10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended June 30, 2004

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

Commission File Number: 1-10777

Ambac Financial Group, Inc.

(Exact name of Registrant as specified in its charter)

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

(212) 668-0340

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

As of July 30, 2004, 108,456,419 shares of Common Stock, par value $0.01 per share, (net of 332,454 treasury shares) of the Registrant were outstanding.

Ambac Financial Group, Inc. and Subsidiaries

INDEX

		PAGE
PART I FINANCIAL INFORMATION
Item 1.	Unaudited Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
	Consolidated Balance Sheets – June 30, 2004 and December 31, 2003	3
	Consolidated Statements of Operations – three and six months ended June 30, 2004 and 2003	4
	Consolidated Statements of Stockholders’ Equity – six months ended June 30, 2004 and 2003	5
	Consolidated Statements of Cash Flows – six months ended June 30, 2004 and 2003	6
	Notes to Unaudited Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	39
PART II OTHER INFORMATION
Item 4.	Submission of Matters to a Vote of Security Holders	40
Item 6.	Exhibits and Reports on Form 8-K	41
SIGNATURES		42
INDEX TO EXHIBITS		43

PART 1 - FINANCIAL INFORMATION

Item 1 - Financial Statements of Ambac Financial Group, Inc. and Subsidiaries

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

June 30, 2004 and December 31, 2003

(Dollars in Thousands)

	June 30, 2004			December 31, 2003
	(unaudited)
Assets
Investments:
Fixed income securities, at fair value (amortized cost of $12,864,478 in 2004 and $12,403,247 in 2003)	$	13,057,681		$	12,860,068
Fixed income securities pledged as collateral, at fair value (amortized cost of $661,637 in 2004 and $662,046 in 2003)		656,938			661,422
Short-term investments, at cost (approximates fair value)		238,184			250,382
Other (cost of $4,196 in 2004 and $4,528 in 2003)		4,208			4,417
Total investments		13,957,011			13,776,289
Cash		33,164			24,449
Securities purchased under agreements to resell		43,000			54,015
Receivable for securities sold		152,192			4,425
Investment income due and accrued		142,361			159,439
Reinsurance recoverable on paid and unpaid losses		2,183			3,030
Prepaid reinsurance		290,234			325,461
Deferred acquisition costs		190,299			175,296
Loans		835,429			837,981
Derivative product assets		978,679			1,146,408
Variable interest entity		150,779			189,482
Other assets		76,175			51,039
Total assets	$	16,851,506		$	16,747,314
Liabilities and Stockholders’ Equity
Liabilities:
Unearned premiums	$	2,727,315		$	2,545,490
Loss and loss expense reserves		238,091			189,414
Ceded reinsurance balances payable		23,134			15,383
Obligations under investment and payment agreements		6,388,408			6,545,759
Obligations under investment repurchase agreements		342,801			530,644
Securities sold under agreement to repurchase		223,200			225,500
Deferred income taxes		110,304			171,058
Current income taxes		39,385			43,176
Debentures		791,807			791,775
Accrued interest payable		56,917			73,941
Derivative product liabilities		796,363			946,178
Other liabilities		233,663			222,126
Variable interest entity		150,779			189,482
Payable for securities purchased		265,126			2,830
Total liabilities		12,387,293			12,492,756
Stockholders’ equity:
Preferred stock		—			—
Common stock		1,088			1,073
Additional paid-in capital		670,293			606,468
Accumulated other comprehensive income		120,035			266,919
Retained earnings		3,698,656			3,380,098
Common stock held in treasury at cost		(25,859	)		—
Total stockholders’ equity		4,464,213			4,254,558
Total liabilities and stockholders’ equity	$	16,851,506		$	16,747,314

