses. Management time and attention will be diverted to managing these changes rather than concentrating fully on running the on-going businesses and our employees may be distracted.

Revenues would be adversely impacted due to a decline in realization of installment premiums.

Due to the installment nature of a significant percentage of its premium income, Ambac Assurance has an embedded future revenue stream. The amount of installment premiums actually realized by Ambac Assurance could be reduced in the future due to factors such as early termination of insurance contracts, accelerated prepayments of underlying obligations or insufficiency of cash flows. Such a reduction would result in lower revenues.

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

Changes in general economic and other conditions can impact our business, including recessions; increases in corporate, municipal and/or consumer bankruptcies; changes in interest rate levels; a continued downturn in the U.S. housing market and commercial real estate market; continued dislocation and lack of liquidity in the credit and financial markets; changes in domestic and international laws, including tax laws and bankruptcy laws; intervention by governments or courts in financial markets, including the imposition of limits on the ability of mortgagees to foreclose on defaulted mortgage loans and/or to increase interest rates on mortgage loans in accordance with original contract terms; wars and terrorist acts; natural disasters, including earthquakes, floods, windstorms and wildfires; rising energy, fuel and utility costs; 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 or to meet Financial Services liquidity needs due to contract terminations or collateral posting requirements, 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 have historically tended to reduce credit spreads and,

 

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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 an installment basis and do not receive a termination premium, 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 and adverse publicity may affect demand for financial guaranty products.

The financial guarantee business is highly competitive and we expect it to remain so in the near future. We face competition from 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.

In light of the recent developments described above in “Prospectus Supplement Summary—Recent Developments,” Ambac Assurance has been placed at a competitive disadvantage in all three of the financial guarantee markets: public finance, structured finance and international. In particular, it has been placed at a significant disadvantage to two of its competitors, Financial Security Assurance Inc. (“FSA Guarantee”) and Assured Guaranty, which are the only principal competitors in the financial guarantee market who have had their triple-A financial strength ratings affirmed “stable” by all three of the major ratings agencies.

Additionally, we could encounter additional competition in the future from new entrants to the financial guarantee insurance market. For example, Berkshire Hathaway recently publicly announced its entrance into the financial guarantee business. See Part I, Item 1, “Business—Competition” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further information.

As a result of the uncertainty regarding the financial stability of financial guarantors (including ourselves), the proportion of newly issued public finance obligations which are insured has dropped dramatically recently. For example, certain municipal issuers, including the State of California, for which Ambac has historically written significant amounts of financial guarantees, have recently discontinued or significantly curtailed their use of insurance for new issues, or indicated their intent to do so. While public finance insured market penetration was 57% in 2005, 48% in 2006 and 47% in 2007, public finance insured market penetration dropped to approximately 30% in December 2007 and 27% in January 2008. If penetration levels remain at that level, new business public finance production for Ambac will be reduced significantly.

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 capital sources, potentially at higher costs.

 

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Our underwriting and risk management policies and practices in the past have not anticipated unforeseen risks and/or the magnitude of potential for loss as the result of foreseen risks.

As described in Part I, Item 1, “Business—Risk Management” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, we have established underwriting and risk management policies and practices which seek to mitigate our exposure to credit risk in our insured portfolio. These policies and practices in the past have not insulated us from risks that were unforeseen and which had unanticipated loss severity, and such policies and practices may not do so in the future. There can be no assurance that these policies and practices will be adequate to avoid future losses. We also rely on internally and externally developed complex financial models which additionally may have been reviewed by third parties to analyze and predict performance of the insured obligations. Flaws in these financial models and/or faulty assumptions used by these financial models could lead to increased losses and loss reserving.

Our net income and earnings have become more volatile due to the application of fair value accounting, or 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, we estimate 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 have caused decreases in the value of such credit derivative transactions; those changes in value are reported in our financial statements and have therefore affected our reported earnings. Similarly, further decreases or increases in estimated fair values in the future can affect our reported earnings. Changes in estimated fair values can be caused by general market conditions, uncertainty regarding the ultimate outcome of subprime mortgage losses and the quality of high yield corporate loans, 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.

On April 18, 2007, the FASB issued an Exposure Draft for public comment entitled “Accounting for Financial Guarantee Insurance Contracts,” an interpretation of SFAS 60 “Accounting and Reporting by Insurance Enterprises.” The comment period ended on June 18, 2007 and a roundtable with interested parties was held on September 4, 2007. The FASB has concluded its re-deliberations of the Exposure Draft and expects to issue a final standard in the first quarter of 2008.

Under the Exposure Draft, Ambac believes that the cumulative effect of initially applying the revenue recognition provisions to our upfront paying policies could have a material adverse effect on our financial statements. Additionally, the revenue recognition for upfront paying insurance transactions originated after the standard’s effective date would be materially different than our current premium revenue recognition methodology. Ambac continues to evaluate the implications of the Exposure Draft with regard to income recognition on installment paying policies, claim liabilities and deferred acquisition costs on its financial statements.

Under the FASB’s re-deliberations, Ambac would be required to recognize premium revenue, for both upfront and installment paying policies, based on applying a fixed percentage of premium to the amount of exposure outstanding at each reporting date (referred to as the level-yield approach), rather than being recognized over the term of each maturity for upfront paying policies. For installment paying policies, the FASB’s re-deliberations also require that the discount, equating to the difference between gross installment premiums and the present value of installment premiums, be accreted through the income statement. Ambac has not yet evaluated the implications of the FASB’s re-deliberations.

 

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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 Securities Exchange Act of 1934, as amended, (the “Exchange 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.

We are subject to extensive regulation in the conduct of our financial guarantee insurance business; amendments to these insurance laws and regulations could have a material adverse impact on our business results.

Our principal subsidiary, Ambac Assurance, is subject to the insurance laws and regulations of each jurisdiction in which it is licensed. Ambac UK Limited, 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 of Ambac Assurance to dividend monies to us, 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.

The New York Insurance Department has indicated that it is undertaking a review of the laws and regulations that are applicable to Ambac Assurance and to other monoline financial guarantee insurance companies. As a result of any changes to such laws and regulations or the New York Insurance Department’s interpretation thereof, Ambac Assurance could become subject to further restrictions on the types and amounts of business that it is authorized to insure, especially in the structured finance area. Any such restrictions could have a material effect on the amount of premiums that Ambac earns in the future. Additionally, any changes to such laws and regulations could subject Ambac Assurance to increased reserving and capital requirements or more stringent regulation generally, which could materially adversely affect our financial condition, results of operations and future business. See “Business—Insurance Regulatory Matters” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further information.

In recent weeks, the New York Insurance Department and other governmental officials have expressed concern that participants in the financial guarantee industry, including Ambac, take actions to augment their capital and maintain credit ratings and warned that, in the absence of such actions, regulatory action may be necessary to protect policyholders. Insurance regulatory authorities’ responsibility is to protect policyholders, not shareholders. We believe this capital raising is responsive to the regulators’ concerns at this time, but there can be no assurance insurance regulators or other authorities will not take actions that are adverse to the interests of our shareholders.

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.

We may be required to raise additional capital which could have a dilutive effect on our outstanding equity capital and/or future earnings.

We may be required to raise additional capital as the result of rating agency capital requirements, unanticipated losses in our insured portfolio and/or diminution in our earnings prospects. Any future equity

 

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offerings could be dilutive to our existing shareholders or could result in the issuance of securities that have rights, preferences and privileges that are senior to those of our other securities. We may also engage in additional reinsurance or risk transfer transactions such as the one we completed with Assured Guaranty Re Limited in December 2007. Further, any capital raising in the form of reinsurance, or other risk transfer transactions of the existing portfolio, will have a dilutive effect on our future earnings. There can be no assurance that we will be able to consummate any capital raising transactions, or as to the terms of any of the currently proposed transactions.

There are limitations on the voting rights attached to our shares of common stock.

Our subsidiary, Ambac Assurance, is a Wisconsin corporation and is subject to the insurance and regulatory laws of the State of Wisconsin. Under Wisconsin insurance holding company laws. There is a presumption that a holder of 10% or more of our voting stock controls Ambac Assurance and any such acquisition of control requires the prior approval of the Office of the Commissioner of Insurance of the State of Wisconsin. Section 4.5 of our amended and restated certificate of incorporation provides that no stockholder may cast votes with respect to 10% or more of our voting stock, regardless of the actual number of shares of voting stock beneficially held by the stockholder. In addition, any voting stock held by a stockholder in excess of 10% will not count in the calculation of or toward a quorum at any meeting of stockholders. In order to avoid these restrictions, a stockholder who acquires or owns 10% or more of our voting stock must have such acquisition or ownership previously approved by the Office of the Commissioner of Insurance of the State of Wisconsin or file a disclaimer of “control” approved by such office.

The foregoing provisions of the Wisconsin insurance holding company laws and legal restrictions contained in our amended and restated certificate of incorporation will have the effect of rendering more difficult or discouraging unsolicited takeover bids from third parties or the removal of incumbent management.

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 Part I, Item 1, “Business—Derivative Products” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, for further information.

Decline in our market position can adversely affect our business prospects.

Perceptions of the financial strength of Ambac Assurance and its affiliates, as well as perception of the financial strength of financial guarantee insurers generally, affects demand for financial guarantee insurance. Recent actions by the rating agencies with respect to our ratings and the ratings of other financial guarantee insurers; further credit deterioration in our insured portfolio and/or increases to our loss reserves; widening of CDS spreads with respect to Ambac Assurance; adverse publicity concerning us and the financial guarantee industry in general and decline of our stock price can contribute to a perception of impaired financial strength and thus a decline in our market position and trading value of Ambac guaranteed obligations, including guaranteed auction rate and variable rate debt obligations. A sustained decline in trading values could result in early termination of financial guarantee insurance policies in respect of which we are paid on an installment basis, thus reducing premium earned in respect of these transactions. Ambac and the financial guarantee insurance industry generally, have suffered a loss of confidence among issuers and fixed income investors and as such, demand for our products has been adversely affected. A sustained loss of confidence would have a materially adverse effect on earnings.

 

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Market risks which impact assets in our investment portfolio could adversely affect our business.

Our investment portfolio has been adversely affected by events and developments in the capital markets, including decreased market liquidity for investment assets; market perception of increased credit risk with respect to the types of securities held in our investment portfolio and corresponding credit spread-widening with respect to our investment assets; and extension of the duration of investment assets. Our investment portfolio may be further adversely affected by these and other events and developments in capital markets, including interest rate movements; downgrades of credit ratings of issuers of investment assets and/or financial guarantee insurers which insure investment assets; and foreign exchange movements which impact investment assets. At December 31, 2007, approximately 33% of our investment portfolio is insured by financial guarantors, including Ambac. Please refer to the table in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Balance Sheet” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, representing the fair value and weighted-average underlying rating, excluding the financial guarantee, of the insured securities at December 31, 2007.

Based on the previously described rating agency actions by Moody’s, S&P and Fitch which occurred during January 2008, management subsequently identified certain investment securities in the Financial Services investment portfolio to potentially sell in order to satisfy additional collateral posting requirements upon a further ratings downgrade and/or to meet potential liquidity needs. We recorded an impairment charge through income on the portion of those securities which were in an unrealized loss position at December 31, 2007. Please refer to Part II, Item 7—Results of Operations—Financial Services, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for further information. The impairments in value in the remaining investment portfolio are not deemed other-than-temporary, as such the remaining unrealized losses have been recognized in other comprehensive income. The following table summarizes amortized cost and estimated fair value of investments at December 31, 2007:

 

     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Estimated
Fair Value

2007:

           

Fixed income securities:

           

Municipal obligations

   $ 8,550,895    $ 231,099    $ 18,176    $ 8,763,818

Corporate obligations

     768,277      25,792      10,393      783,676

Foreign obligations

     303,655      13,861      90      317,426

U.S. government obligations

     134,639      3,376      —        138,015

U.S. agency obligations

     619,634      63,239      105      682,768

Mortgage-backed securities

     4,595,122      7,786      353,218      4,249,690

Asset-backed securities

     2,598,529      11,432      43,029      2,566,932

Short-term

     879,039      28      —        879,067

Other

     13,571      839      132      14,278
                           

Total investments

   $ 18,463,361    $ 357,452    $ 425,143    $ 18,395,670
                           

To the extent that we are required to liquidate large blocks of investment assets in order to pay claims under financial guarantee insurance policies to make payments under investment agreements and/or to collateralize our obligations under investment agreements and interest rate swaps, such investment assets would likely be sold at discounted prices which could be less than the December 31, 2007 fair values shown in the above table.

We are subject to credit and liquidity risk due to unscheduled and unanticipated withdrawals on Investment Agreements.

Ambac’s Investment Agreement business has issued investment agreements to investors that may allow for early withdrawal (i.e. deviate from a defined or expected withdrawal schedule). The provisions that allow for

 

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early withdrawal vary by transaction but include events such as credit events, early call provision, loss events, construction project development variance and changes in tax code. To the extent we experience an increase in unanticipated withdrawals, the Investment Agreement business may be required to liquidate certain asset holdings. This early liquidation of asset holdings may result in a realized loss.

We are subject to the risk of litigation and regulatory inquiries or investigations, and the outcome of proceedings we are or may become involved in could have a material adverse effect on our business, operations, financial position, profitability or cash flows.

Recently, Ambac, and certain of its present and former officers and directors, have been named in lawsuits that allege violations of the federal securities laws and/or state law. At least four federal securities putative class action suits have been filed. The first of these, captioned Reimer v. Ambac Financial Group, Inc., et al. (filed on or about January 16, 2008 in the United States District Court for the Southern District of New York, case No. 08 CV 411) purports to be brought on behalf of purchasers of Ambac’s common stock from October 19, 2005 to November 26, 2007. The suit alleges, among other things, that the defendants issued materially false and misleading statements regarding our business and financial results related to guarantees of CDO and Mortgage Backed Securities (“MBS”) transactions. Three other suits, Babic v. Ambac Financial Group Inc. et al. (filed on or about February 7, 2008 in the United States District Court for the Southern District of New York, case No. 08 CV 1273), Parker v. Ambac Financial Group, Inc. et al (filed on or about February 22, 2008 in the United States District Court for the Southern District of New York, case No. 08 CV 1825) and Minneapolis Firefighters’ Relief Association v. Ambac Financial Group, Inc. et al. (filed on or about February 26, 2008 in the United States District Court for the Southern District of New York, Case No. 08 CV 1918) make substantially the same allegations as the Reimer action. In addition, at least seven shareholder derivative actions have been filed in New York federal court and in Delaware and New York state courts. The first shareholder derivative action captioned Rubery v. Callen, et al. (filed on or about January 23, 2008 in the United States District Court for the Southern District of New York, case No. 08 CV 854), names as defendants certain present and former officers and directors of Ambac and names Ambac as a nominal defendant. This suit asserts violation of state and federal law, including breaches of fiduciary duties, waste of corporate assets, unjust enrichment and violations of the federal securities laws, for conduct occurring between October 2005 and the present regarding, among other things, our guarantees of CDO and MBS transactions and defendants’ alleged insider trading on non-public information. Ambac has also received various regulatory inquiries and requests for information. For example, recently we received a subpoena duces tecum and interrogatories from the Securities Division of the Office of the Secretary of the Commonwealth of Massachusetts, dated January 18, 2008, that seeks certain information and documents concerning “Massachusetts Public Issuer Bonds.” See Item 3, “Legal Proceedings” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement, for additional information.

It is not possible to predict whether additional suits will be filed or whether additional inquiries or requests for information will be made, and it is also not possible to predict the outcome of litigation, inquiries or requests for information. It is possible that there could be unfavorable outcomes in these or other proceedings. Management is unable to make a meaningful estimate of the amount or range of loss that could result from unfavorable outcomes but, under some circumstances, adverse results in legal proceedings could be material to our company’s business, operations, financial position, profitability or cash flows.

 

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Investors may become “controllers” of Ambac Financial Group, Inc. for the purposes of UK law and may require prior approval of UK’s Financial Services Authority

As a result of Ambac Financial Group, Inc. being the holding company of Ambac Assurance UK Limited and Ambac Credit Products Limited the prior consent of the UK’s Financial Services Authority (FSA) will be required for any individual, group or institution who proposes to take a step that would result in his becoming Controller of or increasing his kind of control over Ambac Assurance UK Limited and Ambac Credit Products Limited.

Broadly, in respect of the FSA’s consent, where an individual person or body corporate, inter alia:

 

  (a)   holds 10 per cent. or more of the shares in a parent undertaking (“P”) of a company undertaking a regulated activity (“A”); or

 

  (b)   is able to exercise significant influence over the management of P through his shareholding in P; or

 

  (c)   is able to exercise significant influence over the management of P through his voting power in P; or

 

  (d)   is entitled to exercise or control the exercise of 10 per cent. or more of the voting power in P, then such person will be a Controller of A, in this case A being Ambac Assurance UK Limited and Ambac Credit Products Limited. Any proposed changes in either existing Controllers or the appointment of new Controllers must first be approved by the FSA.

Any such acquisition which occurs without first obtaining this consent could lead to criminal sanctions.

Section 189 of the Financial Services and Markets Act 2000 confers powers on the FSA to impose one or more of the following restrictions on a proposed Controller if such approval is not given:

 

  (a)   the transfer of existing shares or the right to be issued new or further shares is void;

 

  (b)   no further voting rights are exercisable in respect of the shares acquired without approval; no further shares are to be issued in respect of the shares accepted without approval; and

 

  (c)   except in a liquidation, no payment is to be made of any sum due from the body corporate on the shares acquired, whether in respect of capital or otherwise.

The court also has the power to make such order relating to the sale or transfer of the shares as it thinks fit on the application of the FSA.

A person who is already an approved controller by virtue of holding 10 per cent. or more of the shares in the Company or being entitled to exercise or control the exercise of 10 per cent. or more of the voting power in the Company will nevertheless require the prior approval of the FSA if it wishes to increase its level of control beyond certain specified percentages. These are 20 per cent., 33 per cent. and 50 per cent.

 

 

Among the bonds we insure are those issued by sovereign and sub-sovereign entities, and we include statistics concerning those bonds in our Annual Report on Form 10-K for the year ended December 31, 2007, which is attached to this prospectus supplement. We note that we include in the “Sovereign/Sub Sovereign” category bonds not backed by the full faith and credit of a sovereign or sub-sovereign entity, which bonds are generally in the nature of privatizations of essential infrastructure by sovereigns and sub-sovereigns.

 


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USE OF PROCEEDS

We expect to receive net proceeds from this offering, after deducting underwriting discounts and commissions and other offering expenses payable by us, of approximately $            . We intend to contribute the net proceeds from this offering, as well as the approximately $            of net proceeds (after deducting underwriting discounts and commissions and other offering expenses payable by us) from our concurrent offering of common stock, to Ambac Assurance in order to increase its capital position, less approximately $100 million, which we intend to retain at Ambac Financial Group, Inc. to provide incremental holding company liquidity to pay principal and interest on its indebtedness, to pay its operating and other expenses and to pay dividends on its capital stock. We have agreed that at the time of settlement of the purchase contracts, we will use the proceeds therefrom to repay $142.5 million of the Company’s debt maturing August 1, 2011, to the extent that the cash proceeds of such settlement are sufficient for such repayments, and that the remaining proceeds will be used for general corporate purposes including the opportunistic repurchase of outstanding debt. We have agreed that proceeds from the settlement of the purchase contracts will not be used to repurchase common stock.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents capitalization as of December 31, 2007. Each is presented:

 

   

on an actual basis; and

 

   

as adjusted to reflect the sale of              Equity Units in this offering and the sale of              shares of common stock in a concurrent offering and our application of the proceeds of both offerings. See “Use of Proceeds.”

You should read the information in this table together with our consolidated financial statements and the related notes and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement.

 

     At December 31, 2007
     Actual    As Adjusted
    

(unaudited)

(in thousands)

Cash and Cash Equivalents

   $ 123,933    $  
             

Long-term debt:

     

9 3/8% Debentures due 2011

     142,347      142,347

7 1/2% Debentures due 2023

     74,682      74,682

5.95% Debentures due 2103

     200,000      200,000

5.875% Debentures due 2103

     175,000      175,000

5.95% Debentures due 2035

     399,844      399,844

    % Senior Notes due 2021(1)

     —     
             

Total senior long-term debt

     991,873   

Directly-Issued Subordinated Capital Securities due 2037

     397,421      397,421
             

Total long-term debt(2)

     1,389,294   
             

Stockholders’ equity

     2,279,893   
             

Total capitalization

   $ 3,669,187    $  
             

 

(1)   The     % Senior Notes due 2021 are a component of the Equity Units being offered hereby. As adjusted amount will be $              million if the underwriters exercise their over-allotment option in full.
(2)   Total long-term debt does not include $280,651 of variable interest entity notes, which are required to be consolidated pursuant to FIN 46.

 

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COMMON STOCK OFFERING

By means of a separate prospectus supplement, we are concurrently offering up to             shares of common stock. The underwriters of that offering have an option to purchase a maximum of             additional shares of common stock from us to cover over-allotments. This offering and the offering of common stock are contingent upon one another.

 

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PRICE RANGE OF COMMON STOCK AND DIVIDENDS

Our common stock is listed on the New York Stock Exchange under the symbol “ABK.” The closing price of our common stock on the New York Stock Exchange on March 4, 2008 was $10.72 per share. The table below sets forth, for the quarters indicated, the high and low sales prices per share of our common stock and the amount of cash dividends declared per common share.

 

     High    Low    Dividends

2008:

        

First Quarter (Through March 4, 2008)

   $ 26.79    $ 4.50    $ 0.07

2007:

        

Fourth Quarter

   $ 73.20    $ 20.55    $ 0.210

Third Quarter

   $ 88.41    $ 53.10    $ 0.210

Second Quarter

   $ 96.10    $ 84.02    $ 0.180

First Quarter

   $ 91.83    $ 83.48    $ 0.180

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

In connection with our efforts to raise capital and maintain triple-A ratings, we have reduced our quarterly dividend payable on our common shares to $0.01 per share.

 

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DISCUSSION OF CERTAIN PORTFOLIO RISKS

Our insured portfolio is subject to a variety of factors that could adversely affect our business results and prospects. Risk factors that could cause actual results to deviate from expected results in our various business lines include, but are not limited to:

 

   

changes in general economic conditions,

 

   

catastrophic events (natural disasters or terrorist acts),

 

   

downturns in the U.S. housing market or commercial real estate market,

 

   

changes in interest rate level and widening of credit spreads,

 

   

rising energy, fuel and utility costs,

 

   

corporate default rates and correlated loss given default,

 

   

dislocation and lack of liquidity in credit and financial markets, and

 

   

legislative and regulatory developments,

as well as other factors listed under “Forward-Looking Statements” and “Risk Factors.” Different segments of our portfolio, and different business lines within these segments, are affected by differing risk factors and to differing degrees.

Recently, our insured portfolio has been adversely affected by credit deterioration related to residential mortgage markets in the United States that are experiencing financial stress. For the year ended December 31, 2007, Ambac reported a total of $6.0 billion of mark-to-market losses on credit derivative exposures. See “Mark-to-Market Losses and Credit Impairments with respect to Credit Derivatives” below for additional information. Of the $6.0 billion we estimate credit impairment of approximately $1.1 billion related to certain CDO of ABS and CDO-squared transactions that have recently been internally downgraded to below investment grade. In addition, in 2007, we increased our loss reserves relating to RMBS by $291 million. U.S. GAAP requires us to account for our financial guarantee contracts based on the terms of the contract. Generally, insurance contracts (including, without limitation, the financial guarantee insurance that we execute with respect to our RMBS portfolio) are not marked to market and loss reserves reflect management’s estimate of probable and estimable losses due to credit deterioration of insured credits. Ambac’s estimates of credit impairment and estimates of loss reserves are only established when management has observed significant credit deterioration, in most cases, when the underlying credit is considered below investment grade. We do not record loss reserves for performing credits. Furthermore, the objective of establishing loss reserves and impairment estimates is not to reflect the worst possible outcome. As such, there can be no assurance that the actual loss will not exceed our estimates. See “Third-Party Estimates of Losses and Credit Impairments.” The following discussion provides further information about our calculation of loss reserves, credit impairment estimates and mark-to-market valuations of our credit derivatives and includes a discussion of some of the relevant risk sensitivities. We have also included a discussion of potential increased capital requirements of the rating agencies.

We are subject to credit risk throughout our business. In particular, we are exposed to the risk that issuers whose debt we have insured (or with respect to which we have written credit derivatives) may default in their financial obligations, whether as the result of insolvency, lack of liquidity, operational failure, fraud or other reasons. Increased levels of credit risks could cause:

 

   

increased claims payments and loss reserves,

 

   

mark-to-market losses and credit impairments with respect to credit derivatives in our financial guarantee business, and

 

   

the requirement that we hold additional rating agency capital against insured exposures that have been downgraded by those agencies.

 

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Increased Claim Payments and Loss Reserves

This discussion of loss reserves for financial guarantee insurance relates only to Ambac’s non-derivative insurance business. U.S. GAAP requires us to establish loss reserves on our financial guaranty insurance policies (including without limitation the financial guaranty insurance that we execute with respect to our RMBS portfolio) only for probable and estimable losses. See “Critical Accounting Policies and Estimates—Financial Guarantee Insurance Losses and Loss Expenses” in our Annual Report on Form10-K for the year ended December 31, 2007 attached to this prospectus supplement for further detail on case basis and active credit reserves.

The primary assumptions impacting the estimate of loss reserves are the probability of default and severity of loss given a default. When credits are in default or have specific attributes that warrant an adjustment, we typically employ a best judgmental estimate of the loss based upon transaction-specific elements rather than a statistical loss estimate (derived from the product of actuarial estimates of probability of default and loss given default) as we believe we have deal-specific knowledge 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 and/or its estimated loss given a default increases, our total reserve for that insured obligation will also increase. Political, economic, credit or other unforeseen events could have an adverse impact on default probabilities and loss severities. A downgrade by Ambac of the underlying ratings of an adversely classified credit, particularly a credit with a large net par balance, could have a significant impact on our reserves.

For example, we have insured the Las Vegas, NV Monorail project and have established an active credit reserve based on an actuarial estimate of loss. Given the large net par balance for this transaction, downgrades of Ambac’s rating of the underlying credit rating could have a material adverse effect on our reserves. Furthermore, external influences beyond our control may have significant favorable or unfavorable effects on our reserves.

Case basis credit reserves for public finance and other non-collateral dependent transactions are sensitive solely to severity assumptions because the underlying financial obligation has already defaulted (i.e. 100% probability of default). Case basis credit reserves for collateral-dependent transactions (such as mortgage-backed security transactions) are sensitive to both severity assumptions as well as probability of default, as the probability of default will vary based upon the performance of the non-defaulted underlying collateral.

Adjustments to the probability of default or severity assumptions may affect our financial results over various periods. Loss reserve volatility will be correlated with the credit performance of our insured portfolio including the number, size, asset class and quality of credits included on our adversely 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 significant size of certain individual adversely classified credits, modest changes in Ambac’s underlying ratings or classifications may have a significant impact on any quarter’s provision for losses and loss expenses.

The table below indicates the number of credits and net par outstanding for case reserves and active credit reserves on non-investment grade credits at December 31, 2007:

 

$ in millions    Number of
credits
   Net par
outstanding
   Net Loss
Reserves(1)

Active credit reserves

   45    $ 6,513    $ 363.4

Case reserves

   13    $ 1,359    $ 109.8
                  

Total

   58    $ 7,872    $ 473.2
                  

 

(1)   Net of reinsurance recoverable on unpaid losses of $11.1 million.

 

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We have 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 and therefore we have had no basis for altering our estimates of loss severity. However, for certain bond types our recent loss experience has caused us to believe that there are factors that may lead to revisions of our original estimates of loss severity. We have observed that, with respect to four bond types in particular, it is possible that a material change in actual loss severities and defaults could occur over time. These four bond types are healthcare institutions, aircraft lease securitizations known as Enhanced Equipment Trust Certificates (to which we do not currently have any exposure in our classified credit portfolio), mortgage backed and home equity securitizations, and CDOs. These four bond types represent 53% of our ever-to-date claim payments.

Generally, severity assumptions are established within our active credit reserve for entire asset classes and therefore represent an average severity of loss given a default. However, it is our experience that ultimate severity outcomes often vary from averages. Therefore, we have not provided reasonably possible negative scenarios for the severity assumption.

Healthcare Institutions and Transportation

The table below presents our estimates of the impact on the December 31, 2007 consolidated loss reserve from increases in the probability of default estimate that would arise from a one full letter downgrade for each credit (including both investment grade and non-investment grade) of the following bond types that were within the adversely classified credit listing as of December 31, 2007.

 

$ in millions

Category

   Net par
outstanding
   Loss
Reserves at
12/31/07
   Increase in
Reserve
Estimate

Health care

   $ 456    $ 30.8    $ 39.6

Transportation

   $ 867    $ 77.0    $ 77.3

Mortgage-Backed and Home Equity Securitizations

The table below presents the number of credits, net par outstanding and total loss reserves for RMBS exposures that were within the adversely classified credit listing as of December 31, 2007:

 

$ in millions    Number of
credits
   Net par
outstanding
   Net Loss
Reserves
 

Second lien

   12    $ 4,164    $ 266  

First lien—subprime

   11      699      10  

Other

   5      22      26 (1)
                    

Totals

   28    $ 4,885    $ 302  
                    

 

(1)   Includes allowance for reinsurance recoverables.

Continued increases in RMBS defaults as a result of fraud, foreclosures, increases in interest rates, unemployment and/or personal bankruptcies could adversely impact the probability of default and severity of loss for our transactions. The loss experience in the RMBS insured portfolio in 2007 occurred predominantly in transactions composed of HELOCs and closed end second mortgage loans that were securitized in 2006 and 2007. The underlying loans in these vintages are experiencing near-record volumes of delinquencies and losses, due to factors such as weak mortgage industry underwriting standards, declining home values, abrupt slowdowns in voluntary prepayments due to a decreased availability of mortgage credit, and potential misrepresentations and/or fraud, among other factors.

Our loss estimates for the portfolio are primarily based upon the assumption that these factors are contributing to significant collateral delinquencies and early payment defaults that will reach peak loss levels

 

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between months 21 and 29 following transaction close and will then rapidly reduce to substantially lower levels through a period extending to months 50 and 60, after which relatively smaller delinquency and loss rates occur. However, it is possible that our losses in these securities could be substantially higher as a result of continued illiquidity of the mortgage market, continued deterioration in housing prices, and/or the effects of a weakened economy marked by growing unemployment and wage pressures. In other words, we believe that it is possible that the actual loss pattern for these transactions could be more severe and prolonged than we currently assume. If we were instead to assume that delinquency and loss rates peak around the same time as our prior assumption, but that the reduction of these rates occurs over a more prolonged time period extending beyond month 120 and continues at relatively higher rates throughout the life of our portfolio, our net loss reserve would increase from $302 million to approximately $750 million of exposures that were within the adversely classified credit listing as of December 31, 2007.

Collateralized Debt Obligations

The majority of our CDO portfolio (approximately 85% at December 31, 2007) was executed in derivative form and accordingly must be recorded on our balance sheet at fair value. Please refer to “Mark-to-Market Losses with Respect to Credit Derivatives” below for further discussion.

Mark-to-Market Losses and Credit Impairments with Respect to Credit Derivatives

RMBS and CDOs which we have underwritten in the form of Credit Default Swaps (CDS) are subject to FAS 133. FAS 133 requires that credit derivative transactions be recorded at fair value, or “mark-to-market,” in the financial statements. The CDS contracts we execute are a modified version of the standard CDS contracts executed by other financial institutions such as investment banks and broker dealers. These modifications include a provision to “pay-as-you-go” which provides that Ambac pays interest shortfalls on the reference obligation as they are incurred on each scheduled payment date, but only pays principal shortfalls upon the earlier of (i) the date on which the assets designated to fund the referenced obligation have been liquidated and (ii) the legal final maturity date of the referenced obligation. In addition, our CDS contracts do not include any ratings based collateral triggers or otherwise require Ambac to post collateral regardless of Ambac’s ratings or the mark-to-market exposure to Ambac.

Quoted market prices represent prices for particular instruments and include credit and market liquidity components. While quoted market prices may be available for the underlying reference securities, quoted market prices for the CDS contracts we execute are not readily observable in the market. Prospective investors should note that we establish “mark-to-market” (i.e., fair value per FAS 133) for our CDS contracts using valuation models that produce estimates that generally vary from the liquidation value of the underlying reference securities using quoted market prices because we do not own the underlying obligation and are not subject to the risks therein. However, as the credit quality of our CDS portfolio deteriorates, our mark-to-market estimates will approach the fair value of the underlying reference obligations; upon default, the financial guarantee CDS price would equal the value of the underlying reference security. If we used the liquidation value of the underlying reference security as the fair value of our CDS contract, the resulting valuation would have a materially adverse affect on our financial statements. For further discussion, see “Critical Accounting Policies and Estimates—Valuation of Financial Instruments” contained in our Annual Report on Form 10-K for the year ended December 31, 2007 attached to this prospectus supplement.

Ambac’s RMBS exposure embedded in CDOs relates primarily to the asset class commonly referred to as CDO of asset backed securities or CDO of ABS. Ambac participated in both the “High-grade CDO of ABS” and the “Mezzanine CDO of ABS” asset classes. Our CDOs of ABS transactions where the underlying securities are RMBS are subject to various risks, including those described under “Risk Factors—We are subject to credit risk and other risks related to RMBS and CDOs of ABS.” For further discussion please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2007 attached to this prospectus supplement.

 

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Fair value of Ambac’s financial guarantee CDS transactions represents the net present value of the difference between the fees Ambac originally charged for the credit protection and our estimate of the fees that a comparable financial guarantor may charge for the same protections at the balance sheet date. Key variables used in our valuation of credit derivatives on CDOs include the balance of unpaid notional amounts, expected term, fair values of the underlying reference obligations, reference obligation credit ratings, assumptions about current financial guarantee CDS fee levels relative to reference obligation spreads and other factors. Due to the significance of unobservable inputs required in valuing our financial guarantee CDS contracts, they are considered to be Level 3 under FAS 157 fair value hierarchy. See Note 17 in our 2007 audited financial statements in the attached Annual Report on Form 10-K for the year ended December 31, 2007. Notional balances, expected remaining term and reference obligation credit ratings are monitored and determined by Ambac’s surveillance group. Fair values of the underlying reference obligations are obtained from broker quotes when available, or are derived from other market indications such as new issuance spreads and quoted values for similar transactions. Ambac’s CDS fair value calculations are adjusted for increases in expected loss on the reference obligations and observable changes in financial guarantee market pricing. If no adjustment is considered necessary Ambac maintains the same percentage of the spread demanded in the market for the reference obligation as existed at the inception of the CDS. Therefore, absent changes in expected loss on the reference obligations or financial guarantee CDS market pricing, the financial guarantee CDS fees used for a particular contract in Ambac’s fair value calculations represent a consistent percentage, period to period, of the spread (over LIBOR) determinable from the reference obligation value at the balance sheet date. This results in a CDS fair value balance that fluctuates in proportion with the reference obligation value.

The following table summarizes the net par exposure outstanding and net derivative asset (liability) balance related to credit derivatives and total return swaps as of December 31, 2007 by asset type ($ in millions):

 

     CDO of
ABS
    CDO of
CDO
    CLO     Other(2)     Total  

Net par outstanding(1)

   $ 26,675     $ 2,472     $ 20,818     $ 16,284     $ 66,249  

Net asset (liability) fair value

     (3,778 )     (1,871 )     (222 )     (147 )     (6,018 )

 

(1)   Par amounts do not include outstanding commitments to provide guarantees. Certain financial guarantee commitments relate to potential increases in funding levels for existing credit derivative exposures or otherwise require fair value accounting. The amount of such outstanding commitments was $4,749 million at December 31, 2007.
(2)   Includes total return swaps with a total notional value of $535 million as of December 31, 2007.

The following table summarizes the estimated change in fair values on the net balance of Ambac’s net structured credit derivative and total return swap positions assuming immediate parallel shifts in spreads at December 31, 2007 ($ in millions):

 

     Estimated Unrealized Gain / (Loss)        

Change in Underlying Spreads

   CDO of
ABS
    CDO of
CDO
    CLO     Other(1)     Total     Total
Estimated
Unrealized
Gain/(Loss)
 

500 basis point widening

   $ (2,490 )   $ (510 )   $ (1,686 )   $ (1,324 )   $ (6,010 )   $ (12,028 )

250 basis point widening

     (1,246 )     (255 )     (843 )     (663 )     (3,007 )     (9,025 )

50 basis point widening

     (249 )     (51 )     (168 )     (132 )     (600 )     (6,618 )

Base scenario

     —         —         —         —         —         (6,018 )

50 basis point narrowing

     245       51       169       106       571       (5,447 )

250 basis point narrowing

     1,197       255       291       191       1,934       (4,084 )

500 basis point narrowing

     2,345       510       294       193       3,342       (2,675 )

 

(1)   Includes total return swaps.

 

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When reference obligations experience credit deterioration, there is an increase in the probability of default on the obligation and therefore an increase in expected loss. The effects of credit deterioration on financial guarantee CDS fees are not readily observable in the market. Ambac reflects the effects of changes in expected loss on the fair value of its CDS contracts by increasing the percentage of the reference obligation spread which would be captured as a CDS fee at the valuation date, resulting in a higher mark-to-market loss on our CDS relative to any price decline on the reference obligation. The fundamental assumption is that financial guarantee CDS fees will increase relative to reference obligation spreads as the underlying credit quality of the reference obligation deteriorates and approaches payment default. Upon default (“D” rating) the financial guarantee CDS fee would reflect 100% of the reference obligation spread. In 2007, such adjustments were made on CDO of ABS transactions containing over 25% MBS exposure which have suffered credit downgrades. For Ambac’s four CDO of ABS transactions that are rated below investment grade (three CDO squareds and one CDO of Mezzanine ABS), the average spread capture percentage is approximately 89%. Other asset types within the CDS portfolio have not experienced significant downgrades as of December 31, 2007.

The following table summarizes the estimated impact of immediate changes in Ambac’s internal credit rating on the fair value of Ambac’s credit derivative liability balance related to CDO of ABS transactions with >25% RMBS. These scenarios assume that all other variables included in the determination of fair value of these credit derivatives at December 31, 2007 remain unchanged.

 

($ in millions):

            

Change in Ambac Internal Credit Rating

   Estimated Unrealized
Gain/(Loss)
    Estimated Net Fair Value  

Four letter upgrade

   $ 487     ($ 5,162 )

Three letter upgrade

     471       (5,178 )

Two letter upgrade

     370       (5,279 )

One letter upgrade

     230       (5,419 )

Base scenario

     —         (5,649 )

One letter downgrade

     (335 )     (5,984 )

Two letter downgrade

     (978 )     (6,627 )

Three letter downgrade

     (2,002 )     (7,651 )

Four letter downgrade

     (3,255 )     (8,904 )

RMBS and (inner) CDO rating downgrades impact ABS CDOs negatively in two distinct ways. First, rating declines in ABS CDO collateral (i.e., RMBS and CDO) imply direct increases in the default probabilities of that collateral and, therefore, increased expected losses of each CDOs tranche. Second, as they relate to the CDOs within Ambac’s high-grade ABS CDOs, ratings declines in ABS CDO collateral can trigger structural mechanisms that alter tranche cash flows in a manner wholly independent of the ultimate credit performance of that collateral. Generally these mechanisms protect the senior-most CDO tranches in the event of ratings downgrades as the expense of the more junior tranches.

Requirement by rating agencies to hold additional capital

Changes in the ratings of the credit risks in our insured portfolio could require us to hold more capital against these credit risks. In particular, ratings downgrades by a rating agency on our insured portfolio increase the amount of capital necessary to satisfy such rating agency’s capital requirements, the amount of which varies by bond type and the extent of the downgrade. For example, Ambac estimates that the capital required to support its ABS portfolio using Moody’s portfolio risk model would increase by 59% in the event the entire ABS portfolio were downgraded one notch, 99% if downgraded two notches or 153% if downgraded three notches.

Rating Agency Perspective on Stress Testing Ambac’s Capital Adequacy

To provide prospective investors with additional perspective concerning potential losses and risks and uncertainties of certain portions of our financial guarantee business, set forth below is an excerpt from a report

 

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published by S&P and dated February 25, 2008. Investors should be aware that this report may not reflect the current views of Standard & Poor’s (S&P). Investors should consult announcements by the rating agencies and the websites of the rating agencies for current publicly available information. See “Recent Developments—Rating Agencies” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement. This excerpt is reprinted here with the permission of S&P; however, prospective investors should be aware that its report was prepared independently by S&P, and Ambac and the underwriters assume no responsibility for its contents or conclusions. The losses estimated in this report are credit loss estimates and do not represent market or liquidation values. Prospective investors should also be aware that if some of the stress scenarios described below were to occur, there is no assurance that we would maintain our triple-A financial strength ratings from S&P, or from Moody’s; we can also provide no assurance regarding what level our financial strength would be if a downgrade were to occur. S&P’s results are not promulgated under U.S. GAAP and accordingly should not be compared to our financial statements with regard to the market or credit derivatives or loss reserves for non-derivative insurance financial guarantees.

S&P tested the capital adequacy of Ambac against a scenario that applies stressful default assumptions to various RMBS-related transactions that Ambac has insured. (For a full report of this analysis, refer to “Detailed Results of Subprime Stress Test of Financial Guarantors” published on February 25, 2008.) The insured direct RMBS transactions (direct RMBS) and tranches of uninsured RMBS transactions (tranched RMBS) are components of the collateral backing insured CDOs. S&P based the default rates for these transactions on stressful cumulative net loss assumptions that varied by asset type and vintage and included the Alt-A, subprime, closed-end second, home equity line of credit (HELOC), and net interest margin (NIM) asset types with 2005, 2006, and 2007 vintages in this analysis. Table 1 shows the cumulative net loss assumptions for each of the asset classes by vintage.

To stress the direct RMBS component of Ambac’s total exposure, S&P developed rating-sensitive loss assumptions for individual insured transactions in each asset class. S&P also converted the various asset-type loss assumptions to probability distributions of outcomes using their internal data of projected losses for individual transactions. Each of the theoretic outcomes was compared with typical credit enhancement levels for such transactions to determine if the transactions defaulted or not, and if so, what the losses would be. Factoring in the probability of each possible outcome produced an analysis that defined the expected losses at each rating level for transactions in the various asset classes and vintages. Table 2 shows the results of this analysis.

S&P computed the expected loss on each transaction based on the original par value and original rating of the transaction. Next, S&P adjusted the accumulated results to reflect the reality that Ambac’s underwriting and risk remediation processes result in better overall loss rates. S&P effected this adjustment by reducing expected losses by a modest amount. Finally, S&P converted the calculated results to a present value by discounting the losses at 5% per year over a five-year period, assuming an equal payout in each period and adjusting for taxes. Table 6 shows the results of this analysis.

For CDOs, S&P computed rating-sensitive tranche loss assumptions using the same methodology described for computing rating-sensitive loss assumptions on direct RMBS transactions. To reflect the comparatively poorer performance of CDOs versus RMBS transactions, S&P increased the loss assumptions in table 1 (except for the 2006 and 2007 Alt-A asset classes discussed above) by 10%. (Table 3 shows the results of this analysis). For each insured CDO, S&P computed incremental collateral pool losses on all the asset types with 2005-2007 vintages based on the same methodology as described for computing losses on RMBS transactions. In this case, however, there was no adjustment for better underwriting and the present value methodology was changed to reflect different payment patterns. S&P removed the better underwriting adjustment since the collateral of the wrapped CDOs is not insured, and per S&P, does not benefit from Ambac’s underwriting and risk remediation expertise. S&P changed the period for the present value adjustment to 10 years, reflecting the structural features of the CDOs, which often require interest only until the final maturity.

For the portion of the CDO collateral that was made up of tranches of other ABS CDOs, S&P determined incremental loss assumptions based on the typical asset composition of such CDOs. S&P added additional capital

 

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charges to ABS CDOs that are likely to be subject to the negative effects of event-of-default triggers. (Table 4 shows these loss assumptions). S&P handled possible losses on CDO squared transactions on a case-by-case basis. Incremental losses were then aggregated to determine the collateral pool impairment.

S&P then compared the collateral impairment to the subordination supporting the tranche that the bond insurer had insured. In the vast majority of cases, Ambac has insured a “super senior” tranche, meaning that the subordination supporting Ambac’s insured tranches is a least 1.3x the level required to achieve a ‘AAA’ rating. The “subordination impairment ratio” (the ratio of collateral impairment divided by available subordination) shows how much of the available subordination would be lost to theoretic incremental losses.

Subordination impairment ratios above 1.0 signify that theoretic incremental losses would exceed the available subordination. Ratios below 1.0 signify that theoretic incremental losses would be less than the available subordination in the CDO. In this case, Ambac would not incur a loss. Four categories of CDO impairment ratios under 1.0 were defined and incremental capital charges were assigned. (See table 5 for the incremental capital charges assigned and table 7 for the results of this analysis.) The theoretic capital charges varied depending on whether the CDO was “high grade” or “mezzanine.” A high-grade CDO has collateral originally rated in the ‘A’, ‘AA’, or ‘AAA’ rating categories. A mezzanine CDO has collateral originally rated largely in the ‘BBB’ category.

Table 1

 

S&P Asset Class Cumulative Net Loss Assumptions (%)

 

Vintage

   Alt-A    Subprime    Closed-end
second
   HELOC    NIM

2005

   2.75    8.50    17.25    10.35    8.50

2006

   5.50    18.80    40.00    15.75    18.80

2007

   9.00    17.40    40.00    13.00    17.40

Table 2

 

S&P Direct RMBS Transaction Loss Assumptions (%)

 

Vintage/Original Rating

   Alt-A    Subprime    Closed-end
second
   HELOC    NIM

2005

              

AAA

   0.00    0.00    0.06    0.04    0.00

AA

   0.05    0.13    1.49    1.13    0.13

A

   0.38    0.80    3.75    2.98    0.80

BBB

   0.96    2.19    6.58    5.03    2.19

BB and lower

   N/A    N/A    N/A    N/A    20.00

2006

              

AAA

   0.03    0.59    17.40    0.69    0.59

AA

   1.24    5.34    26.12    4.78    5.34

A

   2.47    8.86    29.91    7.91    8.86

BBB

   3.41    11.66    32.82    10.40    11.66

BB and lower

   N/A    N/A    N/A    N/A    20.00

2007

              

AAA

   1.78    0.08    16.18    0.36    0.08

AA

   4.80    2.45    24.95    3.34    2.45

A

   6.10    5.45    28.91    5.92    5.45

BBB

   7.01    8.56    32.05    8.07    8.56

BB and lower

   N/A    N/A    N/A    N/A    20.00

 

N/A-not applicable.

 

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Table 3

 

S&P Tranched RMBS Tranche Loss Assumptions (%)

 

Vintage/Original Rating

   Alt-A    Subprime    Closed-end second    HELOC

2005

           

AAA

   0.00    0.00    0.23    0.13

AA

   3.03    2.50    15.29    18.29

A

   31.60    22.22    45.47    57.71

BBB

   66.23    45.86    64.99    74.49

BB and lower

   90.51    60.34    75.00    76.10

2006

           

AAA

   0.03    1.38    22.58    1.38

AA

   29.41    50.22    86.11    56.32

A

   77.53    82.25    96.01    86.24

BBB

   90.91    88.70    96.57    93.91

BB and lower

   96.64    92.19    97.41    96.86

2007

           

AAA

   1.78    0.25    21.47    0.85

AA

   79.42    27.82    84.86    49.55

A

   94.08    68.09    94.49    84.35

BBB

   96.76    79.70    95.91    92.43

BB and lower

   98.52    85.72    96.92    96.34

NIM transactions were not tranched.

Table 4

 

S&P ABS CDO Collateral Loss Assumptions (%)

 

Wrapped CDO Type/Year of Origination

   No event-of-default risk    Event-of-default risk

High-grade CDO

     

2005

   30.25    40.25

2006

   59.40    69.40

2007

   56.10    66.10

Mezzanine CDO

     

2005

   72.60    77.60

2006

   82.50    87.50

2007

   89.10    94.10

These loss assumptions apply to ABS CDO collateral within wrapped CDOs.

Table 5

 

S&P Incremental Losses/Capital Charges on CDOs (%)

 

Impairment ratio

  High-grade CDOs   Mezzanine CDOs

> 1.00

  Greater of calculated loss or 10.0   Greater of calculated loss or 20.0

> 0.75 < 1.00

  4.0   13.6

> 0.50 < 0.75

  2.2   7.0

> 0.25 < 0.50

  0.6   2.0

> 0.00 < 0.25

  0.4   1.4

Capital charges applied to notional value of insured CDOs.

 

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Table 6

 

S&P RMBS Exposure Information and Stress Test Results

 

     (Mil. $)

Original net par written

  

CES

   15,017.5

HELOCs

   34,521.9

NIMs

   346.1

Alt-A

   15,076.8

Subprime

   48,754.7

Total

   113,717.1

Current par outstanding at Sept. 30, 2007

  

CES

   5,653.6

HELOCs

   12,483.3

NIMs

   27.5

Alt-A

   7,789.5

Subprime

   8,774.1

Total

   34,728.0

Vintage based on original par written

  

2004 and prior

   66.9

2005

   11.3

2006

   12.3

2007

   9.5

Rating distribution based on original par written

  

AAA

   10.2

AA

   5.2

A

   37.8

BBB

   46.7

BB and lower

   0.2

Total projected losses by asset class

  

CES

   1,580.4

HELOCs

   1,013.2

NIMs

   7.0

Alt-A

   67.9

Subprime

   215.7

Total

   2,884.2

Present value of losses

   2,497.5

After-tax net RMBS losses

   1,623.4

 

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Table 7

 

S&P CDO Exposure Information And Stress Test Results

 

     (Mil. $)

CDO net par insured with RMBS exposure as of Sept. 30, 2007

  

High-grade CDOs

   28,683.9

Mezzanine CDOs

   510.0

Secondary market

   N/A

Total

   29,193.9

CDO net par by impairment ratio

  

Impairment ratios > 1.0

   19,159.3

Impairment ratios > 0.75 < 1.0

   1,933.0

Impairment ratios > 0.50 < 0.75

   2,792.3

Impairment ratios > 0.25 < 0.50

   5,309.3

Impairment ratios > 0.0 < 0.25

   0.0

Secondary market

   N/A

Total

   29,193.9

Theoretic loss and incremental capital charges

  

Impairment ratios > 1.0

   4,434.6

Impairment ratios > 0.75 < 1.0

   77.3

Impairment ratios > 0.50 < 0.75

   61.4

Impairment ratios > 0.25 < 0.50

   31.9

Impairment ratios > 0.0 < 0.25

   0.0

Secondary market

   N/A

Total

   4,605.2

Present value of losses

   3,684.2

After-tax net CDO losses

   2,394.7

 

N/A-not applicable.

Third-party Estimates of Losses and Credit Impairments

Various third-party securities analysts and other market participants have made estimates of our loss and credit impairment amounts under various scenarios. In light of various factors, including, without limitation, the volatility in the capital markets, the limited liquidity for certain classes of securities and the various assumptions about the future that are inherent in making such estimates, including estimates regarding the performance of RMBS and the housing market more generally, these third-party estimates vary widely. We have been informed by certain of the underwriters in this offering and the concurrent Equity Units Offering that their estimates of our losses and mark-to market-losses, which include estimates of our credit impairment, materially exceed the corresponding amounts shown in the stress cases of S&P discussed below in “Discussion of Certain Portfolio Risks—Rating Agency Perspective on Stress Testing Ambac’s Capital Adequacy,” and, in some cases, materially exceed the sum of the mark-to-market losses we have reported plus the amount of our loss reserve estimates. In the event that our ultimate losses and credit impairments approach some of these third-party estimates, such losses and credit impairments would have a materially adverse effect on our performance and financial position. In addition, we can provide no assurance that we would be able to maintain our triple-A ratings from Moody’s and S&P or our double-A from Fitch if our losses and credit impairments approached or exceeded these third-party estimates, even if such actual losses and credit impairments were less than the stress losses currently modeled by those rating agencies; we can also provide no assurance regarding at what level our financial strength would be if such a downgrade were to occur.

 

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DESCRIPTION OF THE EQUITY UNITS

The following is a summary of some of the terms of the Equity Units. This summary, together with the summary of some of the provisions of the related documents described below, does not purport to be complete and should be read together with, and is qualified in its entirety by reference to, the documents governing the terms of the Equity Units, copies of which have been or will be filed and incorporated by reference as exhibits to the registration statement of which this prospectus supplement and accompanying prospectus form a part. This summary supplements the description of the stock purchase units in the accompanying prospectus, and, to the extent it is inconsistent, replaces the description in the accompanying prospectus.

As used under this caption “Description of the Equity Units,” references to “we,” “us,” “our” and other similar references mean Ambac Financial Group, Inc. excluding, unless otherwise expressly stated or the context otherwise requires, its subsidiaries.

We will issue the Equity Units under the purchase contract agreement between us and The Bank of New York, whom we refer to as the purchase contract agent. Equity Units may be either Corporate Units or Treasury Units. The Equity Units will initially consist of              Corporate Units (or              Corporate Units if the underwriters exercise their over-allotment option in full), each with a stated amount of $50.

Corporate Units

Each Corporate Unit will consist of a unit comprising:

(a) a purchase contract under which, subject to a holder’s early settlement right as described under “Description of the Purchase Contracts—Early Settlement” and “Description of the Purchase Contracts—Early Settlement Upon Cash Merger”

(1) the holder will agree to purchase from us, and we will agree to sell to the holder, on May 17, 2011, which we refer to as the purchase contract settlement date, for $50 in cash, a number of newly issued shares of our common stock equal to the settlement rate described below under “Description of the Purchase Contracts—Purchase of Common Stock” (which settlement rate will be subject to anti-dilution adjustments under the circumstances set forth under “Description of the Purchase Contracts—Anti-Dilution Adjustments”), and

(2) we will pay the holder quarterly contract adjustment payments at the rate of     % per annum on the stated amount of $50, or $             per Corporate Unit per year, and

(b) either:

(1) a  1/20, or 5%, undivided beneficial ownership interest in a $1,000 principal amount of senior notes initially due February 15, 2021 issued by us, which we refer to as the senior notes, and under which we will pay to the holder  1/20, or 5%, of an interest payment on the $1,000 principal amount senior note at the initial rate of     %, or $             per year; or

(2) following a successful remarketing of the senior notes, the applicable ownership interest in a portfolio of U.S. Treasury securities, which we refer to as the Treasury portfolio.

“Applicable ownership interest” means, with respect to a Corporate Unit and the U.S. Treasury securities in the Treasury portfolio,

(1) a  1/20, or 5%, undivided beneficial ownership interest in $1,000 face amount of U.S. Treasury securities (or principal or interest strips thereof) included in the Treasury portfolio that mature on or prior to May 17, 2011, and

(2) an undivided beneficial ownership interest in U.S. Treasury securities (or principal or interest strips thereof) that mature on or prior to May 17, 2011 in an aggregate amount at maturity equal to the

 

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aggregate interest that would have accrued from, and including, February 15, 2011 to, but excluding, May 17, 2011 (assuming no reset of the interest rate and that May 17, 2011 were an interest payment date in lieu of May 15, 2011) on the principal amount of the senior notes that were formerly included in the Corporate Units but that were remarketed.

The purchase price of each Equity Unit will be allocated between the related purchase contract and the related beneficial interest in the senior note in proportion to their respective fair market values at the time of issuance. We will report the fair market value of each such beneficial interest in the senior note as $         and the fair market value of each purchase contract as $        . This position generally will be binding on each beneficial owner of each Equity Unit but not on the IRS.

As long as an Equity Unit is in the form of a Corporate Unit, your beneficial interest in the senior note or the applicable ownership interest in the Treasury portfolio, as applicable, forming a part of the Corporate Unit will be pledged to us through the collateral agent to secure your obligation to purchase common stock under the related purchase contract.

As described below under “Description of the Purchase Contracts—Requirement for Authorized Share Condition,” we currently may not have a sufficient number of shares of our common stock authorized in order to enable us to satisfy our common stock delivery requirements under the purchase contracts upon settlement. As a result, prior to the time that we satisfy the Authorized Share Condition, our obligation to deliver shares of our common stock, and your obligation to purchase such shares of common stock, will be satisfied through the delivery and purchase of newly issued shares of our Series A Preferred Stock in lieu of shares of our common stock. See “Description of the Purchase Contracts—Requirement for Authorized Share Condition” for more information.

Creating Treasury Units

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, each holder of Corporate Units will have the right, at any time on or prior to the second business day immediately preceding the purchase contract settlement date, to create Treasury Units by substituting for such holder’s ownership interest in the senior notes held by the collateral agent, zero-coupon Treasury securities that mature on February 15, 2011 (CUSIP No. 912820GC5), which we refer to as the Treasury securities and the related maturity date as the Treasury security maturity date, or, following the Treasury security maturity date, a new treasury security that matures on or prior to the purchase contract settlement date in a total principal amount at maturity equal to the aggregate principal amount of the senior notes for which substitution is being made; provided, however, that holders may not create Treasury Units by making such substitutions during the period beginning on and including the business day immediately preceding February 4, 2011, which we refer to as the initial remarketing date, and ending on and including February 15, 2011. We refer to this period as the remarketing period. Because Treasury securities are issued in integral multiples of $1,000, holders of Corporate Units may make this substitution only in integral multiples of 20 Corporate Units. On the Treasury security maturity date, the collateral agent will use all or a portion of the proceeds of the maturing Treasury security, which we refer to as the maturity proceeds, to purchase a new treasury security that matures on or prior to the purchase contract settlement date and will promptly remit any excess of the maturity proceeds over the purchase price of the new treasury security to holders of the Treasury Units. The purchase contract together with such new treasury security shall constitute a Treasury Unit.

If the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, holders of Corporate Units will have the right, at any time on or prior to the second business day immediately preceding the purchase contract settlement date, to create Treasury Units by substituting new treasury securities for the applicable ownership interest in the Treasury portfolio as a component of the Corporate Unit, but holders of Corporate Units may make this substitution only in integral multiples of      Corporate Units.

 

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Each of these substitutions will create Treasury Units, and the applicable senior notes or applicable ownership interest in the Treasury portfolio will be released to the holder and be separately tradable from the Treasury Units.

Each Treasury Unit will consist of a unit with a stated amount of $50 comprising:

(a) a purchase contract under which, subject to a holder’s early settlement right;

(1) the holder will agree to purchase from us, and we will agree to sell to the holder, not later than the purchase contract settlement date, for $50 in cash, a number of newly issued shares of our common stock equal to the settlement rate described below under “Description of the Purchase Contracts—Purchase of Common Stock” (which settlement rate will be subject to anti-dilution adjustment under the circumstances set forth in “Description of the Purchase Contracts—Anti-Dilution Adjustments”), and

(2) we will pay the holder quarterly contract adjustment payments at the rate of     % per annum on the stated amount of $50, or $             per Treasury Unit per year, and

(b) a  1/20, or 5%, undivided beneficial interest in a Treasury security with a principal amount at maturity of $1,000 or, following the Treasury security maturity date, a new treasury security that matures on or prior to the purchase contract settlement date.

To create 20 Treasury Units, unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, a Corporate Unit holder must:

 

   

deposit with the collateral agent a Treasury security or new treasury security that has a principal amount at maturity of $1,000 which must be purchased in the open market at the Corporate Unit holder’s expense, and

 

   

transfer 20 Corporate Units to the purchase contract agent accompanied by a notice stating that the holder has deposited a Treasury security or new treasury security with the collateral agent and requesting the release to the holder of the senior note relating to 20 Corporate Units.

Upon the deposit and receipt of an instruction from the purchase contract agent, the collateral agent will release the related senior note from the pledge under the pledge agreement, free and clear of our security interest, to the purchase contract agent. The purchase contract agent then will:

 

   

cancel the 20 Corporate Units,

 

   

transfer the related senior note to the holder, and

 

   

deliver 20 Treasury Units to the holder.

The Treasury security or new treasury security will be substituted for the senior note and will be pledged to us through the collateral agent to secure the holder’s obligation to purchase common stock under the related purchase contracts. The related senior note released to the holder thereafter will trade separately from the resulting Treasury Units.

If the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, the Corporate Unit holder will follow the same procedure to create a Treasury Unit except that this substitution may only be made in integral multiples of      Treasury Units.

As described below under “Description of the Purchase Contracts—Requirement for Authorized Share Condition,” we may not have a sufficient number of shares of our common stock authorized in order to enable us to satisfy our common stock delivery requirements under the purchase contracts upon settlement. As a result, prior to the time that we satisfy the Authorized Share Condition, our obligation to

 

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deliver shares of our common stock, and your obligation to purchase such shares of common stock, will be satisfied through the delivery and purchase of newly issued shares of our Series A Preferred Stock in lieu of shares of our common stock. See “Description of the Purchase Contracts—Requirement for Authorized Share Condition” for more information.