See accompanying Notes to Unaudited Consolidated Financial Statements

3

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

For the Three and Six Months Ended June 30, 2004 and 2003

(Dollars in Thousands Except Share Data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Revenues:
Financial Guarantee:
Gross premiums written	$	363,196		$	386,005		$	589,630		$	583,224
Ceded premiums written		15,949			(42,313	)		(17,937	)		(73,481	)
Net premiums written	$	379,145		$	343,692		$	571,693		$	509,743
Net premiums earned	$	189,593		$	151,992		$	355,028		$	286,744
Other credit enhancement fees		11,809			12,294			23,245			22,658
Net premiums earned and other credit enhancement fees		201,402			164,286			378,273			309,402
Net investment income		88,081			79,892			174,785			156,487
Net realized investment gains		3,294			12,777			15,165			26,720
Net mark-to-market gains (losses) on credit derivative contracts		3,256			10,002			10,218			(2,174	)
Variable interest entity		839			—			1,900			—
Other income (loss)		1,355			1,931			(10,864	)		2,756
Financial Services:
Interest from investment and payment agreements		45,740			55,476			98,090			114,472
Other revenue (loss)		7,698			(9,544	)		15,118			(3,997	)
Net realized investment (losses) gains		(108	)		4,641			5,843			4,949
Net mark-to-market gains on derivative hedge contracts		41			51			104			728
Corporate:
Net investment income		386			2,108			756			3,039
Net realized investment gains		42			—			18			—
Total revenues		352,026			321,620			689,406			612,382
Expenses:
Financial Guarantee:
Loss and loss expenses		17,500			10,900			35,000			20,700
Underwriting and operating expenses		29,246			21,013			54,900			43,179
Variable interest entity		701			—			1,605			—
Financial Services:
Interest from investment and payment agreements		40,678			50,160			83,370			103,592
Other expenses		3,381			2,557			7,076			5,514
Interest		13,461			14,537			27,086			26,991
Corporate		2,601			2,227			4,790			10,500
Total expenses		107,568			101,394			213,827			210,476
Income before income taxes		244,458			220,226			475,579			401,906
Provision for income taxes		63,562			57,469			122,928			101,087
Income from continuing operations		180,896			162,757			352,651			300,819
Discontinued operations:
Loss from discontinued operations		(310	)		(312	)		(550	)		(543	)
Income tax benefit		(124	)		(126	)		(220	)		(218	)
Net loss from discontinued operations		(186	)		(186	)		(330	)		(325	)
Net income	$	180,710		$	162,571		$	352,321		$	300,494
Earnings per share:
Income from continuing operations	$	1.67		$	1.53		$	3.26		$	2.83
Discontinued operations	$	0.00		$	0.00		$	0.00		$	0.00
Net income	$	1.67		$	1.53		$	3.26		$	2.83
Earnings per diluted share:
Income from continuing operations	$	1.63		$	1.48		$	3.18		$	2.75
Discontinued operations	$	0.00		$	0.00		$	0.00		$	0.00
Net income	$	1.63		$	1.48		$	3.18		$	2.75
Weighted average number of common shares outstanding:
Basic		108,412,326			106,428,045			108,090,945			106,246,887
Diluted		110,924,314			109,417,451			110,673,431			109,005,885

See accompanying Notes to Unaudited Consolidated Financial Statements

4

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

For The Six Months Ended June 30, 2004 and 2003

(Dollars in Thousands)

	2004						2003
Retained Earnings:
Balance at January 1	$	3,380,098					$	2,820,281
Net income		352,321		$	352,321			300,494			300,494
Dividends declared - common stock		(23,754	)					(21,231	)
Exercise of stock options		(10,009	)					(11,179	)
Balance at June 30	$	3,698,656					$	3,088,365
Accumulated Other Comprehensive Income:
Balance at January 1	$	266,919					$	265,427
Unrealized (losses) gains on securities, ($263,429) and $175,726, pre-tax in 2004 and 2003, respectively(1)					(169,379	)					111,634
Gain on derivative hedges					21,680						677
Foreign currency translation gain					815						535
Other comprehensive (loss) income		(146,884	)		(146,884	)		112,846			112,846
Comprehensive income				$	205,437					$	413,340
Balance at June 30	$	120,035					$	378,273
Preferred Stock:
Balance at January 1 and June 30	$	—					$	—
Common Stock:
Balance at January 1	$	1,073					$	1,062
Issuance of stock		15						5
Balance at June 30	$	1,088					$	1,067
Additional Paid-in Capital:
Balance at January 1	$	606,468					$	550,289
Employee benefit plans		27,248						14,489
Issuance of stock		38,735						11,490
Capital issuance costs		(2,158	)					(2,471	)
Balance at June 30	$	670,293					$	573,797
Common Stock Held in Treasury at Cost:
Balance at January 1	$	0					$	(11,880	)
Cost of shares acquired		(51,566	)					(23,835	)
Shares issued under equity plans		25,707						35,715
Balance at June 30	$	(25,859	)				$	0
Total Stockholders’ Equity at June 30	$	4,464,213					$	4,041,502
(1) Disclosure of reclassification amount:
Unrealized holding (losses) gains arising during period	$	(155,933	)				$	135,559
Less: reclassification adjustment for net gains included in net income		13,446						23,925
Net unrealized (losses) gains on securities	$	(169,379	)				$	111,634

See accompanying Notes to Unaudited Consolidated Financial Statements

5

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

For The Six Months Ended June 30, 2004 and 2003

(Dollars in Thousands)