Recreating Corporate Units

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, each holder of Treasury Units will have the right at any time on or prior to the second business day immediately preceding the Purchase Contract Settlement Date to recreate Corporate Units by substituting for the related Treasury securities or new treasury securities held by the collateral agent senior notes having a principal amount equal to the aggregate principal amount at maturity of the Treasury securities or new treasury securities for which substitution is being made; provided, however, that holders may not recreate Corporate Units by making such substitutions during the remarketing period. Because Treasury securities and new treasury securities are issued in integral multiples of $1,000, holders of Treasury Units may make these substitutions only in integral multiples of 20 Treasury Units.

If the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, holders of Treasury Units will have the right, at any time on or prior to the second business day immediately preceding the purchase contract settlement date, to recreate Corporate Units by substituting the applicable ownership interests in the Treasury portfolio for the new treasury securities that were a component of the Treasury Units, but holders of Treasury Units may make this substitution only in integral multiples of      Treasury Units.

Each of these substitutions will recreate Corporate Units, and the applicable Treasury securities or new treasury securities will be released to the holder and be separately tradable from the Corporate Units.

To create 20 Corporate Units, unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, a Treasury Unit holder must:

 

   

deposit with the collateral agent $1,000 principal amount of senior notes, which must be purchased in the open market at the holder’s expense unless otherwise owned by the holder, and

 

   

transfer 20 Treasury Units to the purchase contract agent accompanied by a notice stating that the Treasury Unit holder has deposited $1,000 principal amount of senior notes with the collateral agent and requesting the release to the holder of the Treasury security or new treasury security relating to the Treasury Units.

Upon the deposit and receipt of an instruction from the purchase contract agent, the collateral agent will release the related Treasury security or new treasury security from the pledge under the pledge agreement, free and clear of our security interest, to the purchase contract agent. The purchase contract agent will then:

 

   

cancel the 20 Treasury Units,

 

   

transfer the related Treasury security or new treasury security to the holder, and

 

   

deliver 20 Corporate Units to the holder.

The substituted senior note or, as described below, the applicable ownership interests in the Treasury portfolio will be pledged to us through the collateral agent to secure the Corporate Unit holder’s obligation to purchase common stock under the related purchase contracts.

If the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, the Treasury Unit holder will follow the same procedure to create a Corporate Unit except that this substitution may only be made in integral multiples of      Treasury Units.

 

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Holders that elect to substitute pledged securities, thereby creating Treasury Units or recreating Corporate Units, will be responsible for any fees or expenses payable in connection with the substitution.

Current Payments

Each holder of Corporate Units will be entitled to receive quarterly cash distributions consisting of interest payments at the rate of     % per annum on the holder’s undivided beneficial ownership interest in the senior notes (or distributions on the applicable ownership interest in the Treasury portfolio if the Treasury portfolio has replaced senior notes as a component of Corporate Units), and quarterly contract adjustment payments payable by us at the rate of     % per annum on the stated amount of $50 per Corporate Unit until the earliest of the termination of the purchase contracts, the purchase contract settlement date, the cash merger early settlement date (as described in “Description of the Purchase Contracts—Early Settlement Upon Cash Merger”) and the most recent quarterly payment date on or before any other early settlement of the related purchase contracts. Holders of Treasury Units will be entitled to receive quarterly contract adjustment payments payable by us at the rate of     % per annum on the stated amount of $50 per Treasury Unit until the earliest of the termination of the purchase contracts, the purchase contract settlement date, the cash merger early settlement date (as described in “Description of the Purchase Contracts—Early Settlement Upon Cash Merger”) and the most recent quarterly payment date on or before any other early settlement of the related purchase contracts. There will be no distributions in respect of the Treasury securities or new treasury securities that are a component of the Treasury Units but the holders of the Treasury Units will continue to receive the scheduled quarterly interest payments on the senior notes that were released to them when the Treasury Units were created for as long as they hold the senior notes. We will make these payments on the Corporate Units and the Treasury Units quarterly in arrears on February 15, May 15, August 15 and November 15 of each year, commencing May 15, 2008; provided, that if any of these days is not a business day, we will make the payment on the following business day, without adjustment; provided, however, that the final payment in respect of Corporate Units and Treasury Units will be made on the purchase contract settlement date in lieu of May 15, 2011 and the amount payable on such date shall include amounts accrued to, but excluding, the purchase contract settlement date. Following a successful remarketing, interest on the senior notes will be payable on a semi-annual basis on February 15 and August 15 of each year, commencing on the date specified by us in connection with remarketing.

Ranking

The senior notes will be our unsecured, unsubordinated obligations. The senior notes will rank equally in right of payment with our existing and future unsecured and unsubordinated indebtedness and senior in right of payment to any of our existing and future subordinated indebtedness. The contract adjustment payments are our unsecured, subordinated obligations and will be subordinated in right of payment to all of our existing and future senior indebtedness (as defined below). The senior notes and the contract adjustment payments will be effectively subordinated to any of our secured indebtedness to the extent of the value of the assets securing such indebtedness. Additionally, the senior notes and the contract adjustment payments will be effectively subordinated to all existing and future preferred stock and indebtedness, guarantees and other liabilities of our subsidiaries. See “Risk Factors—The senior notes and the contract adjustment payments are effectively subordinated to any existing or future preferred stock and indebtedness or other liabilities of our subsidiaries, and the contract adjustment payments are subordinated to our existing and future senior indebtedness” and “—Our holding company structure and certain regulatory and other constraints could affect our ability to pay dividends and make other payments.”

Our obligations with respect to the contract adjustment payments will be subordinate in right of payment to our existing and future senior indebtedness. “Senior indebtedness” with respect to the contract adjustment payments means indebtedness of any kind unless the instrument under which such indebtedness is incurred expressly provides that it is on a parity in right of payment with or subordinate in right of payment to the contract adjustment payments.

 

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Voting and Certain Other Rights

Holders of purchase contracts forming part of the Corporate Units or Treasury Units, in such capacities, will have no voting or other rights in respect of the common stock.

Listing of the Securities

We intend to list the Corporate Units on the New York Stock Exchange or another national securities exchange. Unless and until substitution has been made as described in “—Creating Treasury Units” or “—Recreating Corporate Units,” neither the senior notes nor, if applicable, the applicable ownership interest in the Treasury portfolio component of a Corporate Unit nor the Treasury security or new treasury security component of a Treasury Unit will trade separately from the Corporate Units or Treasury Units. The senior notes or the applicable ownership interest in the Treasury portfolio component will trade as a unit with the purchase contract component of the Corporate Units, and the Treasury security or new treasury security component will trade as a unit with the purchase contract component of the Treasury Units. If the Treasury Units or the senior notes are separately traded to a sufficient extent that applicable exchange listing requirements are met, we may endeavor, but are not obligated, to list the Treasury Units or the senior notes on the same exchange as the Corporate Units are then listed, including, if applicable, the New York Stock Exchange.

Miscellaneous

We or our affiliates may from time to time purchase any of the securities offered by this prospectus supplement which are then outstanding by tender, in the open market, by private agreement or otherwise.

 

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DESCRIPTION OF THE PURCHASE CONTRACTS

This section summarizes some of the terms of the purchase contract agreement, purchase contracts, pledge agreement, remarketing agreement, indenture and supplemental indenture No. 1. The summary does not purport to be complete and is subject to, is qualified in its entirety by reference to, and should be read together with, the purchase contract agreement, pledge agreement, remarketing agreement, indenture and supplemental indenture No. 1, forms of which have been or will be filed and incorporated by reference as exhibits to the registration statement of which this prospectus supplement and the accompanying prospectus form a part. This summary supplements the description of the stock purchase units and the indenture in the accompanying prospectus and, to the extent it is inconsistent with any portion of the description in the accompanying prospectus, replaces that portion of the description in the accompanying prospectus.

As used under this caption “Description of the Purchase Contracts,” references to “we,” “us,” “our” and similar references mean Ambac Financial Group, Inc. excluding, unless otherwise expressly stated or the context otherwise requires, its subsidiaries.

Purchase of Common Stock

Subject to a holder’s early settlement right as described below under “—Early Settlement,” and “Early Settlement Upon Cash Merger” and to the further provisions described below under “—Requirement for Authorized Share Condition,” each purchase contract underlying a Corporate Unit or Treasury Unit will obligate the holder of the purchase contract to purchase, and us to sell, on the purchase contract settlement date, for $50 in cash, which is equal to the stated amount of the Corporate Unit or Treasury Unit, a number of newly issued shares of our common stock equal to the settlement rate. The settlement rate will, subject to adjustment under the circumstances described in “—Anti-Dilution Adjustments,” be as follows:

 

   

If the applicable market value of our common stock is equal to or greater than the threshold appreciation price of $            ,             shares of our common stock, which is approximately equal to the stated amount divided by the threshold appreciation price, and which we refer to as the minimum settlement rate.

Accordingly, if the market value for the common stock increases between the date of this prospectus supplement and the period during which the applicable market value is measured and the applicable market value is greater than the threshold appreciation price, the aggregate market value of the shares of common stock issued upon settlement of a purchase contract on the purchase contract settlement date will be higher than the stated amount, assuming that the market price of the common stock on the purchase contract settlement date is the same as the applicable market value of the common stock. If the applicable market value is the same as the threshold appreciation price, the aggregate market value of the shares issued upon settlement will be equal to the stated amount, assuming that the market price of the common stock on the purchase contract settlement date is the same as the applicable market value of the common stock.

 

   

If the applicable market value of our common stock is less than the threshold appreciation price but greater than the reference price of $            , a number of shares of our common stock equal to $50 divided by the applicable market value.

Accordingly, if the market value for the common stock increases between the date of this prospectus supplement and the period during which the applicable market value is measured, but the applicable market value is less than the threshold appreciation price and greater than the reference price, the aggregate market value of the shares of common stock issued upon settlement of a purchase contract on the purchase contract settlement date will be equal to the stated amount, assuming that the market price of the common stock on the purchase contract settlement date is the same as the applicable market value of the common stock.

 

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If the applicable market value of our common stock is less than or equal to the reference price, the settlement rate will be              shares of our common stock, which is approximately equal to the stated amount divided by the reference price, and which we refer to as the maximum settlement rate.

Accordingly, if the market value for the common stock decreases between the date of this prospectus supplement and the period during which the applicable market value is measured and the applicable market value is less than the reference price, the aggregate market value of the shares of common stock issued upon settlement of a purchase contract on the purchase contract settlement date will be less than the stated amount, assuming that the market price on the purchase contract settlement date is the same as the applicable market value of the common stock. If the applicable market value is the same as the reference price, the aggregate market value of the shares issued upon settlement will be equal to the stated amount, assuming that the market price of the common stock on the purchase contract settlement date is the same as the applicable market value of the common stock.

“Applicable market value” means the average of the volume weighted average price per share of our common stock (or exchange property units, as defined under “Description of the Purchase Contracts—Anti-Dilution Adjustments,” in which the purchase contracts will be settled following a reorganization event) on each of the 20 consecutive trading days ending on the third trading day immediately preceding the purchase contract settlement date, which 20 trading day period we refer to as the observation period, subject to anti-dilution adjustments under the circumstances set forth under “—Anti-Dilution Adjustments” below. Following the occurrence of any such reorganization event, references herein to the purchase or issuance of shares of our common stock pursuant to purchase contracts will be construed to be references to settlement into exchange property units, and references herein to the purchase or issuance of any specified number of shares of common stock upon the settlement of purchase contracts will be construed to be references to settlements into the same number of exchange property units. For purposes of calculating the exchange property unit value, (x) the value of any common stock included in the exchange property unit shall be determined using the average of the volume weighted average price per share of such common stock on each of the 20 consecutive trading days ending on the third trading day immediately preceding the applicable settlement date and (y) the value of any other property, including securities other than common stock, included in the exchange property unit shall be the value of such property on the first trading day of the applicable observation period (as determined in good faith by our board of directors, whose determination shall be conclusive and described in a board resolution). The reference price equals the price at which we offered our common stock in the concurrent Common Stock Offering. The threshold appreciation price represents an approximately     % appreciation over the reference price.

“Volume weighted average price” per share of our common stock on any trading day means such price as displayed on Bloomberg (or any successor service) page ABK.N <equity> VAP in respect of the period from 9:30 a.m. to 4:00 p.m., New York City time, on such trading day; or, if such price is not available, the volume weighted average price means the market value per share of our common stock on such day as determined by a nationally recognized independent investment banking firm retained by us for this purpose.

A “trading day” means a day on which the common stock

 

   

is not suspended from trading on any national or regional securities exchange or association or over-the-counter market at the close of business, and

 

   

has traded at least once on the national or regional securities exchange or association or over-the-counter market that is the primary market for the trading of the common stock.

We will not issue any fractional shares of common stock pursuant to the purchase contracts. In lieu of fractional shares otherwise issuable (calculated on an aggregate basis) in respect of purchase contracts being settled by a holder of Equity Units, the holder will be entitled to receive an amount of cash equal to the fraction of a share multiplied by the applicable market value.

 

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On the business day immediately preceding the purchase contract settlement date, unless:

 

   

a holder of Corporate Units or Treasury Units has settled or provided for the settlement of the related purchase contracts prior to the purchase contract settlement date through the early delivery of cash to the purchase contract agent in the manner described under “—Early Settlement,” “—Early Settlement Upon Cash Merger” or “—Notice to Settle with Cash,” or

 

   

an event described under “—Termination” has occurred,

then,

 

   

in the case of Corporate Units where the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, a portion of the proceeds equal to the stated amount of $50 per Corporate Unit of the appropriate applicable ownership interest of the Treasury portfolio, when paid at maturity, will automatically be applied to satisfy in full the holder’s obligation to purchase common stock under the related purchase contracts,

 

   

in the case of Corporate Units where the Treasury portfolio has not replaced the senior notes as a component of the Corporate Units, (1) if holders of Corporate Units exercise their put right with respect to the related senior notes, $50 per Corporate Unit of the put price received by the collateral agent or (2) if such holders elect not to exercise their put right, the cash delivered by such holders on the business day immediately preceding the purchase contract settlement date in settlement of the related purchase contracts, in each case, will automatically be applied to satisfy in full the holder’s obligation to purchase common stock under the related purchase contracts, and

 

   

in the case of Treasury Units, the principal amount of the related new treasury securities, when paid at maturity, will automatically be applied to satisfy in full the holder’s obligation to purchase common stock under the related purchase contracts.

The common stock will then be issued and delivered to the holder or the holder’s designee, upon surrender of the Corporate Units or Treasury Units (which, in the case of Equity Units evidenced by physical certificates, must be made by presentation and surrender of such certificates) and payment by the holder of any transfer or similar taxes payable in connection with the issuance of the common stock to any person other than the holder.

Each holder of Corporate Units or Treasury Units, by acceptance of these securities, will be deemed to have:

 

   

irrevocably agreed to be bound by the terms and provisions of the related purchase contracts and the pledge agreement and to have agreed to perform its obligations thereunder for so long as the holder remains a holder of the Corporate Units or Treasury Units, and

 

   

duly appointed the purchase contract agent as the holder’s attorney-in-fact to enter into and perform the related purchase contracts and pledge agreement on behalf of and in the name of the holder.

In addition, each beneficial owner of Corporate Units or Treasury Units, by acceptance of the beneficial interest therein, will be deemed to have agreed to treat:

 

   

itself as the owner of the related senior notes, applicable ownership interests in the Treasury portfolio or the Treasury securities or new treasury securities, as the case may be, and

 

   

the senior notes as indebtedness for all United States federal income tax purposes.

Requirement for Authorized Share Condition

The purchase contracts may be settled for more shares of common stock than we currently have available on reserve for issuance on the purchase contract settlement date or upon any earlier settlement date of a purchase contract. In order to provide for the authorization of a sufficient number of shares of our common stock with which

 

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to settle the purchase contracts, we have agreed in the Certificate of Designations governing our Series A Preferred Stock, the purchase contract agreement relating to the Equity Units and the underwriting agreement relating to the offering to use commercially reasonable efforts to satisfy the Authorized Share Condition (as defined below) as promptly as practicable following the issuance of the Equity Units.

If the Authorized Share Condition has not been satisfied by the time a purchase contract is settled (whether on the purchase contract settlement date or upon any earlier settlement date), your obligation to purchase our common stock, and our obligation to deliver such common stock, will be satisfied through the purchase and delivery of newly issued shares of our Series A Participating Preferred Stock, par value $0.01 per share, which we refer to as our Series A Preferred Stock, in lieu of shares of our common stock. Each share of our Series A Preferred Stock is intended to be the economic equivalent of holding 100 shares of our common stock. Accordingly, if at the time of settlement of a purchase contract the Authorized Share Condition has not been satisfied, we will issue, in lieu of the number of shares of our common stock that would otherwise be deliverable, a number of shares of our Series A Preferred Stock equal to the number of shares of our common stock that would otherwise be deliverable multiplied by  1/100. Fractional shares of Series A Preferred Stock may be issued down to  1/ 100th of a share and each such fractional interest is intended to be the economic equivalent of holding one share of our common stock. For a description of the Series A Preferred Stock, see “Description of Our Capital Stock—Preferred Stock—Series A Preferred Stock.”

If the Authorized Share Condition has not been satisfied by the 120th day after the issuance of the Equity Units, from such date to, but excluding, the date on which the Authorized Share Condition is satisfied, (i) the quarterly contract adjustment payments payable by us to holders of the Equity Units on all outstanding purchase contracts will increase from     % per annum to a rate of     % per annum on the stated amount of $50 per Equity Unit and (ii) with respect to any Series A Preferred Stock that is outstanding, in addition to the dividends payable on our common stock, we will pay a cash dividend per quarter equal to $             (which is equal to 2.5% (or 10% on an annualized basis) of the reference price of our common stock multiplied by 100) or, in respect of each  1 /100th fractional interest in our Series A Preferred Stock, $             for each such fractional share.

Upon the satisfaction of the Authorized Share Condition, each share of Series A Preferred Stock will automatically convert into 100 shares of our common stock (and, therefore, each 1/100th fractional interest in our Series A Preferred Stock will automatically convert into one share of our common stock) in accordance with the terms of the Series A Preferred Stock. The conversion rate upon automatic conversion of the Series A Preferred Stock upon the satisfaction of the Authorized Share Condition will remain at the fixed rate set forth in the preceding sentence. Upon the occurrence of a stock split or combination in respect of our common stock, the number of outstanding shares of our Series A Preferred Stock held by each holder will be adjusted proportionately upward or downward such that the number of shares of Series A Preferred Stock held by any holder of our Series A Preferred Stock immediately following the event will correspond to the number of shares of our common stock that such holder would have following such event if the Series A Preferred Stock held by such holder had been converted into our common stock immediately prior to such event. In addition, upon the occurrence of a reorganization event pursuant to which our common stock is converted into the right to receive cash, securities or other property, each share of Series A Preferred Stock will automatically convert into the right to receive the amount of cash, securities or other property that a holder of 100 shares of our common stock has the right to receive pursuant to such event.

Holders of outstanding Series A Preferred Stock will be entitled to participate in all dividends or distributions (including, but not limited to, regular quarterly dividends) paid or made in respect of our common stock, whether in the form of cash or securities or any other form of property or assets. Any such dividend or distribution will be payable or deliverable on the date fixed for the related payment or delivery of the dividend or distribution on our common stock to holders of record of our Series A Preferred Stock on the record date fixed for the related dividend or distribution to holders of our common stock. Any such payment or delivery will equal, in respect of each share of our Series A Preferred Stock, the amount of cash, securities or other property or assets that a holder of 100 shares of our common stock is entitled to receive. In addition, holders of Series A Preferred

 

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Stock will be entitled to receive the additional dividend described in the second preceding paragraph. Payment of the additional dividend amount will be made on February 15, May 15, August 15 and November 15 of each year to holders of record of Series A Preferred Stock as of the first day of the month in which the related payment is to be made. Dividends in respect of the Series A Preferred Stock are cumulative and will be payable when, as and if declared by our board of directors.

“Authorized Share Condition” means that we have a sufficient number of authorized and unissued shares of common stock on reserve and registered on a registration statement under the Securities Act for the settlement in all circumstances of all outstanding purchase contracts and the automatic conversion of all outstanding shares of Series A Preferred Stock into shares of common stock.

We have agreed in the Certificate of Designations governing our Series A Preferred Stock the purchase contract agreement relating to the Equity Units and the underwriting agreement relating to the offering that in the event that we authorize any additional shares of our common stock following the date of issuance of the Equity Units, such shares must first be used by us to satisfy the Authorized Share Condition and we will not apply or reserve such shares for any other purpose until the Authorized Share Condition has been satisfied.

Remarketing

Pursuant to a remarketing agreement among us, the purchase contract agent and the remarketing agent to be appointed thereunder (which will be one of the underwriters of this offering), which we refer to as the remarketing agent, the remarketing agent will attempt to remarket the senior notes held by Corporate Unit holders as part of Corporate Units on the initial remarketing date and senior notes that are not part of Corporate Units but whose holders have elected to participate in the remarketing as described under “Description of our Senior Notes—Optional Remarketing,” and in the event such remarketing on this date is not successful, the remarketing agent will thereafter attempt to remarket the senior notes on each of the four succeeding business days until a successful remarketing occurs, in each case, for settlement on the remarketing settlement date. The remarketing settlement date is February 15, 2011.

For each remarketing, the remarketing agent will be required to use its reasonable efforts to obtain a price for the remarketed senior notes that results in proceeds of at least 100% of the sum of the Treasury portfolio purchase price and the separate senior notes purchase price, as defined below. To obtain that price, the remarketing agent, in consultation with the Company, may reset the interest rate on the senior notes. In connection with any remarketing, we may elect to modify the maturity date or redemption provisions of the senior notes, in consultation with the remarketing agent, as described under “Description of our Senior Notes”.

A remarketing on any remarketing date will be considered successful and no further attempts to remarket will be made if the resulting proceeds are at least 100% of the sum of the Treasury portfolio purchase price and the separate senior notes purchase price.

The “separate senior notes purchase price” means the amount in cash equal to the product of (A) the remarketing price per senior note (as defined below) and (B) the number of senior notes included in such remarketing that are not part of Corporate Units, which we refer to as separate senior notes.

In the event of a successful remarketing, each holder of a separate senior note will receive the “remarketing price per senior note,” which, for each senior note, is an amount in cash equal to the quotient of the Treasury portfolio purchase price divided by the number of senior notes included in such remarketing that are held as components of Corporate Units. Each holder of a Corporate Unit whose senior note is included in a successful remarketing will receive an applicable ownership interest in the Treasury portfolio equal to the remarketing price per senior note.

 

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In the event of a successful remarketing of the senior notes, on the remarketing settlement date, the portion of the proceeds from the remarketing equal to the separate senior notes purchase price will be paid to holders of separate senior notes remarketed in a remarketing, and the portion of the proceeds from the remarketing equal to the Treasury portfolio purchase price will be applied to purchase the Treasury portfolio consisting of:

 

   

U.S. Treasury securities (or principal or interest strips thereof) that mature on or prior to May 17, 2011 in an aggregate amount equal to the principal amount of the senior notes that were formerly included in Corporate Units but that were remarketed, and

 

   

U.S. Treasury securities (or principal or interest strips thereof) that mature on or prior to May 17, 2011 in an aggregate amount at maturity equal to the aggregate interest that would have accrued from, and including, February 15, 2011 to, but excluding, May 17, 2011 (assuming no reset of the interest rate and that May 17, 2011 was an interest payment date in lieu of May 15, 2011) on the aggregate principal amount of the senior notes that were formerly included in the Corporate Units but that were remarketed.

The Treasury portfolio will be substituted for the senior notes as a component of the Corporate Units and will be pledged to us through the collateral agent to secure the Corporate Unit holders’ obligation under the purchase contracts. On or promptly following the remarketing settlement date, the remarketing agent will remit to the purchase contract agent any remaining portion of the proceeds for the benefit of the holders of the Corporate Units, the senior notes component of which were included in the remarketing. On the purchase contract settlement date, a portion of the proceeds from the Treasury portfolio equal to the principal amount of the senior notes previously included in the Corporate Units will automatically be applied to satisfy the Corporate Unit holders’ obligation to purchase common stock under the purchase contracts and proceeds from the Treasury portfolio equal to the interest payment (assuming no reset of the interest rate) that would have been paid to the holders of Corporate Units on the senior notes previously included in the Corporate Units on the purchase contract settlement date will be paid to the holders of the Corporate Units. We will separately pay a fee to the remarketing agents. Holders of senior notes that are remarketed will not be responsible for the payment of any remarketing fee in connection with the remarketing.

As used in this context, “Treasury portfolio purchase price” means the lowest aggregate ask-side price quoted by a primary U.S. government securities dealer to the quotation agent between 9:00 a.m. and 11:00 a.m., New York City time, on the date of a successful remarketing for the purchase of the Treasury portfolio described above for settlement the third business day immediately following such date. “Quotation agent” means any primary U.S. government securities dealer in New York City selected by us.

We will cause a notice of any failed remarketing to be published on the business day immediately following the end of the remarketing period, by publication in a daily newspaper in the English language of general circulation in New York City, which is expected to be The Wall Street Journal. In addition, we will request, not later than seven nor more than 15 calendar days prior to the initial remarketing date, that the depositary notify its participants holding senior notes, Corporate Units and Treasury Units of the remarketing, including, in the case where a successful remarketing does not occur during the remarketing period, of the procedures that must be followed if a note holder wishes to exercise its right to put its senior note to us as described in this prospectus supplement. If required under U.S. federal securities laws, we will use our commercially reasonable efforts to ensure that a registration statement with regard to the full amount of the senior notes to be remarketed will be effective and a related prospectus will be available in a form that will enable the remarketing agent to rely on it in connection with the remarketing process.

If a successful remarketing of the senior notes underlying your Corporate Units has not occurred during the remarketing period, the holder of a Corporate Unit will have the right to put such holder’s beneficial interest in the senior note that comprises a part of such Corporate Unit to us on the purchase contract settlement date, at a price equal to the principal amount corresponding to the beneficial interest in the senior note, plus accrued and unpaid interest. The put right of holders of Corporate Units will be deemed to have been automatically exercised with respect to such holder’s beneficial interest in the senior notes unless such holders (1) on or prior to 11:00

 

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a.m., New York City time, on the second business day immediately preceding the purchase contract settlement date, provide written notice of their intention to settle the related purchase contract with separate cash, and (2) on or prior to the business day immediately preceding the purchase contract settlement date, deliver to the collateral agent $50 in cash per purchase contract. Unless a Corporate Unit holder has settled the related purchase contract with separate cash on or prior to the business day immediately preceding the purchase contract settlement date, the portion of the put price equal to the principal amount of senior notes corresponding to a Corporate Unit holder’s beneficial interest in a senior note put to us will be delivered to the collateral agent, who will apply such amount in satisfaction of such holder’s obligations under the related purchase contract on the purchase contract settlement date and remit the remaining portion of the put price to such holder. If we fail to deliver the put price to the collateral agent, we will be deemed to have netted our obligation to pay the put price against the holders’ obligation to pay the purchase price under the related purchase contract on the purchase contract settlement date in full satisfaction of such holder’s obligations under the purchase contracts.

You may elect not to participate in the remarketing and to retain the senior notes underlying your Corporate Units by creating Treasury Units or settling the related purchase contracts early, in each case, at any time on or prior to the second business day prior to the initial remarketing date.

Early Settlement

Subject to the conditions described below, a holder of Corporate Units or Treasury Units may settle the related purchase contracts in cash at any time, except as provided below, on or prior to the second business day immediately preceding the purchase contract settlement date by delivering the related Corporate Unit or Treasury Units (which, if they are in certificated form, must be surrendered at the offices of the purchase contract agent) and an Election to Settle Early form duly completed in accordance with the applicable procedures of the depositary (or, if the Equity Units are certificated, by completing the form of “Election to Settle Early” on the reverse side of such certificate completed and executed as indicated), accompanied by payment to us in immediately available funds of an amount equal to

 

   

the stated amount multiplied by the number of purchase contracts being settled, plus

 

   

if the delivery is made with respect to any purchase contract during the period after the close of business on any record date next preceding any quarterly payment date and prior to the opening of business on such payment date, an amount equal to the contract adjustment payments payable on the payment date with respect to all such purchase contracts.

As a result, if a holder of a Corporate Unit or Treasury Unit settles a purchase contract early (other than pursuant to the merger early settlement right as described below), or if a holder’s purchase contract is terminated as a result of our bankruptcy, insolvency or reorganization, such holder will not be entitled to any accrued contract adjustment payments.

A holder of an Equity Unit may not elect to settle the related purchase contract during the remarketing period. After the remarketing settlement date, each holder of Corporate Units will continue to have the right to settle the related purchase contract at any time on or prior to the second business day immediately preceding the purchase contract settlement date.

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, holders of Corporate Units may settle early only in integral multiples of 20 Corporate Units. If the Treasury portfolio has replaced the senior notes as a component of Corporate Units, holders of the Corporate Units may settle early only in integral multiples of      Corporate Units. Holders of Treasury Units may settle early only in integral multiples of 20 Treasury Units.

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depositary and the purchase contract agent. The early settlement right is also subject to the condition that, if required under the U.S. federal securities laws, we have a registration statement under the Securities Act in effect and a prospectus available covering the shares of common stock and other securities, if any, deliverable upon settlement of a purchase contract. We have agreed that, if required under the U.S. federal securities laws, we will use our commercially reasonable efforts to have a registration statement in effect and a prospectus available covering those shares of common stock and other securities to be delivered in respect of the purchase contracts being settled, in each case in a form that may be used in connection with the early settlement right. Should the Company be unable to deliver registered shares of common stock or other securities to be delivered in respect of the purchase contracts, the investor will not be able to elect an early settlement until such time that registered shares of common stock or other securities are available, and if this occurs there is no obligation on the part of the Company to net cash settle the purchase contracts.

Upon early settlement of the purchase contracts related to any Corporate Units or Treasury Units:

 

   

except as described below in “—Early Settlement Upon Cash Merger,” the holder will receive newly issued shares of common stock per Corporate Unit or Treasury Unit, subject to adjustment under the circumstances described under “—Anti-Dilution Adjustments,” accompanied by an appropriate prospectus if required by law,

 

   

the senior notes, the applicable ownership interest in the Treasury portfolio, the Treasury securities or new treasury securities, as the case may be, related to the Corporate Units or Treasury Units will be transferred to the holder free and clear of our security interest,

 

   

the holder’s right to receive future contract adjustment payments and any accrued and unpaid contract adjustment payments for the period since the most recent quarterly payment date will terminate (unless such early settlement occurs after the close of business on a record date and on or prior to the next succeeding payment date, in which case the contract adjustment payment due and payable on such payment date will be paid, on such payment date, to the person who was the record holder of the applicable Equity Units on the applicable record date), and

 

   

no adjustment will be made to or for the holder on account of any accrued and unpaid contract adjustment payments referred to in the previous bullet.

If the purchase contract agent receives a Corporate Unit or Treasury Unit as described above accompanied by the completed “Election to Settle Early” (as described above) and required immediately available funds, from a holder of Corporate Units or Treasury Units by 5:00 p.m., New York City time, on a business day and all conditions to early settlement have been satisfied, that day will be considered the settlement date.

If the purchase contract agent receives the above after 5:00 p.m., New York City time, on a business day or at any time on a day that is not a business day, the next business day will be considered the settlement date. Upon early settlement of purchase contracts in the manner described above, surrender of the related Corporate Units or Treasury Units and payment of any transfer or similar taxes payable by the holder in connection with the issuance of the related common stock to any person other than the holder of the Corporate Units or Treasury Units, we will cause the shares of common stock being purchased to be issued, and the related senior notes, the applicable ownership interest in the Treasury portfolio, the Treasury securities or new treasury securities, as the case may be, securing the purchase contracts to be released from the pledge under the pledge agreement described in “—Pledged Securities and Pledge Agreement” and transferred, within three business days following the settlement date, to the purchasing holder or the holder’s designee.

Notice to Settle with Cash

A holder of an Equity Unit may settle the related purchase contract with separate cash. A holder of an Equity Unit wishing to settle the related purchase contract with separate cash must notify the purchase contract agent by presenting and surrendering the certificate evidencing the Corporate Unit or Treasury Unit, as the case

 

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may be, at the offices of the purchase contract agent with the form of “Notice to Settle by Separate Cash” on the reverse side of the certificate completed and executed as indicated on or prior to 11:00 a.m., New York City time, on the second business day immediately preceding the purchase contract settlement date and, on or prior to 11:00 a.m., New York City time, on the business day immediately preceding the purchase contract settlement date deliver to the collateral agent $50 in cash per purchase contract; provided, however, that a holder may not elect to settle the related purchase contract with separate cash on or prior to the remarketing settlement date.

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, holders of Corporate Units may settle early only in integral multiples of 20 Corporate Units. If the Treasury portfolio has replaced the senior notes as a component of Corporate Units, holders of the Corporate Units may settle early only in integral multiples of      Corporate Units. Holders of Treasury Units may settle early only in integral multiples of 20 Treasury Units.

If a holder of a Corporate Unit with respect to which the Treasury portfolio has not replaced the senior notes as a component of the Corporate Unit has given notice of its intention to settle the related purchase contract with separate cash and such holder fails to deliver the cash to the collateral agent on the business day immediately preceding the purchase contract settlement date, such holder will be deemed to have automatically exercised its right to put the senior notes to us on the purchase contract settlement date, as described under “—Remarketing” above.

If a holder of a Treasury Unit or a Corporate Unit with respect to which the Treasury portfolio has replaced the senior notes as a component of the Corporate Unit has given notice of its intention to settle the related purchase contract with separate cash fails to deliver the cash to the collateral agent on the business day immediately preceding the purchase contract settlement date, the proceeds from the new treasury securities or Treasury portfolio, as the case may be, will automatically be applied to satisfy such holder’s obligation to purchase common stock under the related purchase contract.

Early Settlement Upon Cash Merger

Prior to the purchase contract settlement date, if we are involved in a consolidation, acquisition or merger, or a sale of all or substantially all of our assets, in each case in which at least 10% of the consideration received by holders of our common stock consists of cash or cash equivalents, which we refer to as a cash merger, then following the cash merger, each holder of a purchase contract will have the right to accelerate and settle such contract early at the settlement rate determined as if the applicable market value equaled the stock price (as defined below), and receive, under certain circumstances, an additional make-whole number of shares, which we refer to as the make-whole shares, provided that at such time, if so required under the U.S. federal securities laws, there is in effect a registration statement and a prospectus available covering the common stock and other securities, if any, to be delivered in respect of the purchase contracts being settled. We refer to this right as the “merger early settlement right.”

The foregoing paragraph includes a phrase relating to a sale of all or substantially all of our assets. There is no precise, established definition of the phrase “substantially all” under applicable law. Accordingly, your right to accelerate and settle such contract early as a result of a sale of substantially all of our assets may be uncertain.

We will provide each of the holders with a notice of the completion of a cash merger within five business days thereof. The notice will specify a date, which we refer to as the “cash merger early settlement date,” which shall be at least ten days after the date of the notice but no later than the earlier of (i) 20 days after the date of such notice and (ii) two business days prior to the purchase contract settlement date, by which each holder’s merger early settlement right must be exercised. The notice will set forth, among other things, the applicable settlement rate and the amount of the cash, securities and other consideration receivable by the holder upon settlement. To exercise the merger early settlement right, you must deliver to the purchase contract agent, three business days before the cash merger early settlement date, your Corporate Units or Treasury Units (by delivery

 

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of certificates if they are held in certificated form), and payment of the applicable purchase price in immediately available funds less the amount of any accrued and unpaid contract adjustment payments (unless such cash merger early settlement date occurs after the related record date for such contract adjustment payments, in which case the applicable purchase price shall not be reduced by the amount of any accrued and unpaid contract adjustment payments).

If you exercise the merger early settlement right, we will deliver to you on the cash merger early settlement date, in respect of each such Equity Unit so settled the kind and amount of securities, cash or other property that you would have been entitled to receive in the cash merger as a holder of a number of shares of our common stock (assuming that the Authorized Share Condition had been satisfied) at the settlement rate described above, and, if applicable, the make-whole shares. You will also receive the senior notes, applicable ownership interests in the Treasury portfolio or Treasury securities or new treasury securities underlying the Corporate Units or Treasury Units as the case may be. If you do not elect to exercise your merger early settlement right, or if your exercise is not effective because the required registration statement is not effective (as described below), your Corporate Units or Treasury Units will remain outstanding and subject to normal settlement, without the make-whole shares, on the purchase contract settlement date with the securities, cash or other property holders of our common stock were entitled to receive in the cash merger. If required under the U.S. federal securities laws, there will be a registration statement in effect and a prospectus available covering the common stock and other securities, if any, to be delivered in respect of the purchase contracts being settled, in each case in a form that may be used in connection with the early settlement upon a cash merger.

Unless the Treasury portfolio has replaced the senior notes as a component of the Corporate Units, holders of the Corporate Units may exercise the merger early settlement right only in integral multiples of 20 Corporate Units, if the Treasury portfolio has replaced the senior notes as a component of          Corporate Units, holders of the Corporate Units may exercise the merger early settlement right only in integral multiples of Corporate Units. A holder of Treasury Units may exercise the merger early settlement right only in integral multiples of 20 Treasury Units.

Calculation of Make-Whole Shares

The number of make-whole shares applicable to a merger early settlement will be determined by reference to the table below, based on the date on which the cash merger becomes effective, which we refer to as the effective date, and the price, which we refer to as the stock price, paid per share for our common stock in such cash merger. If holders of our common stock receive only cash in such transaction, the stock price will be the cash amount paid per share. Otherwise, the stock price will be the average of the closing prices per share of our common stock on each of the 20 consecutive trading days ending on the trading day immediately preceding the effective date of such cash merger.

 

    Stock Prices
  $   $   $   $   $   $   $   $   $   $   $   $   $   $   $
                                                           

Effective Date

                             

March    , 2008

                             

May   17, 2009

                             

May   17, 2010

                             

May   17, 2011

                             

The stock prices and make-whole share amounts set forth in the table will be adjusted upon the occurrence of certain events requiring anti-dilution adjustments to the minimum settlement rate and the maximum settlement rate as set forth under “—Anti-Dilution Adjustments.”

 

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The exact stock price and effective date applicable to a cash merger may not be set forth on the table, in which case:

 

   

if the stock price is between two stock price amounts on the table or the effective date is between two dates on the table, the amount of make-whole shares will be determined by straight line interpolation between the make-whole share amounts set forth for the higher and lower stock price amounts and the two dates, as applicable, based on a 360-day year;

 

   

if the stock price is in excess of $              per share (subject to adjustment as described above), then the make-whole share amount will be zero; and

 

   

if the stock price is less than $              per share (subject to adjustment as described above), which we refer to as the minimum stock price, then the make-whole share amount will be determined as if the stock price equaled the minimum stock price, using straight line interpolation, as described above, if the effective date is between two dates on the table.

Contract Adjustment Payments

Contract adjustment payments in respect of Corporate Units and Treasury Units will be fixed at a rate per year of     % of the stated amount of $50 per purchase contract. Contract adjustment payments payable for any period will be computed on the basis of a 360-day year of twelve 30-day months. Contract adjustment payments will accrue from the date of issuance of the purchase contracts and will be payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year, commencing May 15, 2008; provided, however that the contract adjustment payment payable on May 15, 2011 will be paid on May 17, 2011 in lieu of May 15, 2011 and will include amounts accrued to, but excluding, May 17, 2011. In addition to the foregoing contract adjustment payments, under the circumstances set forth under “—Requirement for Authorized Share Condition,” contract adjustment payments will increase from     % per annum to     % per annum on the stated amount of $50 per purchase contract until, but excluding, the date on which the Authorized Share Condition is satisfied, at which time such contract adjustment payments shall return to     % per annum. We do not have the right to defer the payment of these contract adjustment payments.

Contract adjustment payments will be payable to the holders of purchase contracts as they appear on the books and records of the purchase contract agent at the close of business on the relevant record dates, which (unless otherwise specified) will be on the first day of the month in which the relevant payment date falls. These distributions will be paid through the purchase contract agent, who will hold amounts received in respect of the contract adjustment payments for the benefit of the holders of the purchase contracts relating to the Corporate Units. Subject to any applicable laws and regulations and so long as the Equity Units are in book-entry form, each such payment will be made as described under “—Book-Entry System.”

If any date on which contract adjustment payments are to be made on the purchase contracts related to the Corporate Units or Treasury Units is not a business day, then payment of the contract adjustment payments payable on that date will be made on the next succeeding day which is a business day, with the same force and effect as if made on that payment date, and no interest or payment will be paid in respect of the delay. A business day means any day other than a Saturday, Sunday or any other day on which banking institutions or trust companies in New York City are permitted or required by any applicable law to close.

Our obligations with respect to contract adjustment payments will be subordinated and junior in right of payment to our obligations under any of our senior indebtedness (as defined). See “Description of the Equity Units—Ranking.”

 

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Anti-Dilution Adjustments

The minimum settlement rate and maximum settlement rate, which we refer to collectively as the fixed settlement rates and individually as a fixed settlement rate, will be subject to the adjustments described below.

(1) Stock Dividends. If we pay or make a dividend or other distribution on our common stock in common stock, each fixed settlement rate in effect at the opening of business on the day following the date fixed for the determination of stockholders entitled to receive such dividend or other distribution shall be increased by dividing:

 

   

each fixed settlement rate by

 

   

a fraction of which the numerator shall be the number of shares of our common stock outstanding at the close of business on the date fixed for such determination and the denominator shall be the sum of such number of shares and the total number of shares constituting such dividend or other distribution.

If any dividend or distribution described in this paragraph (1) is declared but not so paid or made, the new fixed settlement rate shall be readjusted to the fixed settlement rate that would then be in effect if such dividend or distribution had not been declared.

(2) Stock Purchase Rights. If we issue to all or substantially all holders of our common stock rights, options, warrants or other securities entitling them to subscribe for or purchase shares of our common stock for a period expiring within 60 days from the date of issuance of such rights, options, warrants or other securities at a price per share of our common stock less than the current market price on the date fixed for the determination of stockholders entitled to receive such rights, options, warrants or securities (other than pursuant to a dividend reinvestment, share purchase or similar plan), each fixed settlement rate in effect at the opening of business on the day following the date fixed for such determination shall be increased by dividing:

 

   

each fixed settlement rate by

 

   

a fraction, the numerator of which shall be the number of shares of our common stock outstanding at the close of business on the date fixed for such determination plus the number of shares of our common stock which the aggregate consideration expected to be received by us upon the exercise, conversion or exchange of such rights, options, warrants or securities would purchase at such current market price and the denominator of which shall be the number of shares of our common stock outstanding at the close of business on the date fixed for such determination and the number of shares of our common stock so offered for subscription or purchase, either directly or indirectly.

If any right, option, warrant or other security described in this paragraph (2) is not exercised or converted prior to the expiration of the exercisability or convertibility thereof, the new fixed settlement rate shall be readjusted to the fixed settlement rate that would then be in effect if such right, option, warrant or other security had not been so issued.

(3) Stock Splits; Reverse Splits; and Combinations. If outstanding shares of our common stock shall be subdivided, split or reclassified into a greater number of shares of common stock, each fixed settlement rate in effect at the opening of business on the day following the day upon which such subdivision, split or reclassification becomes effective shall be proportionately increased, and, conversely, in case outstanding shares of our common stock shall each be combined or reclassified into a smaller number of shares of common stock, each fixed settlement rate in effect at the opening of business on the day following the day upon which such combination or reclassification becomes effective shall be proportionately reduced.

(4) Debt, Asset or Security Distributions. If we, by dividend or otherwise, distribute to all or substantially all holders of our common stock evidences of our indebtedness, assets (including cash) or securities (but excluding any rights, options, warrants or other securities referred to in paragraph (2) above, any dividend or distribution paid exclusively in cash referred to in paragraph (5) below and any dividend or distribution of, shares of capital

 

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stock of any class or series, or similar equity interests, of or relating to a subsidiary or other business unit in the case of a spin-off referred to below, or dividend or distribution referred to in paragraph (1) above), each fixed settlement rate in effect immediately prior to the close of business on the date fixed for the determination of stockholders entitled to receive such distribution shall be increased by dividing:

 

   

each fixed settlement rate by

 

   

a fraction, the numerator of which shall be the current market price (as defined below) of our common stock on the date fixed for such determination less the then fair market value (as determined in good faith by our board of directors, whose determination shall be conclusive and described in a board resolution) of the portion of the assets, securities or evidences of indebtedness so distributed applicable to one share of our common stock and the denominator of which shall be such current market price of our common stock.

In the case of the payment of a dividend or other distribution on our common stock of shares of capital stock of any class or series, or similar equity interests, of or relating to a subsidiary or other business unit of ours, which we refer to as a “spin-off,” the fixed settlement rate in effect immediately before the close of business on the record date fixed for determination of stockholders entitled to receive that dividend or distribution will be increased by dividing:

 

   

each fixed settlement rate by

 

   

a fraction, the numerator of which is the current market price of our common stock and the denominator of which is such current market price plus the fair market value, determined as described below, of those shares of capital stock or similar equity interests so distributed applicable to one share of common stock.

The adjustment to the fixed settlement rate under the preceding paragraph will occur on the date that is the earlier of:

 

   

the 10th trading day from and including the effective date of the spin-off; and

 

   

the date of the securities being offered in the initial public offering of the spin-off, if that initial public offering is effected simultaneously with the spin-off.

For purposes of this section, “initial public offering” means the first time securities of the same class or type as the securities being distributed in the spin-off are offered to the public for cash.

In the event of a spin-off that is not effected simultaneously with an initial public offering of the securities being distributed in the spin-off, the fair market value of the securities to be distributed to holders of our common stock means the average of the closing sale prices of those securities over the first 10 trading days following the effective date of the spin-off. Also, for purposes of such a spin-off, the current market price of our common stock means the average of the closing sale prices of our common stock over the first 10 trading days following the effective date of the spin-off.

If, however, an initial public offering of the securities being distributed in the spin-off is to be effected simultaneously with the spin-off, the fair market value of the securities being distributed in the spin-off means the initial public offering price, while the current market price of our common stock means the closing sale price of our common stock on the trading day on which the initial public offering price of the securities being distributed in the spin-off is determined.

If any dividend or distribution described in this paragraph (4) is declared but not so paid or made, the new fixed settlement rate shall be readjusted to the fixed settlement rate that would then be in effect if such dividend or distribution had not been declared.

 

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(5) Cash Distributions. If we, by dividend or otherwise, make distributions to all or substantially all holders of our common stock exclusively in cash during any quarterly period (excluding any cash that is distributed in a reorganization event to which the provisions described below under “—Reorganization Event” apply or as part of a distribution referred to in paragraph (4) above) in an amount that exceeds $0.01 per share per quarter of our common stock, which per share amount we refer to as the reference dividend, immediately after the close of business on the date fixed for determination of the stockholders entitled to receive such distribution, each fixed settlement rate shall be increased by dividing:

 

   

each fixed settlement rate by

 

   

a fraction, the numerator of which shall be equal to the current market price on the date fixed for such determination less the per share amount of the distribution and the denominator of which shall be equal to such current market price minus the reference dividend.

The reference dividend shall be subject to adjustment on account of the event set forth in paragraphs (1), (2), (3), (4) and (6). Any such adjustment shall be effected by multiplying the reference dividend by a fraction, the numerator of which will equal the fixed settlement rate in effect immediately prior to the adjustment on account of such events and the denominator of which will equal the fixed settlement rate as adjusted.

If any dividend or distribution described in this paragraph (5) is declared but not so paid or made, the new fixed settlement rate shall be readjusted to the fixed settlement rate that would then be in effect if such dividend or distribution had not been declared.

(6) Tender and Exchange Offers. In the case that a tender offer or exchange offer made by us or any subsidiary for all or any portion of our common stock shall expire and such tender or exchange offer (as amended through the expiration thereof) shall require the payment to stockholders (based on the acceptance (up to any maximum specified in the terms of the tender offer or exchange offer) of purchased shares) of an aggregate consideration having a fair market value per share of our common stock that exceeds the closing price of our common stock on the trading day next succeeding the last date on which tenders or exchanges may be made pursuant to such tender offer or exchange offer, then, immediately prior to the opening of business on the day after the date of the last time, which we refer to as the expiration time, tenders or exchanges could have been made pursuant to such tender offer or exchange offer (as amended through the expiration thereof), each fixed settlement rate shall be increased by dividing:

 

   

each fixed settlement rate immediately prior to the close of business on the date of the expiration time by

 

   

a fraction (A) the numerator of which shall be equal to (x) the product of (I) the current market price on the date of the expiration time and (II) the number of shares of common stock outstanding (including any tendered or exchanged shares) on the date of the expiration time less (y) the amount of cash plus the fair market value of the aggregate consideration payable to stockholders pursuant to the tender offer or exchange offer (assuming the acceptance, up to any maximum specified in the terms of the tender offer or exchange offer, of purchased shares), and (B) the denominator of which shall be equal to the product of (x) the current market price on the date of the expiration time and (y) the result of (I) the number of shares of our common stock outstanding (including any tendered or exchanged shares) on the date of the expiration time less (II) the number of all shares validly tendered, not withdrawn and accepted for payment on the date of the expiration time (such validly tendered or exchanged shares, up to any such maximum, we refer to as the purchased shares).

The “current market price” per share of our common stock or any other security on any day means the average of the daily closing sale prices for the 20 consecutive trading days preceding the earlier of the day preceding the day in question and the day before the “ex date” with respect to the issuance or distribution requiring such computation. For purposes of this paragraph, the term “ex date,” when used with respect to any issuance or distribution, means the first date on which our common stock or such other security, as applicable, trades, regular way, on the principal

 

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U.S. securities exchange or quotation system on which our common stock or such other security, as applicable, is listed or quoted at that time, without the right to receive the issuance or distribution.

Reorganization Events

The following events, in each case as a result of which holders of our common stock are entitled to receive stock, other securities, other property or assets (including cash or any combination thereof) with respect to or in exchange for our common stock, are defined as “reorganization events”:

 

   

any consolidation or merger of Ambac Financial Group, Inc. with or into another person or of another person with or into Ambac Financial Group, Inc. (other than a consolidation or merger in which Ambac Financial Group, Inc. is the continuing corporation and in which its shares of common stock outstanding immediately prior to the consolidation or merger are not exchanged for cash, securities or other property of Ambac Financial Group, Inc. or another person); or

 

   

any sale, transfer, lease or conveyance to another person of all or substantially all of the assets of Ambac Financial Group, Inc.; or

 

   

any statutory share exchange of Ambac Financial Group, Inc. with another person (other than in connection with a merger or acquisition); or

 

   

any liquidation, dissolution or termination of Ambac Financial Group, Inc. (other than as a result of or after the occurrence of a termination event (as defined below under “—Termination”)).

The foregoing paragraph includes a phrase relating to a sale of all or substantially all of our assets. There is no precise, established definition of the phrase “substantially all” under applicable law. Accordingly, your right to accelerate and settle such contract early as a result of a sale of substantially all of our assets may be uncertain.

Following the effective date of a reorganization event, the settlement rate relating to the Equity Units shall thereafter be determined by reference to, and settled in lieu of the applicable number of shares of our common stock through the delivery of a corresponding number of, exchange property units. An “exchange property unit” means the kind and amount of securities, cash and other property receivable in such reorganization event (without any interest thereon, and without any right to dividends or distribution thereon which have a record date that is prior to the applicable settlement date) per share of our common stock by a holder of common stock that is not a person with which we are consolidated or into which we are merged or which merged into us or to which such sale, transfer, lease or conveyance was made, or with whom shares were exchanged pursuant to any such statutory share exchange, as the case may be, which person we refer to as a constituent person, or an affiliate of a constituent person, to the extent such reorganization event provides for different treatment of common stock held by our affiliates and non-affiliates. In the event holders of our common stock have the opportunity to elect the form of consideration to be received in such transaction, the exchange property unit that holders of the Corporate Units or Treasury Units will be entitled to receive will be deemed to be the weighted average of the types and amounts of consideration received by the holders of our common stock that affirmatively make an election.

In the event of such a reorganization event, the person formed by such consolidation or merger or the person to whom such sale, transfer, lease or conveyance was made or with whom such statutory share exchange was made shall execute and deliver to the purchase contract agent an agreement, providing that the holder of each Equity Unit that remains outstanding after the reorganization event, if any, shall have the rights described in the preceding paragraph. Such supplemental agreement shall provide for adjustments to the amount of any securities constituting all or a portion of an exchange property unit which, for events subsequent to the effective date of such reorganization event, shall be as nearly equivalent as may be practicable to the adjustments provided for in this “—Anti-Dilution Adjustments” section. The provisions described in the preceding two paragraphs shall similarly apply to successive reorganization events.

Holders have the right to settle their obligations under the Equity Units early in the event of certain cash mergers as described above under “—Early Settlement Upon Cash Merger.”

 

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You may be treated as receiving a constructive distribution from us with respect to the purchase contract if (1) the settlement rate is adjusted (or fails to be adjusted) and, as a result of the adjustment (or failure to adjust), your proportionate interest in our assets or earnings and profits is increased, and (2) the adjustment (or failure to adjust) is not made pursuant to a bona fide, reasonable anti-dilution formula. Thus, under certain circumstances, an increase in (or a failure to decrease) the settlement rate might give rise to a taxable dividend to you even though you will not receive any cash in connection with the increase in (or failure to decrease) the settlement rate. In addition, non-U.S. holders of Equity Units may, in certain circumstances, be deemed to have received a distribution subject to U.S. federal withholding tax. See “Certain United States Federal Income Tax Consequences—U.S. Holders—Purchase Contracts—Adjustment to the Settlement Rate” and “—Non-U.S. Holders.”

In addition, we may increase the settlement rate if our board of directors deems it advisable to avoid or diminish any income tax to holders of our common stock resulting from any dividend or distribution of shares (or rights to acquire shares) or from any event treated as a dividend or distribution for income tax purposes or for any other reasons.

Adjustments to the settlement rate will be calculated to the nearest 1/10,000th of a share. No adjustment in the settlement rate will be required unless the adjustment would require an increase or decrease of at least one percent in the settlement rate. If any adjustment is not required to be made because it would not change the settlement rate by at least one percent, then the adjustment will be carried forward and taken into account in any subsequent adjustment, provided that effect shall be given to all anti-dilution adjustments not later than the applicable settlement date for an Equity Unit.

No adjustment to the settlement rate need be made if holders of Equity Units may participate in the transaction that would otherwise give rise to an adjustment, so long as the distributed assets or securities the holders would receive upon settlement of the Equity Units, if convertible, exchangeable, or exercisable, are convertible, exchangeable or exercisable, as applicable, without any loss of rights or privileges for a period of at least 60 days following settlement of the Equity Units.

The fixed settlement rates will not be adjusted:

 

   

upon the issuance of any shares of our common stock pursuant to any present or future plan providing for the reinvestment of dividends or interest payable on our securities and the investment of additional optional amounts in shares of our common stock under any plan;

 

   

upon the issuance of any shares of our common stock or options or rights to purchase those shares pursuant to any present or future employee, director or consultant benefit plan or program of or assumed by us or any of our subsidiaries;

 

   

upon the issuance of any shares of our common stock pursuant to any option, warrant, right or exercisable, exchangeable or convertible security outstanding as of the date the Equity Units were first issued;

 

   

for a change in the par value or no par value of the common stock; or

 

   

for accumulated and unpaid dividends.

We will be required, as soon as practicable after the fixed settlement rates are adjusted, to provide written notice of the adjustment to the holders of Equity Units.

If an adjustment is made to the fixed settlement rates, a proportional adjustment also will be made to the applicable market value solely to determine which of the clauses of the definition of settlement rate will be applicable on the purchase contract settlement date or any cash merger early settlement date.

 

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In the event that we adopt a shareholder rights plan, holders will receive upon settlement of the Equity Units into shares of common stock, in addition to the shares, the rights under the rights plan, unless prior to any settlement, the shareholder rights plan expires or terminates or the rights have separated from the shares of common stock, in which case the settlement rate will be adjusted at the time of separation as if we distributed, to all holders of our common stock, shares of our common stock, evidences of debt or other assets issuable upon exercise of the rights as described above, subject to readjustment in the event of the expiration, termination or redemption of such rights. A distribution of rights pursuant to such a shareholder rights plan will not trigger a settlement rate adjustment pursuant to paragraphs (2) or (4) above. We currently do not have a shareholder rights plan. In addition, if we become the subject of a case under the U.S. Bankruptcy Code, the foregoing will be subject to the equitable powers of the bankruptcy court under Section 105(a) of the Bankruptcy Code.

Termination

The purchase contracts, and our rights and obligations and the rights and obligations of the holders of the Corporate Units and Treasury Units under the purchase contracts, including the right and obligation to purchase shares of common stock and the right to receive accrued contract adjustment payments, will immediately and automatically terminate, without any further action, upon the termination of the purchase contracts as a result of our bankruptcy, insolvency or reorganization, which we refer to as a termination event. In the event of such a termination of the purchase contracts as a result of our bankruptcy, insolvency or reorganization, holders of the purchase contracts will not have a claim in bankruptcy under the purchase contract with respect to our issuance of shares of common stock or the right to receive contract adjustment payments.

Upon any termination, the collateral agent will release the related interests in the senior notes, the applicable ownership interest of the Treasury portfolio, the Treasury securities or new treasury securities, as the case may be, held by it to the purchase contract agent for distribution to the holders of Equity Units, subject, in the case of the applicable ownership interest in the Treasury portfolio, the Treasury securities or new treasury securities, to the purchase contract agent’s disposition of the subject securities for cash, and the payment of this cash to the holders, to the extent that the holders would otherwise have been entitled to receive less than $1,000 principal amount at maturity of any such security. Upon any termination, however, the release and distribution may be subject to a delay. In the event that we become the subject of a case under the U.S. Bankruptcy Code, the delay may occur as a result of the imposition of the automatic stay under the Bankruptcy Code or the exercise of the bankruptcy court’s power under Section 105(a) of the Bankruptcy Code. In addition, if we become the subject of a case under the U.S. Bankruptcy Code, the foregoing will be subject to the equitable jurisdiction and powers of the bankruptcy court.

If the holder’s purchase contract is terminated as a result of our bankruptcy, insolvency or reorganization, such holder will have no right to receive any accrued contract adjustment payments.

Pledged Securities and Pledge Agreement

Pledged securities will be pledged to us through the collateral agent, for our benefit, pursuant to the pledge agreement to secure the obligations of holders of Corporate Units and Treasury Units to purchase shares of common stock under the related purchase contracts. The rights of holders of Corporate Units and Treasury Units to the related pledged securities will be subject to our security interest created by the pledge agreement.

No holder of Corporate Units or Treasury Units will be permitted to withdraw the pledged securities related to the Corporate Units or Treasury Units from the pledge arrangement except:

 

   

to substitute Treasury securities or new treasury securities, for the related senior notes or the applicable ownership interest in the Treasury portfolio, as the case may be, as provided for under “Description of the Equity Units—Creating Treasury Units,”

 

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to substitute senior notes or the applicable ownership interest of the Treasury portfolio, as the case may be, for the related Treasury securities or new treasury securities, as provided for under “Description of the Equity Units—Recreating Corporate Units,” or

 

   

upon the termination or early settlement of the related purchase contracts.

Subject to the security interest and the terms of the purchase contract agreement and the pledge agreement, each holder of Corporate Units, unless the Treasury portfolio has replaced the senior notes as a component of Corporate Units, will be entitled through the purchase contract agent and the collateral agent to all of the proportional rights of a holder of the related senior notes, including voting and redemption rights. Each holder of Treasury Units and each holder of Corporate Units, if the Treasury portfolio has replaced the senior notes as a component of Corporate Units, will retain beneficial ownership of the related Treasury securities or new treasury securities, or the applicable ownership interest of the Treasury portfolio, as applicable, pledged in respect of the related purchase contracts. We will have no interest in the pledged securities other than our security interest.

Except as described in “Certain Provisions of the Purchase Contracts, Purchase Contract Agreement and the Pledge Agreement—General,” the collateral agent will, upon receipt of payments, if any, on the pledged securities, distribute the payments to the purchase contract agent, which will in turn distribute those payments, together with contract adjustment payments received from us, to the persons in whose names the related Corporate Units or Treasury Units are registered at the close of business on the record date immediately preceding the date of payment.

Book-Entry System

The Depository Trust Company, or DTC, which we refer to along with its successors in this capacity as the depositary, will act as securities depositary for the Corporate Units and Treasury Units. The Corporate Units and Treasury Units will be issued only as fully registered securities and, except in the limited circumstances described below, will be issued in the form of global certificates registered in the name of Cede & Co., the depositary’s nominee. One or more fully registered global security certificates, representing the total aggregate number of Corporate Units and Treasury Units, will be issued and will be deposited with the depositary or its custodian.

The laws of some jurisdictions may require that some purchasers of securities take physical delivery of securities in definitive form. These laws may impair the ability to transfer beneficial interests in the Corporate Units and Treasury Units so long as the Corporate Units and Treasury Units are represented by global security certificates.

DTC advises that it is a limited-purpose trust company organized under the New York Banking Law, a “banking organization” within the meaning of the New York Banking Law, a member of the Federal Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code and a “clearing agency” registered pursuant to the provisions of Section 17A of the Exchange Act. The depositary holds securities that its participants deposit with the depositary. The depositary also facilitates the settlement among participants of securities transactions, including transfers and pledges, in deposited securities through electronic computerized book-entry changes in participants’ accounts, thereby eliminating the need for physical movement of securities certificates. Direct participants include securities brokers and dealers, banks, trust companies, clearing corporations and certain other organizations. The depositary is owned by a number of its direct participants and by The New York Stock Exchange, Inc., the American Stock Exchange, Inc., and the Financial Industry Regulatory Authority. Access to the depositary’s system is also available to others, including securities brokers and dealers, banks and trust companies that clear transactions through or maintain a direct or indirect custodial relationship with a direct participant either directly, or indirectly. The rules applicable to the depositary and its participants are on file with the SEC.

 

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In the event that

 

   

the depositary notifies us that it is unwilling or unable to continue as a depositary for the global security certificates and no successor depositary has been appointed within 90 days after this notice,

 

   

the depositary at any time ceases to be a clearing agency registered under the Exchange Act when the depositary is required to be so registered to act as the depositary and no successor depositary has been appointed within 90 days after we learn that the depositary has ceased to be so registered,

 

   

to the extent permitted by the depositary, we, in our sole discretion, determine that the global security certificates shall be so exchangeable, or

 

   

there shall have occurred and be continuing an event of default with respect to the senior notes.

certificates for the Corporate Units or Treasury Units will be printed and delivered in exchange for beneficial interests in the global security certificates. Any global Corporate Unit or Treasury Unit, or portion thereof, that is exchangeable pursuant to the preceding sentence will be exchangeable for Corporate Unit or Treasury Unit certificates, as the case may be, registered in the names directed by the depositary. We expect that these instructions will be based upon directions received by the depositary from its participants with respect to ownership of beneficial interests in the global security certificates.

As long as the depositary or its nominee is the registered owner of the global security certificates, the depositary or its nominee, as the case may be, will be considered the sole owner and holder of the global security certificates and all Corporate Units and Treasury Units represented by these certificates and all purchase contracts and senior notes that are components thereof for all purposes under the Corporate Units, Treasury Units and the purchase contract agreement, pledge agreement, indenture and supplemental indenture No. 1. Except in the limited circumstances referred to above, owners of beneficial interests in global security certificates:

 

   

will not be entitled to have the Corporate Units or the Treasury Units represented by these global security certificates registered in their names,

 

   

will not receive or be entitled to receive physical delivery of Corporate Unit or Treasury Unit certificates in exchange for beneficial interests in global security certificates, and

 

   

will not be considered to be holders of the global security certificates or any Corporate Units or Treasury Units represented by these certificates or any purchase contracts and notes that are components thereof for any purpose under the Corporate Units, Treasury Units or the purchase contract agreement, pledge agreement, indenture and supplemental indenture No. 1.

All payments on the Corporate Units and Treasury Units represented by the global security certificates and all transfers and deliveries of related senior notes, Treasury securities, new treasury securities, applicable ownership interest in the Treasury portfolio and common stock will be made to the depositary or its nominee, as the case may be, as the holder of the securities.

Ownership of beneficial interests in the global security certificates will be limited to participants or persons that hold beneficial interests through participants that have accounts with the depositary or its nominee. Ownership of beneficial interests in global security certificates will be shown only on, and the transfer of those ownership interests will be effected only through, records maintained by the depositary or its nominee, with respect to participants’ interests, or any participant, with respect to interests of persons held through the participant. Procedures for settlement of purchase contracts on the purchase contract settlement date or upon early settlement will be governed by arrangements among the depositary, participants and persons that may hold beneficial interests through participants designed to permit settlement without the physical movement of certificates. Payments, transfers, deliveries, exchanges and other matters relating to beneficial interests in global security certificates may be subject to various policies and procedures adopted by the depositary from time to time. None of us, the purchase contract agent or any agent of us or the purchase contract agent will have any

 

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responsibility or liability for any aspect of the depositary’s or any participant’s records relating to, or for payments made on account of, beneficial interests in global security certificates, or for maintaining, supervising or reviewing any of the depositary’s records or any participant’s records relating to these beneficial ownership interests or for the performance by the depositary or its direct participants or indirect participants under the rules and procedures governing the depositary.

Although the depositary has agreed to the foregoing procedures in order to facilitate transfers of interests in the global security certificates among participants, the depositary is under no obligation to perform or continue to perform these procedures, and these procedures may be discontinued at any time.

The information in this section concerning the depositary and its book-entry system has been obtained from sources that we believe to be reliable, but we have not attempted to verify the accuracy of this information.

 

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CERTAIN PROVISIONS OF THE PURCHASE CONTRACT

AGREEMENT AND THE PLEDGE AGREEMENT

This summary summarizes some of the other provisions of the purchase contract agreement and the pledge agreement. This summary does not purport to be complete and should be read together with, and is qualified in its entirety by reference to, the purchase contract agreement and pledge agreement, forms of which have been or will be filed and incorporated by reference as exhibits to the registration statement of which this prospectus supplement and the accompanying prospectus form a part.

As used under this caption, “Certain Provisions of the Purchase Contract Agreement and the Pledge Agreement”, references to “we,” “us,” “our” and other similar references mean Ambac Financial Group, Inc., excluding, unless otherwise expressly stated or the context otherwise requires, its subsidiaries.

General

Except as described in “Description of the Purchase Contracts—Book-Entry System,” payments on the Equity Units will be made, purchase contracts (and documents relating to the Corporate Units, Treasury Units and purchase contracts) will be settled, and transfers of the Corporate Units and Treasury Units will be registrable, at the office of the purchase contract agent in the Borough of Manhattan, New York City. In addition, if the Corporate Units and Treasury Units do not remain in book-entry form, payment on the Equity Units may be made, at our option, by check mailed to the address of the holder entitled to payment as shown on the security register or by a wire transfer to the account designated by the holder by a prior written notice.

Shares of common stock will be delivered on the purchase contract settlement date (or earlier upon early settlement), or, if the purchase contracts have terminated, the related pledged securities will be delivered (potentially after a delay as a result of the imposition of the automatic stay under the Bankruptcy Code or the exercise of the bankruptcy court’s power under Section 105(a) of the Bankruptcy Code, see “Description of the Purchase Contracts—Termination”) at the office of the purchase contract agent upon presentation and surrender of the applicable Equity Units (including by book-entry transfer).

If you fail to present and surrender (including by book-entry transfer) the Corporate Units or Treasury Units to the purchase contract agent on or prior to the purchase contract settlement date, the shares of common stock issuable upon settlement of the related purchase contract will be registered in the name of the purchase contract agent. The shares, together with any distributions, will be held by the purchase contract agent as agent for your benefit until the Equity Units are presented and surrendered or you provide satisfactory evidence that the applicable certificate has been destroyed, lost or stolen, together with any indemnity that may be required by the purchase contract agent and us.

If the purchase contracts terminate prior to the purchase contract settlement date, the related pledged securities are transferred to the purchase contract agent for distribution to the holders, and if a holder fails to present and surrender (including by book-entry transfer) the holder’s Corporate Units or Treasury Units to the purchase contract agent, the related pledged securities delivered to the purchase contract agent and payments on the pledged securities will be held by the purchase contract agent as agent for the benefit of the holder until the applicable Equity Units are presented or the holder provides the evidence and indemnity described above.

The purchase contract agent will have no obligation to invest or to pay interest on any amounts held by the purchase contract agent pending payment to any holder.

No service charge will be made for any registration of transfer or exchange of the Corporate Units or Treasury Units, except for any tax or other governmental charge that may be imposed in connection with a transfer or exchange.

 

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Modification

The purchase contract agreement and the pledge agreement will contain provisions permitting us and the purchase contract agent, and in the case of the pledge agreement, the collateral agent, to modify the purchase contracts, the purchase contract agreement or the pledge agreement without the consent of the holders for any of the following purposes:

 

   

to evidence the succession of another person to our obligations;

 

   

to add to the covenants for the benefit of holders or to surrender any of our rights or powers under those agreements;

 

   

to evidence and provide for the acceptance of appointment of a successor purchase contract agent or a successor collateral agent or securities intermediary;

 

   

to make provision with respect to the rights of holders pursuant to the requirements applicable to reorganization events;

 

   

to cure any ambiguity or to correct or supplement any provisions that may be inconsistent; and

 

   

to make any other provisions that do not materially adversely affect the interests of the holders.

The purchase contract agreement and the pledge agreement will contain provisions permitting us and the purchase contract agent, and in the case of the pledge agreement, the collateral agent, with the consent of the holders of not less than a majority of the purchase contracts at the time outstanding to modify the terms of the purchase contracts, the purchase contract agreement or the pledge agreement. However, no such modification may, without the consent of the holder of each outstanding purchase contract affected by the modification,

 

   

change any payment date,

 

   

change the amount or type of pledged securities related to the purchase contract, impair the right of the holder of any pledged securities to receive distributions on the pledged securities or otherwise adversely affect the holder’s rights in or to the pledged securities,

 

   

change the place or currency of payment of or reduce any contract adjustment payments,

 

   

impair the right to institute suit for the enforcement of the purchase contract or payment of any contract adjustment payments,

 

   

reduce the number of shares of common stock or the amount of any other property or securities purchasable under the purchase contract, increase the price to purchase shares of common stock or any other property or securities upon settlement of the purchase contract, change the purchase contract settlement date or the right to early settlement or cash merger early settlement or otherwise adversely affect the holder’s rights under the purchase contract, or

 

   

reduce the above-stated percentage of outstanding purchase contracts the consent of the holders of which is required for the modification or amendment of the provisions of the purchase contracts, the purchase contract agreement or the pledge agreement.

If any amendment or proposal referred to in the second preceding paragraph would adversely affect only the Corporate Units or the Treasury Units, then only the affected class of holders will be entitled to vote on the amendment or proposal, and the amendment or proposal will not be effective except with the consent of the holders of not less than a majority of the affected class or of all of the holders of the affected classes, as applicable.

No Consent to Assumption

Each holder of Corporate Units or Treasury Units, by acceptance of these securities, will under the terms of the purchase contract agreement and the Corporate Units or Treasury Units, as applicable, be deemed expressly

 

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to have withheld any consent to the assumption (i.e., affirmance) of the related purchase contracts by us or our trustee if we become the subject of a case under the U.S. Bankruptcy Code or other similar state or federal law provision for reorganization or liquidation.

Consolidation, Merger, Sale or Conveyance

We will covenant in the purchase contract agreement that we will not consolidate or merge with any other person or convey, transfer or lease our properties and assets as an entirety or substantially as an entirety to another person, unless (1) the successor or transferee is a person organized and existing under the laws of the United States of America, a U.S. state or the District of Columbia and that successor or transferee expressly assumes our obligations under the purchase contracts, the purchase contract agreement, the pledge agreement, the indenture and supplemental indenture No. 1 thereto, the senior notes and the remarketing agreement and (2) the successor or transferee is not, immediately after the transaction, in default of its payment obligations under the purchase contracts, the purchase contract agreement, the pledge agreement, the indenture and supplemental indenture No. 1 thereto, the senior notes or the remarketing agreement or in material default in the performance of any other covenants under these agreements.

Title

We, the purchase contract agent and the collateral agent may treat the registered owner of any Corporate Units or Treasury Units as the absolute owner of the Corporate Units or Treasury Units for the purpose of making payment and settling the related purchase contracts and for all other purposes.

Replacement of Equity Unit Certificates

Any mutilated Corporate Unit or Treasury Unit certificate will be replaced by us at the expense of the holder upon surrender of the certificate to the purchase contract agent. Corporate Unit or Treasury Unit certificates that become destroyed, lost or stolen will be replaced by us at the expense of the holder upon delivery to us and the purchase contract agent of evidence of their destruction, loss or theft satisfactory to us and the purchase contract agent. In the case of a destroyed, lost or stolen Corporate Unit or Treasury Unit certificate, an indemnity satisfactory to the purchase contract agent and us may be required at the expense of the holder of the Corporate Units or Treasury Units evidenced by the certificate before a replacement will be issued.

Notwithstanding the foregoing, we will not be obligated to issue any Corporate Unit or Treasury Unit certificates on or after the business day immediately preceding the purchase contract settlement date (or after early settlement) or after the purchase contracts have terminated. The purchase contract agreement will provide that, in lieu of the delivery of a replacement Corporate Unit or Treasury Unit certificate following the purchase contract settlement date (or early settlement), the purchase contract agent, upon delivery of the evidence and indemnity described above, will deliver the shares of common stock issuable pursuant to the purchase contracts included in the Corporate Units or Treasury Units evidenced by the certificate, or, if the purchase contracts have terminated prior to the purchase contract settlement date, transfer the pledged securities included in the Corporate Units or Treasury Units evidenced by the certificate.

Governing Law

The purchase contract agreement, the pledge agreement and the purchase contracts will be governed by, and construed in accordance with, the laws of the State of New York, without regard to the conflicts of law provisions thereof.

Information Concerning the Purchase Contract Agent

The Bank of New York will be the purchase contract agent. The purchase contract agent will act as the agent for the holders of Corporate Units and Treasury Units from time to time. The purchase contract agreement

 

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will not obligate the purchase contract agent to exercise any discretionary actions in connection with a default under the terms of the Corporate Units and Treasury Units or the purchase contract agreement. In addition, The Bank of New York is the trustee under the indenture and will be the principal paying agent and registrar for the senior notes and an affiliate of The Bank of New York will act as a co-managing underwriter in the offering of Equity Units contemplated hereby as well as a co-managing underwriter in the concurrent Common Stock Offering. In both of these offerings, an affiliate of The Bank of New York will receive customary underwriting commissions and discounts. See “Description of the Equity Units” in this prospectus supplement and “Description of Debt Securities—Our Relationship with the Trustee” in the accompanying prospectus. We have entered, and from time to time may continue to enter, into banking or other relationships with The Bank of New York or its affiliates.

The purchase contract agreement will contain provisions limiting the liability of the purchase contract agent. The purchase contract agreement will contain provisions under which the purchase contract agent may resign or be replaced. This resignation or replacement would be effective upon the acceptance of appointment by a successor.

The Bank of New York will also act as collateral agent, custodial agent and securities intermediary in connection with the Equity Units.

Information Concerning the Collateral Agent

The Bank of New York will be the collateral agent. The collateral agent will act solely as our agent and will not assume any obligation or relationship of agency or trust for or with any of the holders of the Corporate Units or Treasury Units except for the obligations owed by a pledgee of property to the owner of the property under the pledge agreement and applicable law.

The pledge agreement will contain provisions limiting the liability of the collateral agent. The pledge agreement will contain provisions under which the collateral agent may resign or be replaced. This resignation or replacement would be effective upon the acceptance of appointment by a successor.

The Bank of New York is serving as both the collateral agent and the purchase contract agent. If an event of default, except an event of default occurring as a result of a failed remarketing, occurs under the purchase contract agreement or the pledge agreement, The Bank of New York will resign as the collateral agent, but remain as the purchase contract agent. We will then select a new collateral agent in accordance with the terms of the pledge agreement.

For information about our relationship with The Bank of New York, see “Description of our Senior Notes—About the Trustee.”

Miscellaneous

The purchase contract agreement will provide that we will pay all fees and expenses other than underwriters’ expenses (including counsel) related to the offering of the Corporate Units, the retention of the collateral agent and the retention of the purchase contract agent.

Should you elect to substitute the related pledged securities to create Treasury Units or recreate Corporate Units, you shall be responsible for any fees or expenses payable in connection with that substitution, as well as any commissions, fees or other expenses incurred in acquiring the pledged securities to be substituted, and we shall not be responsible for any of those fees or expenses.

 

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DESCRIPTION OF OUR SENIOR NOTES

The following description is a summary of some of the terms of our senior notes, the indenture and supplemental indenture No. 1. The descriptions in this prospectus supplement and the accompanying prospectus of the senior notes, the indenture and the supplemental indenture No. 1 do not purport to be complete and are subject to, qualified in their entirety by reference to, and should be read in conjunction with, the forms of senior notes, the indenture and supplemental indenture No. 1 which are or will be filed or incorporated by reference as exhibits to the registration statement of which this prospectus supplement and the accompanying prospectus are a part and to the Trust Indenture Act. This summary supplements the description of the senior debt securities and indenture in the accompanying prospectus and, to the extent it is inconsistent, replaces the description in the accompanying prospectus.

As used under this caption, “Description of our Senior Notes,” all references to “we,” “us,” “our” and other similar references mean Ambac Financial Group, Inc. excluding, unless otherwise expressly stated or the context otherwise requires, its subsidiaries.

General

The senior notes will be issued under an indenture dated as of February 15, 2006 between us and The Bank of New York, as indenture trustee, as amended and supplemented by supplemental indenture No. 1, to be dated as of March     , 2008 between us and the indenture trustee (as so amended and supplemented, the “indenture”).

The senior notes initially will be issued in an aggregate principal amount of $            . If the over-allotment option is exercised in full by the underwriters an additional $             aggregate principal amount of the senior notes will be issued.

We are a holding company that derives all our income from our subsidiaries. Accordingly, our ability to service our debt, including our obligations under the senior notes, and other obligations are primarily dependent on the earnings of our respective subsidiaries and the payment of those earnings to us, in the form of dividends, loans or advances and through repayment of loans or advances from us. In addition, any payment of dividends, loans or advances by those subsidiaries could be subject to statutory or contractual restrictions. Our subsidiaries have no obligation to pay any amounts due on the senior notes.

Each Corporate Unit includes a  1/20, or 5%, undivided beneficial ownership interest in a $1,000 principal amount senior note that corresponds to the stated amount of $50 per Corporate Unit.

The indenture trustee will initially be the security registrar and the paying agent for the senior notes. Senior notes forming a part of the Corporate Units will be issued in fully registered certificated form, without coupons, will be in denominations of $1,000 and integral multiples of $1,000.

The senior notes may be transferred or exchanged, without service charge but upon payment of any taxes or other governmental charges payable in connection with the transfer or exchange, at the office described below. Payments on senior notes issued as a global security will be made to the depositary or a successor depositary. Principal and interest with respect to certificated notes will be payable, the transfer of the senior notes will be registrable and senior notes will be exchangeable for notes of a like aggregate principal amount in denominations of $1,000 and integral multiples of $1,000, at the office or agency maintained by us for this purpose in New York City. We have initially designated the corporate trust office of the indenture trustee as that office. However, at our option, payment of interest may be made by check mailed to the address of the holder entitled to payment or by wire transfer to an account appropriately designated by the holder entitled to payment.

The senior notes will not be subject to a sinking fund provision. The entire principal amount of the senior notes will mature and initially become due and payable, together with any accrued and unpaid interest thereon,

 

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on February 15, 2021, which maturity date may be modified to an earlier date in connection with a successful remarketing. As described below under “—Put Option Upon Failed Final Remarketing,” holders will have the right to require us to purchase their senior notes under certain circumstances.

The indenture will not contain any financial covenants or any restrictions on the payment of dividends, the making of investments, the incurrence of indebtedness, redemption or repurchase of securities by us.

The indenture does not contain provisions that afford holders of the senior notes protection in the event we are involved in a highly leveraged transaction or other similar transaction that may adversely affect such holders. The indenture does not limit our ability to issue or incur other unsecured debt or issue preferred stock.

Ranking

The senior notes will be our unsecured, unsubordinated obligations. The senior notes will rank equally in right of payment with our existing and future unsecured and unsubordinated indebtedness and senior in right of payment to any of our existing and future subordinated indebtedness. Additionally, the senior notes will be effectively subordinated to all existing and future preferred stock and indebtedness, guarantees and other liabilities of our subsidiaries. See “Risk Factors—The senior notes and the contract adjustment payments are effectively subordinated to any existing or future preferred stock and indebtedness or other liabilities of our subsidiaries, and the contract adjustment payments are subordinated to our existing and future senior indebtedness” and “—Our holding company structure and certain regulatory and other constraints could affect our ability to pay dividends and make other payments”.

Interest

Each senior note will bear interest initially at the rate of     % per annum, from the issuance date, payable quarterly in arrears on February 15, May 15, August 15 and November 15 of each year, commencing May 15, 2008, to the person in whose name the senior note is registered at the close of business on the first day of the month in which the interest payment date falls (unless otherwise specified).

Following a successful remarketing, each senior note will bear interest at the reset rate and be payable on a semi-annual basis.

The applicable interest rate on the senior notes may be reset to the reset rate upon successful remarketing as described above under “Description of the Purchase Contracts—Remarketing and below under “—Market Reset Rate.” The reset rate will become effective on the reset effective date, which will be the remarketing settlement date if the senior notes are successfully remarketed. If the senior notes are not successfully remarketed, the interest rate on the senior notes will not be reset.

The amount of interest payable on the senior notes for any period will be computed (1) for any full quarterly or semi-annual period on the basis of a 360-day year of twelve 30-day months and (2) for any period shorter than a full quarterly or semi-annual period, on the basis of a 30-day month and, for any period less than a month, on the basis of the actual number of days elapsed per 30-day month. In the event that any date on which interest is payable on the senior notes is not a business day, then payment of the interest payable on such date will be made on the next day that is a business day (and without any interest or other payment in respect of any such delay), with the same force and effect as if made on such originally scheduled date.

Market Reset Rate

The reset rate will be equal to the rate that is sufficient to allow a successful remarketing of the senior notes and will be determined by the remarketing agent, in consultation with the Company. In the case of a reset on a remarketing date, which rate would be effective on the third business day following the date of such remarketing,

 

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if successful, the reset rate will be the rate determined by the remarketing agent as the rate the senior notes should bear in order for the senior notes included in the remarketing to have an approximate aggregate market value on the remarketing date of 100% of the sum of the Treasury portfolio purchase price and the separate senior notes purchase price, described under “Description of the Purchase Contracts—Remarketing.” Following a successful remarketing, interest at the reset rate will be payable on a semi-annual basis on February 15 and August 15 of each year, commencing August 15, 2011.

Modification of the Terms of the Senior Notes in Connection with a Successful Remarketing

In connection with the remarketing of the senior notes, without the consent of any of the holders of the senior notes, in consultation with the remarketing agent, we may (but will not be required to) modify the maturity date of the senior notes, effective on and after the remarketing settlement date, and provided that notice thereof is provided to holders prior to such time (which, if applicable, may be in the form of the prospectus used for the remarketing of the senior notes), to make the senior notes mature at any time earlier than stated maturity, provided that the senior notes may not mature earlier than two years following the purchase contract settlement date.

Optional Remarketing

On or prior to the second business day immediately preceding the initial remarketing date, but no earlier than the payment date immediately preceding such date, holders of senior notes that are not components of Corporate Units may elect to have their senior notes remarketed in the same manner and at the same price as senior notes that are components of Corporate Units by delivering their senior notes along with a notice of this election to the custodial agent. The custodial agent will hold the senior notes in an account separate from the collateral account in which the pledged securities will be held. Holders of senior notes electing to have their senior notes remarketed will also have the right to withdraw the election on or prior to the second business day immediately preceding the initial remarketing date. Holders of Treasury Units that are also holders of senior notes that are not part of the Corporate Units may also participate in any remarketing by recreating Corporate Units from their Treasury Units at any time on or prior to the second business day immediately prior to the initial remarketing date.

Put Option Following the Failure to Remarket During the Remarketing Period

If the senior notes have not been successfully remarketed prior to the purchase contract settlement date, the holders of the senior notes that are not part of Corporate Units will have the right to put their senior notes to us on the purchase contract settlement date, upon at least two business days’ prior notice to the trustee, at a price equal to $1,000 per senior note, plus accrued and unpaid interest. For information regarding the put rights of holders of senior notes that are part of Corporate Units, see “Description of the Purchase Contracts—Remarketing.”

Optional Redemption

At any time on or after May 17, 2013, we may redeem, at our option, the senior notes, in whole but not in part, at a price equal to $1,000 per senior note plus accrued and unpaid interest, if any, to the date of redemption, upon not less than 30 nor more than 60 days’ notice. In connection with the remarketing of the senior notes, without the consent of any of the holders of the senior notes, we may (but will not be required to) modify our right to call the senior notes for redemption, effective on and after the remarketing settlement date, to eliminate the redemption right in its entirety or to provide that the optional redemption right will arise at a later date.

Redemption Procedures

We will mail, or cause the trustee to mail, every redemption notice to the holders of record of the senior notes to be redeemed at their respective last addresses appearing on our books. Such mailing will be at least 30

 

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days and not more than 60 days before the date fixed for redemption. Any senior notes to be redeemed pursuant to the notice will, on the date fixed for redemption, become due and payable at the redemption price. From and after such date such senior notes will cease to bear interest. Upon surrender of any such senior notes for redemption in accordance with said notice, such senior notes will be paid by us at the redemption price, subject to certain conditions. If any senior notes called for redemption are not so paid upon surrender thereof for redemption, the redemption price will, until paid, bear interest from the redemption date at the applicable interest rate for the senior notes.

Consolidation, Merger, Sale of Assets and Other Transactions

So long as any senior notes are outstanding, we may not consolidate or merge with any other person or convey, transfer or lease our properties and assets as an entirety or substantially as an entirety to another person unless:

 

   

the successor or purchaser is a person organized under the laws of the United States, any state within the United States or the District of Columbia;

 

   

the successor or purchaser expressly assumes our obligations under the indenture and the senior notes; and

 

   

immediately after the transaction, no Event of Default, and no event which, if notice was given and/or a certain period of time passed, would become an Event of Default shall exist.

Except as described above, neither the indenture nor the senior notes contain change of control or similar provisions intended to protect you by requiring us to repurchase or redeem the senior notes if we become involved in a merger or other significant corporate event. In addition, except as described above, no indenture provisions prohibit us from entering into a merger or a significant corporate event.

Events of Default

In addition to the events of default described in the accompanying prospectus under “Description of the Debt Securities—Events of Default,” it shall be an event of default under the senior notes if:

 

   

we fail on the date payment is due to pay the put price of any senior notes following the exercise of the put right by any holder of senior notes, unless the senior notes are a component of Corporate Units, in which case our obligation to pay the put price will be netted against such holder’s obligations to pay the purchase price under the related purchase contract on the purchase contract settlement date in full satisfaction of such holders’ obligations under the purchase contracts; and

 

   

any event of default shall have occurred in respect of our indebtedness (including guaranteed indebtedness but excluding any subordinated indebtedness), and, as a result, an aggregate principal amount exceeding $100 million of such indebtedness is accelerated prior to its scheduled maturity and such acceleration is not rescinded or annulled within 30 days after we receive written notice.

Modification

In addition to the modification provisions described in the accompanying prospectus under “Description of the Debt Securities—Modification and Waiver,” without the consent of each holder of a senior note affected, no modification may:

 

   

modify the put right upon a failed final remarketing; or

 

   

modify the interest rate reset or remarketing provisions of the senior notes, it being understood that any reset of the interest rate or modification of the maturity date or redemption provisions of the senior notes

 

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in connection with a successful remarketing is permitted under the Indenture and does not require any modification to the provisions of the Indenture.

Furthermore, the modification provision described in the accompanying prospectus under “Description of Debt Securities—Modification and Waiver” that provides for modification to the indenture, without the consent of each holder affected, to allow for the issuance of additional debt securities of any series shall not apply to the senior notes.

Defeasance; Satisfaction and Discharge

The defeasance or covenant defeasance provisions of the indenture will not apply the senior notes. The satisfaction and discharge provisions of the indenture will apply to the senior notes. You should refer to the description of these provisions under “Description of Debt Securities—Discharge; Defeasance and Covenant Defeasance” in the accompanying prospectus.

Governing Law

The indenture, supplemental indenture No. 1 and the senior notes will be governed by, and construed in accordance with, the laws of the State of New York, without regard to the conflicts of law provisions thereof.

About the Trustee

The Bank of New York is the trustee under the indenture and will be the principal paying agent and registrar for the senior notes. The Bank of New York will also act as purchase contract agent, collateral agent, custodial agent and securities intermediary in connection with the Equity Units. In addition, an affiliate of The Bank of New York will act as a co-managing underwriter in the offering of Equity Units contemplated hereby as well as a co-managing underwriter in the concurrent Common Stock Offering. In both of these offerings, an affiliate of The Bank of New York will receive customary underwriting commissions and discounts. We have entered, and from time to time may continue to enter, into banking or other relationships with The Bank of New York or its affiliates. See “Description of the Equity Units” in this prospectus supplement and “Description of Debt Securities—Our Relationship with the Trustee” in the accompanying prospectus.

Agreement by Purchasers of Certain Tax Treatment

Each senior note will provide that, by acceptance of the senior note or a beneficial interest therein, you intend that the senior note constitutes debt and you agree to treat it as debt for United States federal, state and local tax purposes.

Book-Entry System

Senior notes which are released from the pledge following substitution or settlement of the purchase contracts will be issued in the form of one or more global certificates, which are referred to as global securities, registered in the name of the depositary or its nominee. Except under the limited circumstances described below or except upon recreation of Corporate Units, senior notes represented by the global securities will not be exchangeable for, and will not otherwise be issuable as, senior notes in certificated form. The global securities described above may not be transferred except by the depositary to a nominee of the depositary or by a nominee of the depositary to the depositary or another nominee of the depositary or to a successor depositary or its nominee. For additional information concerning the depositary and its book-entry system, see “Description of the Purchase Contracts—Book-Entry System” above and “Description of the Debt Securities—Book-Entry System” in the accompanying prospectus.

 

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The laws of some jurisdictions may require that some purchasers of securities take physical delivery of the securities in certificated form. These laws may impair the ability to transfer beneficial interests in such a global security.

Except as provided below, owners of beneficial interests in such a global security will not be entitled to receive physical delivery of senior notes in certificated form and will not be considered the holders (as defined in the indenture) thereof for any purpose under the indenture, and no global security representing senior notes shall be exchangeable, except for another global security of like denomination and tenor to be registered in the name of the depositary or its nominee or a successor depositary or its nominee. Accordingly, each beneficial owner must rely on the procedures of the depositary, or if such person is not a participant, on the procedures of the participant through which such person owns its interest to exercise any rights of a holder under the indenture.

In the event that

 

   

the depositary notifies us that it is unwilling or unable to continue as a depositary for the global security certificates or the depositary ceases to be a clearing agency registered under the Exchange Act, and no successor depositary has been appointed within 90 days after this notice,

 

   

an event of default occurs and is continuing with respect to the senior notes; or

 

   

to the extent permitted by the depositary, we determine in our sole discretion that the global securities shall be exchangeable,

certificates for the senior notes will be printed and delivered in exchange for beneficial interests in the global security certificates. Any global note that is exchangeable pursuant to the preceding sentence shall be exchangeable for note certificates registered in the names directed by the depositary. We expect that these instructions will be based upon directions received by the depositary from its participants with respect to ownership of beneficial interests in the global security certificates. In addition, as noted above, interests in global securities may be exchanged for senior notes in certificated form in connection with the recreation of Corporate Units.

DESCRIPTION OF OUR CAPITAL STOCK

The following description is a summary of some of the terms of our common stock and Series A Preferred Stock. The descriptions in this prospectus supplement and the accompanying prospectus of the common stock and Series A Preferred Stock do not purport to be complete and are subject to, and qualified in their entirety by reference to, their governing documents, copies of which have been or will be filed or incorporated by reference as exhibits to the registration statement of which this prospectus supplement and the accompanying prospectus form a part. This summary supplements the description of the common stock and preferred stock in the accompanying prospectus and, to the extent it is inconsistent, replaces the description in the accompanying prospectus.

As used under this caption, “Description of Our Capital Stock,” all references to “we,” “us,” “our” and other similar references mean Ambac Financial Group, Inc. excluding, unless otherwise expressly stated or the context otherwise requires, its subsidiaries.

Our authorized capital stock consists of 350,000,000 shares of common stock, par value $0.01 per share, and 4,000,000 shares of preferred stock. No shares of preferred stock were issued or outstanding as of March     , 2008.

 

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Common Stock

Voting Rights

Each holder of common stock is entitled to one vote for each share held on all matters to be voted upon by stockholders.

Dividends

The holders of common stock, after any preferences of holders of any preferred stock, are entitled to receive dividends as determined by the board of directors.

Liquidation and Dissolution

If we liquidate or dissolve, the holders of the common stock will be entitled to share in our assets available for distribution to common stockholders in proportion to the amount of common stock they own. The amount available for common stockholders is calculated after payment of liabilities. Holders of any preferred stock will receive a preferential share of our assets before the holders of the common stock receive any assets.

Other Rights

Holders of the common stock have no right to:

 

   

convert or exchange the stock into any other security;

 

   

have the stock redeemed; or

 

   

purchase additional stock or to maintain their proportionate ownership interest.

The common stock does not have cumulative voting rights. Holders of shares of our common stock are not required to make additional capital contributions.

Our common stock is listed and traded on the New York Stock Exchange under the symbol “ABK.”

Transfer Agent and Registrar

The Bank of New York is the transfer agent and registrar for the common stock.

Removal of Directors by Stockholders

Delaware law provides that members of a board of directors may be removed, with or without cause, by a majority of the outstanding shares entitled to vote on the election of the directors.

Stockholder Nomination of Directors

Our by-laws provide that a stockholder must notify us in writing of any stockholder nomination of a director at least 60, but not more than 90, days prior to the date of the meeting for the election of directors. Except that if we give less than 70 days’ notice or prior public disclosure of the date for the meeting, then notice by a stockholder is timely if received by us no later than the close of business on the 10th day after which such notice was mailed or such public disclosure was made.

10% Stockholder Provision

Our subsidiary, Ambac Assurance, is a Wisconsin corporation and subject to the insurance and regulatory laws of the State of Wisconsin. Under Wisconsin insurance holding company laws, any acquisition of control of

 

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Ambac requires the prior approval of the Office of the Commissioner of Insurance of the State of Wisconsin. As a result, Section 4.5 of our Amended and Restated Certificate of Incorporation provides that no stockholder may cast votes with respect to 10% or more of our voting stock, regardless of the actual number of shares of voting stock beneficially held by the stockholder. In addition, any voting stock held by a stockholder in excess of 10% will not count in the calculation of or toward a quorum at any meeting of stockholders. These voting restrictions will not apply to any stockholder whose acquisition or ownership of 10% or more of our voting stock has been approved by the Office of the Commissioner of Insurance of the State of Wisconsin.

Delaware Business Combination Statute

Section 203 of the Delaware General Corporation Law (“DGCL”) is applicable to us. Section 203 of the DGCL restricts some types of transactions and business combinations between a corporation and a 15% stockholder. A 15% stockholder is generally considered by Section 203 to be a person owning 15% or more of the corporation’s outstanding voting stock. Section 203 refers to a 15% stockholder as an “interested stockholder.” Section 203 restricts these transactions for a period of three years from the date the stockholder acquired 15% or more of our outstanding voting stock. With some exceptions, unless the transaction is approved by the board of directors and the holders of at least two-thirds of the outstanding voting stock of the corporation, Section 203 prohibits significant business transactions such as:

 

   

a merger with, disposition of significant assets to, or receipt of disproportionate financial benefits by, the 15% stockholder, or

 

   

any other transaction that would increase the 15% stockholder’s proportionate ownership of any class or series of our capital stock.

The shares held by the 15% stockholder are not counted as outstanding when calculating the two-thirds of the outstanding voting stock needed for approval.

The prohibition against these transactions does not apply if:

 

   

prior to the time that any stockholder became a 15% stockholder, the board of directors approved either the business combination or the transaction in which such stockholder acquired 15% or more of our outstanding voting stock, or

 

   

the 15% stockholder owns at least 85% of the outstanding voting stock of the corporation as a result of the transaction in which such stockholder acquired 15% or more of our outstanding voting stock.

Shares held by persons who are both directors and officers or by some types of employee stock plans are not counted as outstanding when making this calculation.

Preferred Stock

General

We are currently authorized to issue 4,000,000 shares of preferred stock. No shares of preferred stock are currently issued or outstanding. Our board of directors may, without stockholder approval, issue shares of preferred stock. The board can issue more than one series of preferred stock. The board has the right to fix the number of shares, dividend rights, conversion rights, voting rights, redemption rights, liquidation preferences and any other rights, preferences, privileges and restrictions applicable to the preferred stock it decides to issue.

Voting Rights.

The DGCL provides that the holders of preferred stock will have the right to vote separately as a class on any proposal involving fundamental changes in the rights of holders of such preferred stock.

 

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Series A Preferred Stock

The following summary sets forth the material terms and provisions of our Series A Participating Preferred Stock, which we refer to as the Series A Preferred Stock. This description may not be complete in all respects, and is qualified in its entirety by reference to the pertinent sections of our Amended and Restated Certificate of Incorporation and the Certificate of Designations creating such Series A Preferred Stock, copies of which are available upon request to Ambac Financial Group, Inc. Requests should be directed to Ambac Financial Group, Inc., One State Street Plaza, New York, New York 10004, Attention: Anne Gill-Kelly.

General. An aggregate amount of shares of preferred stock of the Company has been designated as the Series A Participating Preferred Stock. As of the date of this prospectus supplement, all of these shares are on reserve for issuance upon settlement of the purchase contracts. As of the date of this prospectus supplement, there are no shares of Series A Preferred Stock outstanding.

Voting Rights. Each share of Series A Preferred Stock will entitle the holder to 100 votes on all matters submitted to a vote of the holders of the common stock of the Company. Except as required by law and as to matters that would adversely affect the rights of the Series A Preferred Stock relative to the common stock, the Series A Preferred Stock shall vote together with the common stock as a single class on all matters.

10% Stockholder Provision

Our subsidiary, Ambac Assurance, is a Wisconsin corporation and subject to the insurance and regulatory laws of the State of Wisconsin. Under Wisconsin insurance holding company laws, any acquisition of control of Ambac requires the prior approval of the Office of the Commissioner of Insurance of the State of Wisconsin. As a result, Section 4.5 of our Amended and Restated Certificate of Incorporation provides that no stockholder may cast votes with respect to 10% or more of our voting stock, regardless of the actual number of shares of voting stock beneficially held by the stockholder. In addition, any voting stock held by a stockholder in excess of 10% will not count in the calculation of or toward a quorum at any meeting of stockholders. These voting restrictions will not apply to any stockholder whose acquisition or ownership of 10% or more of our voting stock has been approved by the Office of the Commissioner of Insurance of the State of Wisconsin.

Dividends and Distributions. Holders of outstanding Series A Preferred Stock will be entitled to participate in all dividends or distributions (including, but not limited to, regular quarterly dividends) paid or made in respect of our common stock, whether in the form of cash or securities or any other form of property or assets. Any such dividend or distribution will be payable or deliverable on the date fixed for the related payment or delivery of the dividend or distribution on the common stock to holders of record of Series A Preferred Stock on the record date fixed for the related dividend or distribution to holders of the common stock. Any such payment or delivery will equal, in respect of each share of Series A Preferred Stock, the amount of cash, securities or other property or assets that a holder of 100 shares of common stock is entitled to receive. We may not pay dividends or make distributions on the common stock without making such dividends or distributions and paying any accrued and unpaid dividends on the Series A Preferred Stock. In addition to the foregoing, if the Authorized Share Condition has not been satisfied by the 120th day after the issuance of the Equity Units, dividends will accrue on shares of the Series A Preferred Stock from such date to, but excluding, the date on which the Authorized Share Condition is satisfied, in an amount per quarter equal to $             per share.

Notwithstanding any of the foregoing, the additional dividend described in the preceding paragraph will be made on February 15, May 15, August 15 and November 15 of each year to holders of record of Series A Preferred Stock as of the first day of the month in which the related payment is to be made. Dividends in respect of the Series A Preferred Stock are cumulative and will be payable when, as and if declared by our board of directors. Any accrued and unpaid dividends on outstanding shares of Series A Preferred Stock shall be paid to holders upon the automatic conversion of Series A Preferred Stock into shares of our common stock in connection with the satisfaction of the Authorized Share Condition.

 

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Conversion. The Series A Preferred Stock is not convertible at the election of the holders, but shall be converted automatically, without any further action of any holder, at such time that we have authorized and reserved a sufficient number of shares of common stock to permit the full conversion of all outstanding shares of Series A Preferred Stock into common stock.

Each share of Series A Preferred Stock will convert into 100 shares of common stock. The number of shares issuable upon automatic conversion of the Series A Preferred Stock upon the satisfaction of the Authorized Share Condition will remain at the fixed rate set forth in the preceding sentence. Upon the occurrence of a stock split or combination in respect of the common stock, the number of outstanding shares of Series A Preferred Stock held by each holder will be adjusted proportionately upward or downward such that the number of shares of Series A Preferred Stock held by any holder of our Series A Preferred Stock immediately following the event will correspond to the number of shares of our common stock that such holder would have following such event if the Series A Preferred Stock held by such holder had been converted into our common stock immediately prior to such event. In addition, upon the occurrence of a reorganization event pursuant to which our common stock is converted into the right to receive cash, securities or other property, each share of Series A Preferred Stock will automatically convert into the right to receive the amount of cash, securities or other property that a holder of 100 shares of our common stock has the right to receive pursuant to such event.

Redemption. The Series A Preferred Stock is not redeemable.

Fractional Shares. Fractional shares of Series A Preferred Stock may be issued down to 1/100th of a share. Any fractional shares of common stock that would be issued upon conversion of the Series A Preferred Stock shall be paid in cash.

Authorized Share Condition. We have agreed to use commercially reasonable efforts to satisfy the Authorized Share Condition as promptly as practicable following the issuance of the Equity Units.

“Authorized Share Condition” means that we have a sufficient number of authorized and unissued shares of common stock on reserve and registered on a registration statement under the Securities Act for the settlement in all circumstances of all outstanding purchase contracts and the automatic conversion of all outstanding shares of Series A Preferred Stock into shares of common stock.

If the Authorized Share Condition has not been satisfied at the time a purchase contract is settled (whether on the purchase contract settlement date or on any earlier settlement date), our obligation to deliver such common stock will be satisfied through the delivery of newly issued shares of our Series A Preferred Stock and we will not have any obligation to deliver any cash or other assets in connection with such settlement.

We have agreed in the Certificate of Designations governing our Series A Preferred Stock, the purchase contract agreement relating to the Equity Units and the underwriting agreement relating to the offering that in the event that we authorize any additional shares of our common stock following the date of issuance of the Equity Units, such shares must first be used by us to cause the satisfaction of the Authorized Share Condition and we will not apply or reserve such shares for any other purpose until the Authorized Share Condition has been satisfied.

 

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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES

The following is a summary of certain United States federal income tax consequences of the purchase, ownership and disposition of the Equity Units (including a component thereof) and our common stock or Series A Preferred Stock, as applicable, acquired under a purchase contract. Unless otherwise stated, this summary deals only with Equity Units (including a component thereof) and our common stock or Series A Preferred Stock, as applicable, held as capital assets (generally, assets held for investment) by holders that purchase Equity Units upon original issuance at the “issue price” (which will generally equal the first price to the public (not including bond houses, brokers or similar persons or organizations acting in the capacity of underwriters, placement agents or wholesalers) at which a substantial amount of the Equity Units is sold for money. The tax treatment of a holder may vary depending on the holder’s particular situation. This summary does not address all of the tax consequences that may be relevant to holders that may be subject to special tax treatment such as, for example, banks, insurance companies, traders or dealers in securities or currencies, tax-exempt organizations, regulated investment companies, persons holding Equity Units, senior notes, or shares of our common stock or Series A Preferred Stock, as applicable, as part of a straddle, hedge, conversion transaction or other integrated investment, partnerships (or other entities treated as partnerships for United States federal income tax purposes) and their partners, and U.S. Holders (as defined below) whose functional currency is not the U.S. dollar. In addition, this summary does not address any aspects of state, local, or foreign tax laws. This summary is based on the United States federal income tax laws, regulations, rulings and decisions in effect as of the date hereof, which are subject to change or differing interpretations, possibly on a retroactive basis.

For purposes of this summary, a “U.S. Holder” is a beneficial owner of Equity Units (including a component thereof), who or that is, for United States federal income tax purposes (1) an individual who is a citizen or resident of the United States, (2) a corporation (or other entity taxable as a corporation for United States federal income tax purposes) created or organized in or under the laws of the United States or any state thereof or the District of Columbia, (3) an estate the income of which is subject to United States federal income taxation regardless of its source, or (4) a trust if (a) a court within the United States is able to exercise primary supervision over the administration of the trust and one or more United States persons have the authority to control all substantial decisions of the trust or (b) the trust has in effect a valid election to be treated as a domestic trust for United States federal income tax purposes. A beneficial owner of Equity Units (including a component thereof), that is not a U.S. Holder is referred to herein as a “Non-U.S. Holder.” A holder of Equity Units (including a component thereof) or common stock or Series A Preferred Stock, as applicable, that is a partnership and partners in such partnership should consult their own tax advisors as to the tax consequences to them of purchasing, owning and disposing of Equity Units (including a component thereof) or common stock or Series A Preferred Stock, as applicable.

The IRS has issued a public ruling addressing certain aspects of instruments substantially similar to the Equity Units. In the ruling, the IRS concluded that the senior notes issued as part of a unit with a purchase contract were treated as debt for U.S. federal income tax purposes. However, notwithstanding the ruling, there is no assurance that the IRS or a court will agree with the tax consequences described below.

Holders should consult their own tax advisors as to the particular tax consequences to them of purchasing, owning, and disposing of the Equity Units (including a component thereof) or our common stock or Series A Preferred Stock, as applicable, including the application and effect of United States federal, state, local and foreign tax laws.

U.S. Holders

Equity Units

Allocation of Purchase Price. A U.S. Holder’s acquisition of an Equity Unit will be treated as an acquisition of a unit consisting of two components—an undivided beneficial ownership interest in our senior notes and the purchase contract. Unless the context otherwise requires, each reference herein to “senior note” or “senior notes”

 

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is a reference to a holder’s undivided beneficial interest in our senior notes. The purchase price of each Equity Unit will be allocated between the components in proportion to their respective fair market values at the time of purchase. The allocation will establish a U.S. Holder’s initial tax basis in the senior note and the purchase contract. We will report the fair market value of each senior note as $     and the fair market value of each purchase contract as $    . This position will be binding upon each U.S. Holder (but not on the IRS) unless such U.S. Holder explicitly discloses a contrary position on a statement attached to such U.S. Holder’s timely filed United States federal income tax return for the taxable year in which an Equity Unit is acquired. Thus, absent such disclosure, U.S. Holders are required to allocate the purchase price for an Equity Unit in accordance with the foregoing. The remainder of this discussion assumes that this allocation of purchase price will be respected for United States federal income tax purposes.

Ownership of Senior Notes, Treasury Securities, or Treasury Portfolio. U.S. Holders will be treated as owning the senior notes, the Treasury securities or the applicable ownership interest in the Treasury portfolio constituting a part of an Equity Unit for United States federal income tax purposes. We and, by virtue of their acquisition of Equity Units, U.S. Holders, agree to treat the senior notes, the Treasury securities or the applicable ownership interest in the Treasury portfolio constituting a part of the Equity Units as owned by such U.S. Holders for United States federal income tax purposes, and the remainder of this summary assumes such treatment. Unless the context requires otherwise, each reference herein to the Treasury securities includes a reference to the new treasury securities.

Sales, Exchanges or Other Taxable Dispositions of Equity Units. A U.S. Holder that sells, exchanges or otherwise disposes of Equity Units in a taxable disposition (collectively, a “disposition”) will be treated as having sold, exchanged or disposed of each of the purchase contract and the senior note or the Treasury securities or Treasury portfolio, as the case may be, that constitute such Equity Units, and the proceeds realized on such disposition will be allocated between the purchase contract and the senior note or the Treasury securities or Treasury portfolio, as the case may be, in proportion to their respective fair market values. As a result, as to each of the purchase contract and the senior note or the Treasury securities or Treasury portfolio, as the case may be, a U.S. Holder generally will recognize gain or loss equal to the difference between (i) the portion of the proceeds received by such U.S. Holder that is allocable to the purchase contract and the senior note or the Treasury securities or Treasury portfolio, as the case may be, and (ii) such U.S. Holder’s adjusted tax basis in the purchase contract and such senior note or Treasury securities or the Treasury portfolio, respectively, except to the extent such U.S. Holder is treated as receiving an amount with respect to (a) accrued contract adjustment payments, which amount may be treated as ordinary income to the extent not previously included in income by such U.S. Holder or (b) accrued but unpaid interest on the senior note or accrued acquisition discount on the Treasury portfolio or Treasury security which is taxable as ordinary interest income if not previously included in such U.S. Holder’s income. In the case of Treasury securities or Treasury portfolio, such gain or loss will generally be capital gain or loss, and such gain or loss generally will be long-term capital gain or loss if such U.S. Holder held such component of the Equity Units for more than one year immediately prior to such disposition. Long-term capital gains of individuals are currently eligible for reduced rates of taxation. In the case of the senior note, such gain or loss will be taxed as described under the heading “Senior Notes—Sales, Exchanges, Remarketings or Other Taxable Dispositions of the Senior Notes.” In the case of the purchase contract, it is unclear whether such gain or loss will be long-term or short-term capital gain or loss even if the applicable holding period is longer than one year. The deductibility of capital losses is subject to limitations. The rules governing the determination of the character of gain or loss on the disposition of the senior notes, the Treasury securities and the Treasury portfolio are summarized below.

If the disposition of an Equity Unit occurs when the purchase contract has a negative value, the tax consequences are, in the absence of any authorities on point, not clear. U.S. Holders should consult their tax advisors regarding a disposition of an Equity Unit at a time when the purchase contract has a negative value. In determining gain or loss, contract adjustment payments that have been received by U.S. Holders, but have not previously been included in their income, should either reduce their adjusted tax basis in the purchase contract or result in an increase in the amount realized on the disposition of the purchase contract. Any contract adjustment

 

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payments previously included in a U.S. Holder’s income, but not received by such U.S. Holder, should increase such U.S. Holder’s adjusted tax basis in the purchase contract (see “—U.S. Holders—Purchase Contracts—Contract Adjustment Payments” below).

Senior Notes

Classification of the Senior Notes. It is a condition to the closing of the Equity Units Offering that Wachtell, Lipton, Rosen & Katz, special tax counsel to the Company, deliver its opinion to the Company that, for United States federal income tax purposes, the senior notes and the purchase contracts will be treated as separate securities, and the senior notes will be treated as our debt instruments. The remainder of this discussion assumes such treatment. Because of the terms of the senior notes, the senior notes should be classified as contingent payment debt instruments subject to the “noncontingent bond method” for accruing original issue discount (“OID”), as set forth in the applicable Treasury regulations. We intend to treat the senior notes as such, and the remainder of this discussion assumes that the senior notes will be so treated for United States federal income tax purposes. As described more fully below, under those Treasury regulations (1) regardless of a U.S. Holder’s regular method of tax accounting, such U.S. Holder would be required to accrue interest income with respect to the senior notes on a constant yield basis at an assumed yield; (2) for all accrual periods ending on or prior to February 15, 2011, the OID that accrues on the senior notes may exceed the stated interest payments on the senior notes; and (3) any gain and all or a portion of any loss on the sale, exchange or other taxable disposition of ownership interests in the senior notes generally would be ordinary rather than capital in nature. U.S. Holders should consult their own tax advisors regarding the treatment of the senior notes, including the application of the contingent payment debt rules.

A U.S. Holder of senior notes will accrue OID on a constant yield to maturity basis based on the “comparable yield” of the senior notes. The comparable yield of the senior notes will generally be the rate at which we would issue a fixed rate debt instrument with terms and conditions similar to the senior notes. We have determined that the comparable yield is     % and the projected payments for the senior notes per $50 of principal amount are $             on May 15, 2008, $             for each subsequent quarter ending on or prior to February 15, 2011, and $             for each quarter ending after February 15, 2011. We have also determined that the projected payment for the senior notes, per $50 of principal amount, at the maturity date is $             (which includes the stated principal amount of the senior notes as well as the final projected interest payment).

The amount of OID on a senior note for each accrual period will be determined by multiplying the comparable yield of the senior note, adjusted for the length of the accrual period, by the senior note’s adjusted issue price at the beginning of the accrual period. Based on the allocation of the purchase price of each Equity Unit described above under “Equity Units—Allocation of Purchase Price,” the adjusted issue price of each senior note, per $50 of principal amount, at the beginning of the first accrual period will be $            , and the adjusted issue price of each senior note at the beginning of each subsequent accrual period will be equal to $            , increased by any OID previously accrued by the U.S. Holder on the senior note and decreased by the amount of projected payments on the senior note through that date. The amount of OID so determined will then be allocated on a ratable basis to each day in the accrual period that the U.S. Holder holds the senior note.

If after February 15, 2011, the remaining amounts of principal and interest payable on the senior notes differ from the payments set forth on the foregoing projected payment schedule, negative or positive adjustments reflecting such difference should generally be taken into account by a U.S. Holder as adjustments to interest income in a reasonable manner over the period to which they relate. We expect to account for any such difference with respect to a period as an adjustment for that period.

U.S. Holders are generally bound by the comparable yield and projected payment schedule provided by us unless either is unreasonable. A U.S. Holder that uses its own comparable yield and projected payment schedule must explicitly disclose this fact and the reason that it has used its own comparable yield and projected payment schedule. In general, this disclosure must be made on a statement attached to the timely filed United States

 

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federal income tax return of the U.S. Holder for the taxable year that includes the date of its acquisition of the senior note.

The foregoing comparable yield and projected payment schedule are supplied solely for computing income under the noncontingent bond method for United States federal income tax purposes and do not constitute a projection or representation as to the amounts that a U.S. Holder of senior notes will actually receive.

Tax Basis in the Senior Notes. A U.S. Holder’s initial tax basis in a senior note will equal the portion of the purchase price for the Equity Unit allocated to the senior note as described above (see “—Equity Units— Allocation of Purchase Price” above). A U.S. Holder’s tax basis in a senior note will be increased by the amount of OID included in income with respect to the senior note and decreased by the amount of projected payments with respect to the senior notes through the computation date.

Sales, Exchanges, Remarketing or Other Taxable Dispositions of Senior Notes. A U.S. Holder will recognize gain or loss on the disposition of the senior notes (including upon the remarketing of the senior notes) in an amount equal to the difference between the amount realized by such U.S. Holder on the disposition of the senior notes and such U.S. Holder’s adjusted tax basis in the senior notes, except to the extent such U.S. Holder is treated as receiving accrued but unpaid stated interest which is taxable as ordinary interest income if not previously included in such U.S. Holder’s income. Gain recognized on the disposition of a senior note prior to the purchase contract settlement date, or at any time prior to the date that is six months after the date of a successful remarketing (unless no further payments are due on the senior notes during the remainder of the six month period following the date of a successful remarketing), will be treated as ordinary interest income. Loss recognized on the disposition of a senior note prior to the purchase contract settlement date, or at any time prior to the date that is six months after the date of a successful remarketing (unless no further payments are due on the senior notes during the remainder of the six month period following the date of a successful remarketing) will be treated as ordinary loss to the extent of such U.S. Holder’s prior inclusion of OID on the senior note and as capital loss thereafter. In general, gain recognized on the disposition of a senior note on or after the date that is six months after the date of a successful remarketing (or at a time when there are no further payments due on the senior note during the remainder of the six month period following the date of a successful remarketing) will be ordinary interest income to the extent attributable to the excess, if any, of the total remaining principal and interest payments due on the senior note over the total remaining payments set forth on the projected payment schedule for the senior note, to the extent not previously accrued and included in income by the U.S. Holder. Any gain recognized in excess of such amount and any loss recognized on such a disposition will generally be treated as a capital gain or loss. Long-term capital gains of individuals are currently eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations.

If a U.S. Holder does not participate in the remarketing, any reset of the interest rate and/or modification of the maturity date and redemption provisions of the senior notes in connection with the remarketing should not cause such U.S. Holder to be treated as having sold, exchanged or otherwise disposed of its senior notes.

Treasury Securities

Original Issue Discount. If U.S. Holders hold Treasury Units, they will be required to treat their ownership interest in the Treasury securities included in a Treasury Unit as an interest in a bond that was originally issued on the date they acquired the Treasury securities. Any such Treasury securities that are owned or treated as owned by U.S. Holders will generally have OID equal to the excess of the amount payable at maturity of such Treasury securities over the purchase price thereof. U.S. Holders will be required to include such OID in income on a constant yield to maturity basis over the period between the purchase date of the Treasury securities and the maturity date of the Treasury securities, regardless of their regular method of tax accounting and in advance of the receipt of cash attributable to such OID. A U.S. Holder’s adjusted tax basis in the Treasury securities will be increased by the amounts of such OID included in such U.S. Holder’s gross income.

 

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Sales, Exchanges or Other Taxable Dispositions of Treasury Securities. As discussed below, in the event that U.S. Holders obtain the release of Treasury securities or by delivering senior notes to the collateral agent, U.S. Holders generally will not recognize gain or loss upon such substitution. A U.S. Holder will recognize gain or loss on a subsequent disposition of the Treasury securities in an amount equal to the difference between the amount realized by such U.S. Holder on such disposition and such U.S. Holder’s adjusted tax basis in the Treasury securities. Such gain or loss generally will be capital gain or loss and generally will be long-term capital gain or loss if such U.S. Holder held such Treasury securities for more than one year immediately prior to such disposition. Long-term capital gains of individuals are currently eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations. With respect to Treasury securities with a fixed maturity date not more than one year from the date of their issuance, gain recognized by a U.S. Holder that uses the cash method of accounting will be treated as ordinary income in an amount equal to such U.S. Holder’s ratable share of acquisition discount (as defined below).

Substitution of Treasury Securities to Create or Recreate Treasury Units. U.S. Holders of Corporate Units who deliver Treasury securities to the collateral agent in substitution for senior notes will not recognize gain or loss upon their delivery of such Treasury securities or their receipt of the senior notes. U.S. Holders will continue to take into account items of income or deduction otherwise includible or deductible, respectively, by U.S. Holders with respect to such Treasury securities and senior notes, and their adjusted tax bases in the Treasury securities, the senior notes and the purchase contract will not be affected by such delivery and release.

Purchase Contracts

Contract Adjustment Payments. There is no direct authority addressing the treatment, under current law, of the contract adjustment payments, and such treatment is, therefore, unclear. Contract adjustment payments may constitute taxable ordinary income to U.S. Holders when received or accrued, in accordance with their regular method of tax accounting. To the extent we are required to file information returns with respect to contract adjustment payments, we intend to report such payments as taxable ordinary income to U.S. Holders. U.S. Holders should consult their tax advisors concerning the treatment of contract adjustment payments, including the possibility that any contract adjustment payment may be treated as a loan, purchase price adjustment, rebate or payment analogous to an option premium, rather than being includible in income on a current basis. The treatment of contract adjustment payments could affect a U.S. Holder’s adjusted tax basis in a purchase contract or our common stock or Series A Preferred Stock, as applicable, received under a purchase contract or the amount realized by a U.S. Holder upon the sale or other disposition of an Equity Unit or the termination of a purchase contract. In particular, any contract adjustment payments (i) that have been included in a U.S. Holders’ income, but that have not been paid to such U.S. Holder, should increase such U.S. Holder’s adjusted tax basis in the purchase contract and (ii) that have been paid to a U.S. Holder, but that have not been included in such U.S. Holder’s income, should either reduce such U.S. Holder’s adjusted tax basis in the purchase contract or result in an increase in the amount realized on the disposition of the purchase contract. See “—Acquisition of Our Common Stock or Series A Preferred Stock Under a Purchase Contract,” “—Termination of Purchase Contract” and “—U.S. Holders—Equity Units—Sales, Exchanges or Other Taxable Dispositions of Equity Units.”

Acquisition of Our Common Stock or Series A Preferred Stock Under a Purchase Contract. A U.S. Holder generally will not recognize gain or loss on the purchase of our common stock or Series A Preferred Stock, as applicable, under a purchase contract, except with respect to any cash paid to such U.S. Holder in lieu of a fractional share of our common stock or Series A Preferred Stock, as applicable, which should be treated as paid in respect of such fractional share. A U.S. Holder’s aggregate initial tax basis in our common stock or Series A Preferred Stock, as applicable, received under a purchase contract should generally equal the purchase price paid for such common stock or Series A Preferred Stock, as applicable, plus the properly allocable portion of their adjusted tax basis (if any) in the purchase contract, less the portion of such purchase price and adjusted tax basis allocable to the fractional share. The holding period for our common stock or Series A Preferred Stock, as applicable, received under a purchase contract will commence on the day following the acquisition of such common stock or Series A Preferred Stock, as applicable.

 

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Ownership of Our Common Stock or Series A Preferred Stock Acquired Under the Purchase Contract. Any distribution on our common stock or Series A Preferred Stock, as applicable, generally will be treated as a dividend to a U.S. Holder of our common stock or Series A Preferred Stock, as applicable, to the extent of our current and accumulated earnings and profits as determined under United States federal income tax principles at the end of the tax year in which the distribution occurs. To the extent the distribution exceeds our current and accumulated earnings and profits, the excess will be treated first as a tax-free return of capital to the extent of the U.S. Holder’s adjusted tax basis in the common stock or Series A Preferred Stock, as applicable, and thereafter as gain from the sale or exchange of that stock. Eligible dividends received by a non-corporate U.S. Holder in tax years beginning on or before December 31, 2010, will be subject to tax at the special reduced rate generally applicable to long-term capital gain. A U.S. Holder generally will be eligible for this reduced rate only if such U.S. Holder has held our common stock or Series A Preferred Stock, as applicable for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date. Corporate U.S. Holders generally will be entitled to claim the dividends received deduction with respect to dividends paid on our common stock or Series A Preferred Stock, as applicable, subject to applicable restrictions. Upon a disposition of our common stock or Series A Preferred Stock, as applicable, U.S. Holders generally will recognize capital gain or loss equal to the difference between the amount realized and their adjusted tax basis in the our common stock or Series A Preferred Stock, as applicable. Such gain or loss generally will be long-term capital gain or loss if the U.S. Holder’s holding period in respect of such common stock or Series A Preferred Stock, as applicable, is more than one year. Long-term capital gains of individuals are currently eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations.

Because the terms of the Series A Preferred Stock require it to participate with the common stock in dividends and in liquidation, for United States federal income tax purposes the tax consequences of ownership of our Series A Preferred Stock will be the same as ownership of our common stock. If a U.S. Holder’s shares of Series A Preferred Stock are exchanged with us for shares of common stock, a U.S. Holder will not have gain or loss and the U.S. Holder’s holding period and the U.S. Holder’s basis in the U.S. Holder’s shares of common stock will be the same as the U.S. Holder’s basis and holding period in the Series A Preferred Stock exchanged therefor.

Early Settlement of Purchase Contract. U.S. Holders will not recognize gain or loss on the receipt of their proportionate share of senior notes, Treasury securities or the Treasury portfolio upon early settlement of a purchase contract, and U.S. Holders will have the same adjusted tax basis in such senior notes or Treasury securities or the Treasury portfolio as before such early settlement.

Termination of Purchase Contract. If a purchase contract terminates, a U.S. Holder will recognize gain or loss equal to the difference between the amount realized (if any) upon such termination and such U.S. Holder’s adjusted tax basis (if any) in the purchase contract at the time of such termination. Such gain or loss generally will be capital gain or loss, but it is unclear whether such gain will be long-term or short-term capital gain or loss even if the applicable holding period is longer than one year. Long-term capital gains of individuals are currently eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations. A U.S. Holder will not recognize gain or loss on the return of such U.S. Holder’s proportionate share of the senior notes, Treasury securities or the Treasury portfolio upon termination of the purchase contract and will have the same adjusted tax basis in such senior notes, Treasury securities or the Treasury portfolio as before such distribution.

Adjustment to Settlement Rate. A U.S. Holder may be treated as having received a constructive distribution from us if (1) the settlement rate is adjusted (or fails to be adjusted) and as a result of such adjustment (or failure to adjust), the proportionate interest of U.S. Holders of Equity Units in our assets or earnings and profits is increased and (2) the adjustment (or failure to adjust) is not made pursuant to a bona fide, reasonable anti-dilution formula. An adjustment in the settlement rate would not be considered made pursuant to such a formula if the adjustment were made to compensate a U.S. Holder for certain taxable distributions with respect to our common stock or Series A Preferred Stock, as applicable. Thus, under certain

 

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circumstances, an increase in (or failure to decrease) the settlement rate might give rise to a taxable dividend to U.S. Holders even though such U.S. Holders would not receive any cash related thereto.

The Treasury Portfolio

Interest Income, Original Issue Discount and Acquisition Discount. Following a successful remarketing, if the Treasury portfolio contains interest-paying securities that are not Treasury strips, a U.S. Holder will be required to recognize ordinary income to the extent of such U.S. Holder’s pro rata portion of the interest paid with respect to such U.S. Treasury securities.

In addition, each U.S. Holder will be required to treat such U.S. Holder’s pro rata portion of each Treasury strip in the Treasury portfolio as a bond that was originally issued on the date the collateral agent acquired the relevant Treasury strip and that has OID (or, in the case of short-term U.S. Treasury securities, acquisition discount, each as defined below) equal to such U.S. Holder’s pro rata portion of the excess, if any, of the amounts payable on such Treasury strip over such U.S. Holder’s pro rata portion of the purchase price of the Treasury strip acquired on behalf of such U.S. Holder. Whether a U.S. Holder is on the cash or accrual method of tax accounting, if such OID exists, such U.S. Holder will be required to include it (but not acquisition discount on short-term U.S. Treasury securities, as defined below) in gross income for U.S. federal income tax purposes as it accrues on a constant yield to maturity basis. The actual cash payments on the Treasury strips, however, will not generally be taxable.

In the case of any U.S. Treasury security with a maturity of one year or less from the date of its issue (a “short-term U.S. Treasury security”), if a U.S. Holder is an accrual method taxpayer, in general, such U.S. Holder will be required to include the excess of the amount payable at maturity with respect to such U.S. Treasury security over such U.S. Holder’s U.S. federal income tax basis in the short-term U.S. Treasury security (“acquisition discount”) in gross income as it accrues. Unless such U.S. Holder elects to accrue the acquisition discount on a short-term security on a constant yield to maturity basis, such acquisition discount will be accrued on a straight-line basis. If a U.S. Holder is a cash method taxpayer, such U.S. Holder will be required to recognize the acquisition discount as ordinary income upon payment on the short-term U.S. Treasury securities. A U.S. Holder that obtains the release of its applicable ownership interest in the Treasury portfolio and subsequently disposes of such interest will recognize ordinary income on such disposition to the extent of any gain realized on any short-term U.S. Treasury security that does not exceed an amount equal to the ratable share of the acquisition discount on such U.S. Treasury security not previously included in income.

Tax Basis of the Applicable Ownership Interest in the Treasury Portfolio. A U.S. Holder’s initial tax basis in such U.S. Holder’s applicable ownership interest in the Treasury portfolio will equal such U.S. Holder’s proportionate share of the amount paid by the collateral agent for the Treasury portfolio. A U.S. Holder’s adjusted tax basis in the applicable ownership interest in the Treasury portfolio will be increased by the amount of OID or acquisition discount included in gross income with respect thereto and decreased by the amount of cash received with respect to OID or acquisition discount in the Treasury portfolio.

Substitution of Senior Notes to Recreate Corporate Units

U.S. Holders of Treasury Units who deliver senior notes to the collateral agent in substitution for Treasury securities will not recognize gain or loss upon their delivery of such senior notes or their receipt of the Treasury securities. U.S. Holders will continue to take into account items of income or deduction otherwise includible or deductible, respectively, by U.S. Holders with respect to such Treasury securities and senior notes, and their adjusted tax bases in the Treasury securities, the senior notes and the purchase contract will not be affected by such delivery and release.

 

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Remarketing of Senior Notes

A successful remarketing will be a taxable event for U.S. Holders of senior notes if such U.S. Holders participate in the remarketing, which will be subject to tax in the manner described under “—senior notes—Sales, Exchanges, Remarketing or Other Taxable Dispositions of Senior Notes.”

Non-U.S. Holders

United States Federal Withholding Tax

United States federal withholding tax generally will not apply to any payment to a Non-U.S. Holder of principal or interest on the senior notes or the Treasury portfolio provided that:

 

   

in the case of the senior notes, the Non-U.S. Holder does not actually or constructively own 10% or more of the total combined voting power of all classes of our voting stock within the meaning of the Internal Revenue Code of 1986, as amended, and the Treasury regulations thereunder;

 

   

in the case of the senior notes, the Non-U.S. Holder is not a controlled foreign corporation that is related to us through stock ownership;

 

   

in the case of the senior notes, the Non-U.S. Holder is not a bank within the meaning of Section 881(c)(3)(A) of the Code; and

 

   

(a) the Non-U.S. Holder provides its name, address and certain other information on an IRS Form W-8BEN (or a suitable substitute form), and certifies, under penalties of perjury, that it is not a U.S. person or (b) the Non-U.S. Holder holds its senior notes, Treasury securities or the Treasury portfolio through certain foreign intermediaries or certain foreign partnerships and certain certification requirements are satisfied.

In general, United States federal withholding tax at a rate of 30% will apply to the dividends, if any (and generally any deemed dividends resulting from certain adjustments or failures to make an adjustment as described under “—U.S. Holders—Purchase Contracts—Adjustment to Settlement Rate”), paid on the shares of common stock or Series A Preferred Stock, as applicable, acquired under the purchase contract.

We also intend to withhold at a rate of 30% on any contract adjustment payments made with respect to a purchase contract. It is possible that United States withholding tax on deemed dividends would be withheld from interest (or some other amount) paid to you. If a income tax treaty applies, you may be eligible for a reduced rate of withholding. Similarly, contract adjustment payments, and constructive or actual dividends, that are effectively connected with the conduct of a trade or business by a Non-U.S. Holder within the United States are generally not subject to the United States federal withholding tax, but instead are generally subject to United States federal income tax, as described below. In order to claim any such exemption from or reduction in the 30% withholding tax, a Non-U.S. Holder is required to provide a properly executed IRS Form W-8BEN (or suitable substitute form) claiming a reduction of or an exemption from withholding under an applicable tax treaty or a properly executed IRS Form W-8ECI (or a suitable substitute form) stating that such payments are not subject to withholding tax because they are effectively connected with such Non-U.S. Holder’s conduct of a trade or business in the United States.

In general, United States federal withholding tax generally will not apply to any gain or income realized by a Non-U.S. Holder on the sale, exchange or other disposition of the Equity Units, purchase contracts (except potentially with respect to any accrued but unpaid contract adjustment payments that have not previously been included in income), senior notes, Treasury securities or common stock or Series A Preferred Stock, as applicable, acquired under the purchase contracts.

 

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United States Federal Income Tax

Any gain realized on the disposition by a Non-U.S. Holder of an Equity Unit (including a component thereof) or common stock or Series A Preferred Stock, as applicable, acquired under the purchase contract generally will not be subject to United States federal income tax unless:

 

   

such gain or income is effectively connected with the Non-U.S. Holder’s conduct of a trade or business in the United States (and, where an applicable tax treaty so provides, is also attributable to a U.S. permanent establishment maintained by such Non-U.S. Holder); or

 

   

the Non-U.S. Holder is an individual who is present in the United States for 183 days or more in the taxable year of the disposition and certain other conditions are met; or

 

   

the Non-U.S. Holder, by virtue of holding a purchase contract or a senior note, is considered to own an interest in a U.S. real property holding corporation and does not meet the criteria for exemption from United States federal income tax.

Purchase contracts or shares of our common stock or Series A Preferred Stock, as applicable, generally will be treated as U.S. real property interests if we are (or, during a specified period, have been) a “United States real property holding corporation” for United States federal income tax purposes. We believe that we are not, and do not anticipate becoming, a United States real property holding corporation.

If a Non-U.S. Holder is engaged in a trade or business in the United States (and, if a tax treaty applies, such Non-U.S. Holder maintains a permanent establishment within the United States), and any income or gain recognized on the senior notes, the Treasury securities or the Treasury portfolio, the purchase contracts or our common stock or Series A Preferred Stock, as applicable, is effectively connected with the conduct of such trade or business (and, if a tax treaty applies, is attributable to such permanent establishment), such Non-U.S. Holder will be subject to United States federal income tax (but not withholding tax) on such income or gain on a net income basis in the same manner as if the Non-U.S. Holder were a U.S. Holder. In addition, in certain circumstances, if a Non-U.S. Holder is a foreign corporation it may be subject to a 30% branch profits tax (or, if a tax treaty applies, such lower rate as provided).

Information Reporting and Backup Withholding

Payments of interest or dividends made by us on, or the proceeds from the sale or other disposition of, the Equity Units (or any component thereof) or shares of our common stock or Series A Preferred Stock, as applicable, generally will be subject to information reporting and United States federal backup withholding at the rate then in effect if a Non-U.S. Holder receiving such payment fails to comply with applicable United States information reporting or certification requirements. Any amount withheld under the backup withholding rules is allowable as a credit against the Non-U.S. Holder’s United States federal income tax liability, provided that the required information is timely furnished to the IRS.

 

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UNDERWRITING

Under the terms and subject to the conditions contained in an underwriting agreement dated                     , 2008, each of the underwriters named below, for whom Credit Suisse Securities (USA) LLC, Citigroup Global Markets Inc., Banc of America Securities LLC and UBS Securities LLC are acting as representatives, have severally agreed to purchase, and we have agreed to sell to them, the following respective number of Equity Units:

 

Name

   Number of
Equity Units

Credit Suisse Securities (USA) LLC

  

Citigroup Global Markets Inc.

  

Banc of America Securities LLC

  

UBS Securities LLC

  

Keefe, Bruyette & Woods, Inc. 

  

Total

  

The underwriters are offering the Equity Units subject to their acceptance of the Equity Units from us and subject to prior sale. The underwriting agreement provides that the obligations of the several underwriters to pay for and accept delivery of the Equity Units offered by this prospectus supplement are subject to the approval of certain legal matters by their counsel and to certain other conditions. The underwriting agreement also provides that the underwriters are obligated to purchase all of the Equity Units in the offering if any are purchased, other than those Equity Units covered by the over-allotment option described below. The underwriting agreement further provides that if an underwriter defaults, the purchase commitments of non-defaulting underwriters may be increased or the offering may be terminated.

Over-allotment Option

We have granted to the underwriters a 13-day option to purchase on a pro rata basis up to additional Equity Units at the initial offering price listed on the cover page of this prospectus supplement less underwriting discounts and commissions. The option may be exercised only to cover any over-allotments of Equity Units.

Reserved Shares

At our request, the underwriters have reserved up to     % of the Equity Units for sale at the public offering price to persons who are directors, officers or managing directors of the Company. In addition, the underwriters in the concurrent Common Stock Offering have reserved up to     % of the shares of common stock for sale at the public offering price to persons who are directors, officers or managing directors of the Company.

The number of Equity Units available for sale to the general public will be reduced by the number of directed Equity Units purchased by participants in the program. Any directed Equity Units not purchased will be offered by the underwriters to the general public on the same basis as all other Equity Units offered. We have agreed to indemnify the underwriters against certain liabilities and expenses, including liabilities under the Securities Act, in connection with the sales of the directed Equity Units.

Commissions and Expenses

The underwriters propose to offer the Equity Units initially at the public offering price on the cover page of this prospectus supplement and to the selling group members at that price less a selling concession not in excess of $              per Equity Unit. After the initial offering, the underwriters may change the public offering price and concession and discount to broker/dealers.

 

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The following table summarizes the compensation and estimated expenses we will pay:

 

     Per Equity Unit    Total
     Without
Over-allotment
   With
Over-allotment
   Without
Over-allotment
   With
Over-allotment

Underwriting Discounts and Commissions paid by us(1)

   $                $                $                $            

Expenses payable by us

   $                $                $                $            

 

(1)   Included in the calculation of “Underwriting Discounts and Commissions paid by us” is a structuring fee paid to Credit Suisse Securities USA LLC of 1% of gross proceeds raised in any capital raising transaction by us. For a further discussion of this fee, please see “—Other Relationships” below.

Lock-Up Agreements

We have agreed that we will not, directly or indirectly, take any of the following actions with respect to our Equity Units, purchase contracts, senior notes, shares of common stock, shares of participating preferred stock or any securities convertible into or exchangeable or exercisable for any such securities: (i) offer, sell, issue, contract to sell, pledge or otherwise dispose of any such securities, (ii) offer, sell, issue, contract to sell, contract to purchase or grant any option, right or warrant to purchase any such securities, (iii) enter into any swap, hedge or any other agreement that transfers, in whole or in part, the economic consequences of ownership of any such securities, (iv) establish or increase a put equivalent position or liquidate or decrease a call equivalent position in any such securities within the meaning of Section 16 of the Exchange Act, or (v) file with the SEC a registration statement under the Securities Act, relating to any such securities, or publicly disclose the intention to take any such action, in each case, without the prior written consent of Credit Suisse Securities (USA) LLC and Citigroup Global Markets Inc., for a period of 90 days after the date of this prospectus supplement, except issuances pursuant to the conversion or exchange of convertible or exchangeable securities or the exercise of warrants or options outstanding on the date hereof (or solely in the case of the Ambac 1997 Equity Plan and the Ambac 1997 Non-Employee Directors’ Equity Plan, as amended to reflect an aggregate increase in the numbers of shares authorized under those plans by up to 6.5 million shares), or grants of employee stock options pursuant to the terms of plans in effect on the date hereof, or issuances of such securities pursuant to the exercise of such options, or the issuance of the Equity Units (including the related purchase contracts and senior notes) being offered hereby or the issuance of shares of common stock in the concurrent Common Stock Offering.

Our executive officers and directors have agreed that they will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any Equity Units, purchase contracts, shares of our common stock, shares of our participating preferred stock or securities convertible into or exchangeable or exercisable for any Equity Units, purchase contracts, shares of our common stock or shares of our participating preferred stock, enter into a transaction that would have the same effect, or enter into any swap, hedge or other arrangement that transfers, in whole or in part, any of the economic consequences of ownership of Equity Units, purchase contracts or shares of our common stock or participating preferred stock, whether any of these transactions are to be settled by delivery of Equity Units, purchase contracts or shares of our common stock or participating preferred stock or other securities, in cash or otherwise, or publicly disclose the intention to make any offer, sale, pledge or disposition, or to enter into any transaction, swap, hedge or other arrangement, and will not make any demand for or exercise any right with respect to the registration of any Equity Units, purchase contracts or shares of our common stock or participating preferred stock or any security convertible into or exchangeable or exercisable for securities without, in each case, the prior written consent of Credit Suisse Securities (USA) LLC and Citigroup Global Markets Inc. for a period of 90 days after the date of this prospectus supplement, except transfers of any such securities received upon exercise of options granted to such employee, executive officer or director, transfers to family members or trusts in which the transferee agrees to be bound in writing by these same obligations and which transfer, in each case, requires no filing with the SEC in connection therewith and except for the withholding of shares of common stock to pay taxes upon settlement of restricted stock units granted to such employee and executive officer pursuant to the terms of plans in effect on the date hereof.

 

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Indemnification

We have agreed to indemnify the underwriters against liabilities under the Securities Act, or contribute to payments that the underwriters may be required to make in that respect.

Listing

Prior to this offering, there has been no public market for the Equity Units. We intend to list the Corporate Units on the New York Stock Exchange or another national securities exchange. Neither the Treasury Units, the senior notes nor shares of Series A Preferred Stock initially will be listed. However, if the Treasury Units or the senior notes are separately traded or the Series A Preferred Stock is issued to a sufficient extent so that applicable exchange listing requirements are met, we may endeavor, but are not obligated, to list the Treasury Units, the senior notes or the Series A Preferred Stock on the same exchange as the Corporate Units are then listed, including, if applicable, the New York Stock Exchange. With respect to the shares of Series A Preferred Stock, in the event that the Authorized Share Increase described above in “Description of the Equity Units” does not occur on or prior to the 120 th day following the completion of the offering contemplated by this prospectus supplement, we may endeavor to apply to have the shares of Series A Preferred Stock listed on The New York Stock Exchange. However, even if we attempt to list one or more of those securities, an active trading market in those securities may not develop and we may not be successful in effecting any such listing.

Stabilization, Short Positions and Penalty Bids

In connection with the offering, the underwriters may engage in stabilizing transactions, over-allotment transactions, syndicate covering transactions and penalty bids.

 

   

Stabilizing transactions permit bids to purchase the underlying security so long as the stabilizing bids do not exceed a specified maximum.

 

   

Over-allotment involves sales by the underwriters of Equity Units in excess of the number of Equity Units the underwriters are obligated to purchase, which creates a syndicate short position. The short position may be either a covered short position or a naked short position. In a covered short position, the number of Equity Units over-allotted by the underwriters is not greater than the number of Equity Units that they may purchase in the over-allotment option. In a naked short position, the number of Equity Units involved is greater than the number of Equity Units in the over-allotment option. The underwriters may close out any covered short position by either exercising their over-allotment option and/or purchasing Equity Units in the open market.

 

   

Syndicate covering transactions involve purchases of the Equity Units in the open market after the distribution has been completed in order to cover syndicate short positions. In determining the source of Equity Units to close out the short position, the underwriters will consider, among other things, the price of Equity Units available for purchase in the open market as compared to the price at which they may purchase Equity Units through the over-allotment option. If the underwriters sell more Equity Units than could be covered by the over-allotment option, a naked short position, the position can only be closed out by buying Equity Units in the open market. A naked short position is more likely to be created if the underwriters are concerned that there could be downward pressure on the price of the Equity Units in the open market after pricing that could adversely affect investors who purchase in the offering.

 

   

Penalty bids permit the representatives to reclaim a selling concession from a syndicate member when the Equity Units originally sold by the syndicate member are purchased in a stabilizing or syndicate covering transaction to cover syndicate short positions.

These stabilizing transactions, syndicate covering transactions and penalty bids may have the effect of raising or maintaining the market price of our Equity Units or preventing or retarding a decline in the market

 

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price of the Equity Units. As a result, the price of our Equity Units may be higher than the price that might otherwise exist in the open market. These transactions may be effected on a national securities exchange or otherwise and, if commenced, may be discontinued at any time.

Neither we nor the underwriters make any representation or prediction as to the direction or magnitude of any effect that the transactions described above may have on the price of the Equity Units. In addition, neither we nor the underwriters make any representation that the underwriters will engage in these stabilizing transactions or that any transaction, once commenced, will not be discontinued without notice.

Electronic Distribution

A prospectus supplement in electronic format may be made available on Internet sites or through other online services maintained by one or more of the underwriters and/or selling group members participating in this offering, or by their affiliates. In those cases, prospective investors may view the prospectus supplement online and, depending upon the particular underwriter or selling group member, prospective investors may be allowed to place orders online. The underwriters may agree with us to allocate a specific number of Equity Units for sale to online brokerage account holders. Any such allocation for online distributions will be made by the representatives on the same basis as other allocations. In addition, one or more of the underwriters participating in this offering may distribute prospectuses electronically.

Other than the prospectus supplement in electronic format, information on the underwriters or selling group member’s website and any information contained in any other website maintained by an underwriter or selling group member is not part of this prospectus supplement, the accompanying prospectus or the registration statement of which this prospectus supplement and accompanying prospectus form a part, has not been approved and/or endorsed by us or any underwriter or selling group member in its capacity as underwriter or selling group member and should not be relied on by investors.

Other Relationships

The underwriters and their affiliates have from time to time provided, and expect to provide in the future, investment banking, commercial banking and other financial services to us and our affiliates, for which they have received and may continue to receive customary fees and commissions. Several of the underwriters and their affiliates have utilized products and services provided by us and our affiliates, including certain of our financial guarantee and credit derivative products in transactions underwritten by such parties, and certain of the underwriters and their affiliates are the beneficiaries of the products and services provided by us and our affiliates, including by being a holder of one of our financial guarantee policies or a counterparty to one of our credit derivatives. As beneficiaries of our products and services, these underwriters have an interest in our being successful in our efforts to raise capital and maintain our triple-A ratings from Moody’s and S&P. For example, certain of the underwriters are counterparties to a significant portion of our CDO of ABS credit default swaps that have greater than 25% RMBS Exposure. For a discussion of these products see “Residential Mortgage-Backed Securities Exposure” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which is attached to this prospectus supplement. In addition, certain of the underwriters on various occasions have disclosed information regarding the extent of their commercial relationships with us and our competitors, including in filings made with the SEC. In addition, certain underwriters have exposure to deteriorations in our credit through holding our securities, holding derivatives for which our securities are the reference security, or otherwise, and as part of trading strategies and/or credit risk management have entered into CDS based upon our credit.

Credit Suisse Securities (USA) LLC, one of the joint book running managers for this offering, has executed an engagement letter with us pursuant to which it has, among other things, agreed to review and analyze our strategic plans and our financing and other business alternatives, and identify and structure potential capital raising transactions. In connection with the engagement, we have paid Credit Suisse Securities (USA) LLC a

 

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financial advisory fee of $5 million for their services. Additionally, upon completion of any equity or debt raising transaction, we have agreed to pay Credit Suisse a structuring fee equal to 1% of the gross proceeds raised by us in any such transactions; the $5 million fee will be creditable against any such fee. We have also agreed to indemnify Credit Suisse Securities (USA) LLC for any losses, claims, damages or liabilities suffered by Credit Suisse Securities (USA) LLC arising from the engagement other than to the extent such losses are determined to be caused by the bad faith or gross negligence of Credit Suisse Securities (USA) LLC.

Each of the underwriters in this offering is also acting as an underwriter in the concurrent Common Stock Offering for which each will receive customary underwriting commissions.

Ambac and its subsidiary Ambac Assurance Corporation have entered into a $400 million revolving credit facility with some of the affiliates of some of the underwriters. Citibank, N.A. serves as administrative agent and lender, and Citigroup Global Markets Inc. serves as sole lead arranger and sole book runner under the revolving credit facility and, in connection with the offering, has entered into an amendment to the credit facility for which it received a fee under the credit facility. These companies also receive standard fees for their services.

In addition, commencing in January 2008, a number of financial institutions and other market participants, consisting in significant part of insured counterparties to our CDOs of ABS, contemplated various transactions with the objective of enhancing our ability to maintain our credit ratings. An affiliate of Citigroup Global Markets, Inc., one of the co-book running managers of this Equity Units Offering and the concurrent Common Stock Offering, was a principal participant in these matters. Certain other underwriters of this offering and the concurrent Common Stock Offering also were participants in these matters. As counterparties to our insured swaps, beneficiaries of our other products and services and holders of our securities and derivatives on our securities, the financial institutions, including those whose affiliates are underwriters in this transaction, have an interest in our being successful in our efforts to raise capital in this Equity Units Offering and the concurrent Common Stock Offering and our maintaining our triple-A ratings.

European Economic Area

In relation to each Member State of the European Economic Area which has implemented the Prospectus Directive (each, a Relevant Member State), each underwriter has represented and agreed that with effect from and including the date on which the Prospectus Directive is implemented in that Relevant Member State (the Relevant Implementation Date) it has not made and will not make an offer of Equity Units to the public in that Relevant Member State prior to the publication of a prospectus in relation to the Equity Units which has been approved by the competent authority in that Relevant Member State or, where appropriate, approved in another Relevant Member State and notified to the competent authority in that Relevant Member State, all in accordance with the Prospectus Directive, except that it may, with effect from and including the Relevant Implementation Date, make an offer of Equity Units to the public in that Relevant Member State at any time:

(a) to legal entities which are authorised or regulated to operate in the financial markets or, if not so authorised or regulated, whose corporate purpose is solely to invest in securities;

(b) to any legal entity which has two or more of (1) an average of at least 250 employees during the last financial year; (2) a total balance sheet of more than €43,000,000; and (3) an annual net turnover of more than €50,000,000, as shown in its last annual or consolidated accounts;

(c) to fewer than 100 natural or legal persons (other than qualified investors as defined in the Prospectus Directive) subject to obtaining the prior consent of the representatives for any such offer; or

(d) in any other circumstances which do not require the publication by the Issuer of a prospectus pursuant to Article 3 of the Prospectus Directive.

For the purposes of this provision, the expression an “offer of Equity Units to the public” in relation to any Equity Units in any Relevant Member State means the communication in any form and by any means of

 

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sufficient information on the terms of the offer and the Equity Units to be offered so as to enable an investor to decide to purchase or subscribe to the Equity Units, as the same may be varied in that Relevant Member State by any measure implementing the Prospectus Directive in that Relevant Member State and the expression Prospectus Directive means Directive 2003/71/EC and includes any relevant implementing measure in each Relevant Member State.

United Kingdom

Each underwriter has severally represented and agreed that:

 

   

it has only communicated or caused to be communicated and will only communicate or cause to be communicated an invitation or inducement to engage in investment activity (within the meaning of Section 21 of the Financial Services and Markets Act 2000 (“FSMA”)) received by it in connection with the issue or sale of the Equity Units in circumstances in which Section 21(1) of the FSMA does not apply to the Company; and

 

   

it has complied and will comply with all applicable provisions of the FSMA with respect to anything done by it in relation to the Equity Units in, from or otherwise involving the United Kingdom.

Notice to Residents of Hong Kong

The underwriters and each of their affiliates have not (i) offered or sold, and will not offer or sell, in Hong Kong, by means of any document, our shares of common stock other than (a) to “professional investors” as defined in the Securities and Futures Ordinance (Cap.571) of Hong Kong and any rules made under that Ordinance or (b) in other circumstances which do not result in the document being a “prospectus” as defined in the Companies Ordinance (Cap. 32 of Hong Kong) or which do not constitute an offer to the public within the meaning of that Ordinance or (ii) issued or had in its possession for the purposes of issue, and will not issue or have in its possession for the purposes of issue, whether in Hong Kong or elsewhere any advertisement, invitation or document relating to our shares of common stock which is directed at, or the contents of which are likely to be accessed or read by, the public in Hong Kong (except if permitted to do so under the securities laws of Hong Kong) other than with respect to our securities which are or are intended to be disposed of only to persons outside Hong Kong or only to “professional investors” as defined in the Securities and Futures Ordinance and any rules made under that Ordinance. The contents of this document have not been reviewed by any regulatory authority in Hong Kong. You are advised to exercise caution in relation to the offer. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice.

Notice to Residents of Singapore

This prospectus supplement or any other offering material relating to our shares of common stock has not been and will not be registered as a prospectus with the Monetary Authority of Singapore, and the shares of common stock will be offered in Singapore pursuant to exemptions under Section 274 and Section 275 of the Securities and Futures Act, Chapter 289 of Singapore (the “Securities and Futures Act”). Accordingly our shares of common stock may not be offered or sold, or be the subject of an invitation for subscription or purchase, nor may this prospectus supplement or any other offering material relating to our shares of common stock be circulated or distributed, whether directly or indirectly, to the public or any member of the public in Singapore other than (a) to an institutional investor or other person specified in Section 274 of the Securities and Futures Act, (b) to a sophisticated investor, and in accordance with the conditions specified in Section 275 of the Securities and Futures Act or (c) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the Securities and Futures Act.

Notice to Residents of the United Arab Emirates

This prospectus supplement is not intended to constitute an offer, sale or delivery of shares or other securities under the laws of the United Arab Emirates (UAE). The shares of common stock have not been and

 

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will not be registered under Federal Law No. 4 of 2000 Concerning the Emirates Securities and Commodities Authority and the Emirates Security and Commodity Exchange, or with the UAE Central Bank, the Dubai Financial Market, the Abu Dhabi Securities market or with any other UAE exchange. The offering, the Equity Units and interests therein have not been approved or licensed by the UAE Central Bank or any other relevant licensing authorities in the UAE, and do not constitute a public offer of securities in the UAE in accordance with the Commercial Companies Law, Federal Law No. 8 of 1984 (as amended) or otherwise. In relation to its use in the UAE, this prospectus supplement is strictly private and confidential and is being distributed to a limited number of investors and must not be provided to any person other than the original recipient, and may not be reproduced or used for any other purpose. The interests in the Equity Units may not be offered or sold directly or indirectly to the public in the UAE.

 

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WHERE YOU CAN FIND MORE INFORMATION

We file reports, proxy statements, and other information with the SEC. These reports, proxy statements, and other information can be read and copied at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. The SEC maintains an internet site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding companies that file electronically with the SEC, including Ambac. These reports, proxy statements and other information can also be read at the offices of the NYSE, 20 Broad Street, New York, New York 10005 or on our internet site at www.ambac.com. Information on our website is not incorporated into this prospectus supplement or our other SEC filings and is not a part of this prospectus supplement or those filings.

This prospectus supplement is part of a registration statement filed by us with the SEC. The full registration statement can be obtained from the SEC as indicated above, or from us.

The SEC allows us to “incorporate by reference” the information we file with the SEC. This permits us to disclose important information to you by referencing these filed documents. Any information referenced this way is considered part of this prospectus supplement, and any information filed with the SEC subsequent to this prospectus supplement and prior to the termination of the particular offering referred to in this prospectus supplement will automatically be deemed to update and supersede this information. We incorporate by reference the following documents which have been filed with the SEC:

 

   

Annual Report on Form 10-K for the fiscal year ended December 31, 2007 (filed on February 29, 2008); and

 

   

Current Reports on Form 8-K filed on January 18, 2008, January 22, 2008, January 23, 2008, January 25, 2008, February 1, 2008 and February 13, 2008, in each case excluding any portions of such Current Reports on Form 8-K which are specifically or deemed to be furnished to the SEC.

We incorporate by reference the documents listed above and any future filings made with the SEC prior to the termination of the particular offering referred to in this prospectus supplement in accordance with Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act, with the exception of any documents deemed not to be filed.

We will provide without charge upon written or oral request, a copy of any or all of the documents which are incorporated by reference in this prospectus supplement, other than exhibits which are specifically incorporated by reference into those documents. Requests should be directed to Vandana Sharma, First Vice President, Ambac Financial Group, Inc., One State Street Plaza, New York, New York 10004 (telephone number (212) 208-3333 or at vsharma@ambac.com).

LEGAL OPINIONS

Anne Gill Kelly, Esq., Managing Director, Secretary and Assistant General Counsel of Ambac, One State Street Plaza, New York, New York, will issue an opinion about the legality of the securities offered hereby. Anne Gill Kelly, Esq. beneficially owns, or has the right to acquire under Ambac’s employee benefit plans, an aggregate of less than 1% of our common stock. Additionally, certain legal matters relating to the securities offered hereby will be passed upon for us by Wachtell, Lipton, Rosen & Katz, New York, New York, and for the underwriters by Sidley Austin LLP, New York, New York and Sullivan & Cromwell LLP, New York, New York. Sidley Austin LLP has in the past represented certain of our affiliates, and has also represented issuers and/or underwriters in transactions insured by our affiliates or for which our affiliates issued credit derivatives.

EXPERTS

The consolidated financial statements and related financial statement schedules of Ambac as of December 31, 2007 and 2006, and for each of the years in the three-year period ended December 31, 2007, have been included in this preliminary prospectus supplement (and incorporated by reference in the registration statement of which it forms a part), in reliance upon the reports of KPMG LLP, independent registered public accounting firm, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. The reports of KPMG LLP on such consolidated financial statements and related financial statement schedules refer to changes in Ambac’s method of accounting for variable interest entities and stock-based compensation in 2006.

 

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PROSPECTUS

LOGO

Ambac Financial Group, Inc.

Ambac Financial Group, Inc. may sell from time to time

Common Stock

Preferred Stock

Depositary Shares

Senior Debt Securities

Junior Subordinated Debt Securities

Warrants

Stock Purchase Contracts

Stock Purchase Units

 

 

This prospectus describes some of the general terms that may apply to these securities. The specific terms of the common stock, preferred stock, depositary shares, senior debt securities, junior subordinated debt securities, warrants to purchase our capital stock or debt securities, stock purchase contracts and stock purchase units then being offered will be described in supplements to this prospectus. The prospectus supplements may also add, update or change information contained in this prospectus. You should read this prospectus and the applicable prospectus supplement carefully before you make your investment decision.

We may offer and sell these securities through one or more underwriters, dealers and agents, underwriting syndicates managed or co-managed by one or more underwriters, or directly to purchasers, on a continuous or delayed basis.

This prospectus may not be used to sell securities unless accompanied by a prospectus supplement.

The prospectus supplement for each offering of securities will describe in detail the plan of distribution for that offering. Our common stock is listed on the New York Stock Exchange under the trading symbol “ABK”. Each prospectus supplement will indicate if the securities offered thereby will be listed on any securities exchange.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus or the accompanying prospectus supplement is truthful or complete. Any representation to the contrary is a criminal offense.

The date of this prospectus is January 16, 2008.


Table of Contents

TABLE OF CONTENTS

 

ABOUT THIS PROSPECTUS

   1

AMBAC FINANCIAL GROUP, INC.

   1

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

   3

USE OF PROCEEDS

   4

RATIO OF EARNINGS TO FIXED CHARGES

   5

DESCRIPTION OF SECURITIES

   6

Description of Capital Stock

   6

Description of Depositary Shares

   8

Description of Debt Securities

   11

Description of Warrants

   21

Description of Stock Purchase Contracts and Stock Purchase Units

   22

WHERE YOU CAN FIND MORE INFORMATION

   23

LEGAL OPINIONS

   24

EXPERTS

   25

 

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ABOUT THIS PROSPECTUS

This prospectus is part of a registration statement that we filed with the SEC using a “shelf” registration process. Under this shelf process, we may, from time to time, sell any combination of the securities described in this prospectus in one or more offerings. This prospectus provides you with a general description of the securities we may offer. Each time we sell securities, we will provide a prospectus supplement that will contain specific information about the terms of that offering. The prospectus supplement may also add, update or change information contained in this prospectus. You should read both this prospectus and any prospectus supplement together with additional information described under the heading “Where You Can Find More Information.” Unless otherwise stated or the context otherwise requires, references in this prospectus to “Ambac”, “we”, “our” or “us” refer to Ambac Financial Group, Inc., and its direct and indirect subsidiaries.

AMBAC FINANCIAL GROUP, INC.

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, or Ambac Assurance. 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., or Moody’s, in 1987, Standard & Poor’s Ratings Services, or S&P, in 1979 and Fitch, Inc., or Fitch, in 1994. Ambac Assurance’s ratings have been periodically affirmed by each of these rating agencies. Moody’s rating was last reaffirmed in December 2007. S&P’s rating was last reaffirmed in December 2007; however, its outlook was changed from stable to negative. Fitch’s rating was changed from stable to rating watch negative in December 2007. 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 “Business—Rating Agencies” and “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, which is incorporated by reference in this prospectus, for further information.

Ambac Assurance provides its financial guarantees for a variety of products, including:

 

   

public finance securities, which include bonds issued by state and local municipalities such as cities, counties, towns and villages, as well as water districts, sewer districts, higher educational institutions, hospitals, transportation authorities, housing authorities and other similar agencies;

 

   

securities issued in connection with privatizations of essential infrastructures by sovereign entities and sub-sovereigns where the insured debt is backed by payments made by private companies which own concessions to build, maintain and operate roads, hospitals, schools and other essential infrastructure;

 

   

mortgage-backed securities, which are bonds and notes where investors receive payments out of the interest and principal on the underlying mortgages that back the securities;

 

   

asset-backed securities, which are bonds and notes where investors receive payments out of cash flows from the underlying accounts receivable, loans, corporate debt or sovereign debt that back the securities; and

 

   

structured credit derivatives, which are privately negotiated contracts that provide an investor with credit protection against the occurrence of a specific event such as a payment default or bankruptcy relating to an underlying obligation.

 

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Ambac Assurance and its subsidiary Ambac Assurance UK Limited, which serve the global capital markets, are primarily engaged in guaranteeing public finance securities, mortgage-backed securities, asset-backed securities and other structured finance obligations. Global capital markets include the U.S. financial markets and international markets such as the United Kingdom, Italian, Japanese and Australian financial markets.

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, which is the entity responsible for making payments. In the case of default on a guaranteed obligation, payments under the financial guarantee policy generally may not be accelerated by the policyholder without Ambac Assurance’s consent. As of December 31, 2006 and September 30, 2007, Ambac Assurance’s net financial guarantee in force, after giving effect for reinsurance, was $802.7 billion and $892.0 billion, respectively.

Ambac Credit Products, LLC, a wholly owned subsidiary of Ambac Assurance, primarily provides credit protection in the global markets in the form of structured credit derivatives. Structured credit derivatives are privately negotiated contracts that require Ambac Credit to make payments upon the occurrence of certain defined credit events relating to an underlying obligation. Structured credit derivatives issued by Ambac Credit are guaranteed by Ambac Assurance. Ambac Credit generally enters into structured credit derivative contracts in which its exposure is to highly rated risks.

Ambac provides financial services and investment products principally to its financial guarantee clients which include municipalities and their authorities, school districts, health care organizations and asset-backed issuers.

Through its financial services subsidiaries, Ambac provides financial and investment products that include:

 

   

investment agreements, which are contracts between Ambac and a client that provide for the guaranteed return of principal invested and for the payment of interest at a guaranteed rate;

 

   

interest rate swaps, currency swaps and total return swaps; and

 

   

funding conduits, which are special purpose companies that help clients raise funds by issuing notes for the purpose of acquiring financial assets such as trade receivables.

We conduct our investment agreement business through our subsidiary, Ambac Capital Funding, Inc., or Ambac Capital. Ambac Capital provides investment agreements primarily to municipalities and their authorities, mortgage-backed security issuers, asset-backed security issuers and international issuers. The investment agreements written by Ambac Capital are guaranteed by Ambac Assurance. Investment agreements are primarily used by issuers to invest bond proceeds until the proceeds can be used for their intended purpose.

Ambac provides interest rate and currency swaps through its subsidiary, Ambac Financial Services, L.L.C. and total return swaps through its subsidiary Ambac Capital Services, L.L.C., primarily to states, municipalities and their authorities, issuers of asset-backed securities, investment banks and other entities in connection with their financings. The swaps provided by Ambac Financial Services and Ambac Capital Services are guaranteed by Ambac Assurance and provide a financing alternative that is intended to reduce an issuer’s overall borrowing costs and/or help manage their risk.

As a holding company, Ambac Financial Group, Inc. is largely dependent on dividends from Ambac Assurance to pay dividends on its capital stock, to pay principal of 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.

Our principal executive offices are located at One State Street Plaza, New York, New York 10004 and our telephone number is (212) 668-0340.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus and accompanying prospectus supplement may contain or incorporate by reference information that includes or is based upon forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent management’s belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. You can identify these statements by the fact that they do not relate strictly to historical or current facts and relate to future plans or objectives and results.

Any or all of our 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 our securities. Among factors that could cause actual results to differ materially are:

 

   

changes in the economic, credit or interest rate environment in the United States and abroad;

 

   

the level of activity within the national and worldwide debt markets;

 

   

competitive conditions and pricing levels;

 

   

legislative and regulatory developments;

 

   

changes in tax laws;

 

   

the policies and actions of the United States and other governments;

 

   

changes in capital requirement or other criteria of rating agencies;

 

   

changes in accounting principles or practices that may impact Ambac’s reported financial results;

 

   

the amount of reserves established for losses and loss expenses;

 

   

default of one or more of Ambac’s reinsurers;

 

   

market spreads and pricing on insured pooled debt obligations and other derivative products insured or issued by Ambac;

 

   

prepayment speeds on insured asset-backed securities and other factors that may influence the amount of installment premiums paid to Ambac; and

 

   

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 our reports to the SEC.

 

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USE OF PROCEEDS

Unless otherwise indicated in the applicable prospectus supplement, we intend to use the proceeds of any securities sold for general corporate purposes.

 

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RATIO OF EARNINGS TO FIXED CHARGES

The following table contains our ratio of earnings to fixed charges for each of the periods indicated:

 

     Years Ended December 31,    Nine Months Ended
     2006    2005    2004    2003    2002    September 30,
2007
   September 30,
2006

Ratio of earnings to fixed charges

   16.4x    18.3x    18.1x    16.0x    13.3x    1.4x    16.2x

We computed the ratio of earnings to fixed charges by dividing earnings before income taxes and extraordinary items plus fixed charges by the fixed charges. For the purpose of this ratio, fixed charges consist of interest expense incurred, capitalized interest, amortization of debt expense and one-third of rental payments under operating leases, an amount deemed representative of the appropriate interest factor. Since we did not have any preferred stock outstanding during the periods indicated above, our ratio of earnings to combined fixed charges and preference dividends for each relevant period will be the same as our ratio of earnings to fixed charges.

The decline in the ratio of earnings to fixed charges from September 30, 2006 to September 30, 2007 was primarily a result of the impact on earnings of net mark-to-market losses on credit and total return derivatives of $816.0 million during the 9-month period ended September 30, 2007 versus net mark-to-market gains of $16.4 million during the 9-month period ended September 30, 2006.

 

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DESCRIPTION OF SECURITIES

This prospectus contains a summary of the capital stock (including common stock and preferred stock), depositary shares, debt securities (including senior debt securities and junior subordinated debt securities), warrants to purchase our capital stock or debt securities, stock purchase contracts and stock purchase units that we may sell. These summaries are not meant to be a complete description of each security. However, this prospectus, together with the applicable accompanying prospectus supplement, contain all the material terms of the securities being offered.

Description of Capital Stock

Our authorized capital stock consists of 350,000,000 shares of common stock, par value $0.01 per share, and 4,000,000 shares of preferred stock, par value $0.01 per share. No shares of preferred stock were issued or outstanding as of January 16, 2008.

Common Stock

Voting rights. Each holder of common stock is entitled to one vote for each share held on all matters to be voted upon by stockholders.

Dividends. The holders of common stock, after any preferences of holders of any preferred stock, are entitled to receive dividends as determined by the board of directors.

Liquidation and dissolution. If we liquidate or dissolve, the holders of the common stock will be entitled to share in our assets available for distribution to common stockholders in proportion to the amount of common stock they own. The amount available for common stockholders is calculated after payment of liabilities. Holders of any preferred stock will receive a preferential share of our assets before the holders of the common stock receive any assets.

Other rights. Holders of the common stock have no right to:

 

   

convert or exchange the stock into any other security;

 

   

have the stock redeemed; or

 

   

purchase additional stock or to maintain their proportionate ownership interest.

The common stock does not have cumulative voting rights. Holders of shares of our common stock are not required to make additional capital contributions.

Our common stock is listed and traded on the New York Stock Exchange under the symbol “ABK.”

Transfer Agent and Registrar

The Bank of New York Mellon is the transfer agent and registrar for the common stock.

Removal of Directors by Stockholders

Delaware law provides that members of a board of directors may be removed, with or without cause, by a majority of the outstanding shares entitled to vote on the election of the directors.

Stockholder Nomination of Directors

Our by-laws provide that a stockholder must notify us in writing of any stockholder nomination of a director at least sixty, but not more than ninety, days prior to the date of the meeting for the election of directors. Except that if we give less than seventy days notice or prior public disclosure of the date for the meeting, then notice by a stockholder is timely if received by us no later than the close of business on the tenth day after which such notice was mailed or such public disclosure was made.

 

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10% Stockholder Provision

Our subsidiary, Ambac Assurance, is a Wisconsin corporation and subject to the insurance and regulatory laws of the State of Wisconsin. Under Wisconsin insurance holding company laws, any acquisition of control of Ambac requires the prior approval of the Office of the Commissioner of Insurance of the State of Wisconsin. As a result, section 4.5 of our amended and restated certificate of incorporation provides that no stockholder may cast votes with respect to 10% or more of our voting stock, regardless of the actual number of shares of voting stock beneficially held by the stockholder. In addition, any voting stock held by a stockholder in excess of 10% will not count in the calculation of or toward a quorum at any meeting of stockholders. These voting restrictions will not apply to any stockholder whose acquisition or ownership of 10% or more of our voting stock has been approved by the Office of the Commissioner of Insurance of the State of Wisconsin.

Delaware Business Combination Statute

Section 203 of the Delaware General Corporation Law (“DGCL”) is applicable to us. Section 203 of the DGCL restricts some types of transactions and business combinations between a corporation and a 15% stockholder. A 15% stockholder is generally considered by Section 203 to be a person owning 15% or more of the corporation’s outstanding voting stock. Section 203 refers to a 15% stockholder as an “interested stockholder.” Section 203 restricts these transactions for a period of three years from the date the stockholder acquired 15% or more of our outstanding voting stock. With some exceptions, unless the transaction is approved by the board of directors and the holders of at least two-thirds of the outstanding voting stock of the corporation, Section 203 prohibits significant business transactions such as:

 

   

a merger with, disposition of significant assets to, or receipt of disproportionate financial benefits by, the 15% stockholder, or

 

   

any other transaction that would increase the 15% stockholder’s proportionate ownership of any class or series of our capital stock.

The shares held by the 15% stockholder are not counted as outstanding when calculating the two-thirds of the outstanding voting stock needed for approval.

The prohibition against these transactions does not apply if:

 

   

prior to the time that any stockholder became a 15% stockholder, the board of directors approved either the business combination or the transaction in which such stockholder acquired 15% or more of our outstanding voting stock, or

 

   

the 15% stockholder owns at least 85% of the outstanding voting stock of the corporation as a result of the transaction in which such stockholder acquired 15% or more of our outstanding voting stock. Shares held by persons who are both directors and officers or by some types of employee stock plans are not counted as outstanding when making this calculation.

Preferred Stock

General. We are authorized to issue 4,000,000 shares of preferred stock. No shares of preferred stock are currently issued or outstanding. Our board of directors may, without stockholder approval, issue shares of preferred stock. The board can issue more than one series of preferred stock. The board has the right to fix the number of shares, dividend rights, conversion rights, voting rights, redemption rights, liquidation preferences and any other rights, preferences, privileges and restrictions applicable to the preferred stock it decides to issue.

Voting rights. The DGCL provides that the holders of preferred stock will have the right to vote separately as a class on any proposal involving fundamental changes in the rights of holders of such preferred stock.

Conversion or exchange. The prospectus supplement will describe the terms, if any, on which the preferred stock may be convertible into or exchangeable for our debt securities, common stock, warrants or other preferred stock. These terms will include provisions as to whether conversion or exchange is mandatory, at the option of the holder or at our option. These provisions may allow or require the number of our shares of common stock or other securities to be received by the holders of preferred stock to be adjusted.

 

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Description of Depositary Shares

General

We may elect to offer fractional shares of preferred stock rather than full shares of preferred stock. In that event, we will issue receipts for depositary shares, and each of these depositary shares will represent a fraction (to be set forth in the applicable prospectus supplement) of a share of a particular series of preferred stock.

The shares of any series of preferred stock underlying the depositary shares will be deposited under a deposit agreement between us and a bank or trust company selected by us. The depositary will have its principal office in the United States and a combined capital and surplus of at least $50,000,000.

Subject to the terms of the deposit agreement, each owner of a depositary share will be entitled, in proportion to the applicable fraction of a share of preferred stock underlying the depositary share, to all the rights and preferences of the preferred stock underlying that depositary share. Those rights may include dividend, voting, redemption, conversion and liquidation rights.

The depositary shares will be evidenced by depositary receipts issued under a deposit agreement. Depositary receipts will be distributed to those persons purchasing the fractional shares of preferred stock underlying the depositary shares, in accordance with the terms of the offering. The following description of the material terms of the deposit agreement, the depositary shares and the depositary receipts is only a summary, and you should refer to the forms of the deposit agreement and depositary receipts that will be filed with the SEC in connection with the offering of the specific depositary shares for more complete information.

Pending the preparation of definitive engraved depositary receipts, the depositary may, upon our written order, issue temporary depositary receipts substantially identical to the definitive depositary receipts but not in definitive form. These temporary depositary receipts entitle their holders to all the rights of definitive depositary receipts. Temporary depositary receipts will then be exchangeable for definitive depositary receipts at our expense.

Dividends and Other Distributions

The depositary will distribute all cash dividends or other cash distributions received with respect to the underlying stock to the record holders of depositary shares in proportion to the number of depositary shares owned by those holders.

If there is a distribution other than in cash, the depositary will distribute property received by it to the record holders of depositary shares that are entitled to receive the distribution, unless the depositary determines that it is not feasible to make the distribution. If this occurs, the depositary may, with our approval, sell the property and distribute the net proceeds from the sale to the applicable holders.

Withdrawal of Underlying Preferred Stock

Unless we say otherwise in a prospectus supplement, holders may surrender depositary receipts at the principal office of the depositary and, upon payment of any unpaid amount due to the depositary, be entitled to receive the number of whole shares of underlying preferred stock and all money and other property represented by the related depositary shares. We will not issue any partial shares of preferred stock. If the holder delivers depositary receipts evidencing a number of depositary shares that represent more than a whole number of shares of preferred stock, the depositary will issue a new depositary receipt evidencing the excess number of depositary shares to that holder.

Redemption of Depositary Shares

If a series of preferred stock represented by depositary shares is subject to redemption, the depositary shares will be redeemed from the proceeds received by the depositary resulting from the redemption, in whole or in part,

 

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of that series of underlying stock held by the depositary. The redemption price per depositary share will be equal to the applicable fraction of the redemption price per share payable with respect to that series of underlying stock. Whenever we redeem shares of underlying stock that are held by the depositary, the depositary will redeem, as of the same redemption date, the number of depositary shares representing the shares of underlying stock so redeemed. If fewer than all the depositary shares are to be redeemed, the depositary shares to be redeemed will be selected by lot or proportionately or by other equitable method, as may be determined by the depositary.

Voting

Upon receipt of notice of any meeting at which the holders of the underlying stock are entitled to vote, the depositary will mail the information contained in the notice to the record holders of the depositary shares underlying the preferred stock. Each record holder of the depositary shares on the record date (which will be the same date as the record date for the underlying stock) will be entitled to instruct the depositary as to the exercise of the voting rights pertaining to the amount of the underlying stock represented by that holder’s depositary shares. The depositary will then try, as far as practicable, to vote the number of shares of preferred stock underlying those depositary shares in accordance with those instructions, and we will agree to take all reasonable actions which may be deemed necessary by the depositary to enable the depositary to do so. The depositary will not vote the underlying shares to the extent it does not receive specific instructions with respect to the depositary shares representing the preferred stock.

Conversion or Exchange of Preferred Stock

If the deposited preferred stock is convertible into or exchangeable for other securities, the following will apply. The depositary shares, as such, will not be convertible into or exchangeable for such other securities. Rather, any holder of the depositary shares may surrender the related depositary receipts, together with any amounts payable by the holder in connection with the conversion or the exchange, to the depositary with written instructions to cause conversion or exchange of the preferred stock represented by the depositary shares into or for such other securities. If only some of the depositary shares are to be converted or exchanged, a new depositary receipt or receipts will be issued for any depositary shares not to be converted or exchanged.

Amendment and Termination of the Deposit Agreement

The form of depositary receipt evidencing the depositary shares and any provision of the deposit agreement may at any time be amended by agreement between us and the depositary. However, any amendment which materially and adversely alters the rights of the holders of depositary shares will not be effective unless the amendment has been approved by the holders of at least a majority of the depositary shares then outstanding. The deposit agreement may be terminated by us upon not less than 60 days’ notice whereupon the depositary shall deliver or make available to each holder of depositary shares, upon surrender of the depositary receipts held by such holder, the number of whole or fractional shares of preferred stock represented by such receipts. The deposit agreement will automatically terminate if (a) all outstanding depositary shares have been redeemed or converted into or exchanged for any other securities into or for which the underlying preferred stock are convertible or exchangeable or (b) there has been a final distribution of the underlying stock in connection with our liquidation, dissolution or winding up and the underlying stock has been distributed to the holders of depositary receipts.

Charges of Depositary

We will pay all transfer and other taxes and governmental charges arising solely from the existence of the depositary arrangements. We will also pay charges of the depositary in connection with its duties in accordance with the deposit agreement. Holders of depositary receipts will pay transfer and other taxes and governmental and other charges, including a fee for any permitted withdrawal of shares of underlying stock upon surrender of depositary receipts, as are expressly provided in the deposit agreement to be for their accounts.

 

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Reports

The depositary will forward to holders of depositary receipts all reports and communications from us that we deliver to the depositary and that we are required to furnish to the holders of the underlying stock.

Limitation on Liability

Neither we nor the depositary will be liable if either of us is prevented or delayed by law or any circumstance beyond our control in performing our respective obligations under the deposit agreement. Our obligations and those of the depositary will be limited to performance in good faith of our respective duties under the deposit agreement. Neither we nor the depositary will be obligated to prosecute or defend any legal proceeding in respect of any depositary shares or underlying stock unless satisfactory indemnity is furnished. We and the depositary may rely upon written advice of counsel or accountants, or upon information provided by persons presenting underlying stock for deposit, holders of depositary receipts or other persons believed to be competent and on documents believed to be genuine.

In the event the depositary receives conflicting claims, requests or instructions from any holders of depositary shares, on the one hand, and us, on the other, the depositary will act on our claims, requests or instructions.

Resignation and Removal of Depositary

The depositary may resign at any time by delivering notice to us of its election to resign. We may remove the depositary at any time. Any resignation or removal will take effect upon the appointment of a successor depositary and its acceptance of the appointment. The successor depositary must be appointed within 60 days after delivery of the notice of resignation or removal and must be a bank or trust company having its principal office in the United States and having a combined capital and surplus of at least $50,000,000.

 

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Description of Debt Securities

The debt securities covered by this prospectus will be our direct unsecured obligations. The debt securities will be either senior debt securities that rank on an equal basis with all our other unsecured and unsubordinated debt, or they will be junior subordinated debt securities that will rank junior to all of our senior unsecured debt including any senior subordinated debt.

The following description briefly sets forth certain general terms and provisions of the debt securities. The prospectus supplement for a particular series of debt securities will describe the particular terms of the debt securities we offer and the extent to which these general provisions may apply to that particular series of debt securities.

Our senior debt securities have been or will be issued under a senior debt indenture, dated as of February 15, 2006, by and among us and Bank of New York Mellon, as trustee, as supplemented by an officers’ certificate issued pursuant thereto or a supplemental indenture entered into by us and the trustee pursuant thereto. Our junior subordinated debt securities have been or will be issued under a junior subordinated debt indenture, dated as of February 12, 2007, as supplemented by an officers’ certificate issued pursuant thereto or a supplemental indenture entered into by us and the trustee pursuant thereto. Forms of the senior debt indenture and the junior subordinated debt indenture have been filed with the SEC and are incorporated by reference as Exhibits 4.1 and 4.4, respectively, to the registration statement on Form S-3 under the Securities Act of 1933, of which this prospectus forms a part. The senior debt indenture and the junior subordinated debt indenture are sometimes referred to in this prospectus individually as an “indenture” and collectively as the “indentures.”

We have summarized all material provisions of the indentures below. You should read the indentures for further information. If we make no distinction in the following summaries between the senior debt securities and the junior subordinated debt securities or between the indentures, such summaries refer to any debt securities and either indenture.

General

The indentures allow us to issue either senior or junior subordinated debt securities from time to time under the applicable indenture without limitation as to amount. We may issue the debt securities in one or more series with the same or different terms.

Because we are a holding company, our rights and the rights of our creditors, including the holders of debt securities, to participate in the assets of any subsidiary upon its liquidation or recapitalization will be subject to the prior claims of the subsidiary’s creditors, except to the extent that we may ourself be a creditor with recognized claims against the subsidiary.

We may sell debt securities at a substantial discount below their stated principal amount that bear no interest or below market rates of interest. The applicable prospectus supplement will describe the material federal income tax consequences and special investment considerations applicable to any such series of debt securities.

Provisions Generally Applicable to Both Senior and Junior Subordinated Debt Securities

Unless otherwise indicated, the following terms apply to both the senior debt securities and the junior subordinated debt securities and to both of the indentures.

Terms Specified in the Prospectus Supplement

A prospectus supplement relating to any series of debt securities being offered will include specific terms relating to the offering.

 

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With respect to either indenture, the prospectus supplement will include some or all of the following for a particular series of debt securities:

 

   

the title of debt securities;

 

   

any limit on the aggregate principal amount of the debt securities;

 

   

the price or prices at which we will sell the debt securities;

 

   

the maturity date or dates of the debt securities;

 

   

the per annum interest rate or rates, if any, on the series and the date or dates from which any such interest will accrue;

 

   

whether the amount of payments of principal of and premium, if any, or interest on the debt securities may be determined with reference to any index, formula or other method, such as one or more currencies, commodities, equity indices or other indices, and the manner of determining the amount of such payments;

 

   

the dates or dates, or the method by which such date or dates will be determined or, in the case of the junior subordinated indenture, extended, on which we will pay interest on the debt securities and the regular record date for determining who is entitled to the interest payable on any interest payment date;

 

   

the place or places where the principal of and premium, if any, and interest on the debt securities will be payable;

 

   

if we possess the option to do so, the periods within which and the prices at which we may redeem the debt securities, in whole or in part, pursuant to optional redemption provisions, and the other terms and conditions of any such provisions;

 

   

our obligation, if any, to redeem, repay or purchase debt securities by making periodic payments to a sinking fund or through an analogous provision or at the option of holders of the debt securities, and the period or periods within which and the price or prices at which we will redeem, repay or purchase the debt securities, in whole or in part, pursuant to such obligation, and the other terms and conditions of such obligation;

 

   

the denominations in which the debt securities will be issued, if other than $1,000 and integral multiples of $1,000;

 

   

the portion or methods of determining the portion of the principal amount of the debt securities which we must pay upon the acceleration of the maturity of the debt securities in connection with an Event of Default, as described below, if other than the full principal amount;

 

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