	Six Months Ended June 30,
	2004			2003
Cash flows from operating activities:
Net income	$	352,321		$	300,494
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,520			1,614
Amortization of bond premium and discount		(2,958	)		6,915
Current income taxes		(3,791	)		(19,335	)
Deferred income taxes		18,865			(1,767	)
Deferred acquisition costs		(15,003	)		(591	)
Unearned premiums, net		217,052			223,663
Loss and loss expenses		49,524			10,533
Ceded reinsurance balances payable		7,751			(1,896	)
Investment income due and accrued		17,078			495
Accrued interest payable		(17,024	)		(13,837	)
Net realized investment gains		(21,026	)		(31,669	)
Net mark-to-market (gains) losses on credit derivative contracts and derivative hedge contracts		(10,322	)		1,446
Other, net		(53,002	)		32,724
Net cash provided by operating activities		540,985			508,789
Cash flows from investing activities:
Proceeds from sales of bonds		1,704,361			1,604,622
Proceeds from matured bonds		750,199			1,570,333
Purchases of bonds		(2,776,072	)		(3,849,511	)
Change in short-term investments		12,198			6,616
Securities purchased under agreements to resell		11,015			81,210
Loans		2,552			23,362
Other, net		26,140			(8,644	)
Net cash used in investing activities		(269,607	)		(572,012	)
Cash flows from financing activities:
Dividends paid		(23,754	)		(21,231	)
Securities sold under agreements to repurchase		(2,300	)		8,092
Proceeds from issuance of investment and payment agreements		934,521			956,327
Payments for investment and payment agreement draws		(1,218,540	)		(1,062,892	)
Proceeds from issuance of debentures		—			363,188
Payment for redemption of debentures		—			(200,000	)
Capital issuance costs		(2,158	)		(2,471	)
Issuance of common stock		38,751			11,494
Proceeds from sale of treasury stock		25,707			35,715
Purchases of treasury stock		(51,566	)		(23,835	)
Net cash collateral received		36,676			—
Net cash (used in) provided by financing activities		(262,663	)		64,387
Net cash flow		8,715			1,164
Cash at January 1		24,449			25,816
Cash at June 30	$	33,164		$	26,980
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes	$	71,170		$	100,000
Interest expense on debt	$	27,583		$	26,840
Interest expense on investment agreements	$	78,713		$	101,447

See accompanying Notes to Unaudited Consolidated Financial Statements

6

Ambac Financial Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands)

(1) Background and Basis of Presentation

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

Ambac’s consolidated unaudited interim financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America (“GAAP”) and, in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of Ambac’s financial condition, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the three and six months ended June 30, 2004 may not be indicative of the results that may be expected for the full year ending December 31, 2004. These consolidated financial statements and notes should be read in conjunction with the financial statements and notes included in the consolidated financial statements of Ambac Financial Group, Inc. and its subsidiaries contained in (i) Ambac’s Annual Report on Form 10-K for the year ended December 31, 2003, which was filed with the Securities and Exchange Commission on March 15, 2004, and (ii) Ambac’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004, which was filed with the SEC on May 10, 2004.

The consolidated financial statements include the accounts of Ambac, its subsidiaries and a variable interest entity for which Ambac is the primary beneficiary. All significant intercompany balances have been eliminated.

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

(2) Segment Information

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

7

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

Pursuant to insurance and indemnity agreements, Ambac Assurance guarantees the swap and investment agreement obligations of Ambac’s Financial Services subsidiaries. Intersegment revenues include the premiums earned under those agreements and dividends received. Such premiums are determined as if they were premiums to third parties, that is, at current market prices.

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

The following table summarizes the financial information from continuing operations by reportable segment as of and for the three and six month periods ended June 30, 2004 and 2003:

(Dollars in thousands) Three months ended June 30,	Financial Guarantee		Financial Services			Corporate And Other			Intersegment Eliminations			Consolidated
2004:
Revenues:
Unaffiliated customers	$	298,227	$	53,371		$	428		$	—		$	352,026
Intersegment		5,599		(1,128	)		25,750			(30,221	)		—
Total revenues	$	303,826	$	52,243		$	26,178		$	(30,221	)	$	352,026
Income before income taxes:
Unaffiliated customers	$	250,780	$	9,312		$	(15,634	)	$	—		$	244,458
Intersegment		7,021		(1,180	)		25,164			(31,005	)		—
Total income before income taxes	$	257,801	$	8,132		$	9,530		$	(31,005	)	$	244,458
Identifiable assets	$	8,791,608	$	7,961,957		$	97,941		$	—		$	16,851,506
2003:
Revenues:
Unaffiliated customers	$	268,888	$	50,624		$	2,108		$	—		$	321,620
Intersegment		1,218		(1,113	)		22,400			(22,505	)		—
Total revenues	$	270,106	$	49,511		$	24,508		$	(22,505	)	$	321,620
Income before income taxes:
Unaffiliated customers	$	236,975	$	(2,093	)	$	(14,656	)	$	—		$	220,226
Intersegment		1,754		(660	)		21,974			(23,068	)		—
Total income before income taxes	$	238,729	$	(2,753	)	$	7,318		$	(23,068	)	$	220,226
Identifiable assets	$	7,787,223	$	8,822,514		$	187,562		$	—		$	16,797,299

8

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

(Dollars in thousands) Six months ended June 30,	Financial Guarantee		Financial Services			Corporate And Other			Intersegment Eliminations			Consolidated
2004:
Revenues:
Unaffiliated customers	$	569,477	$	119,155		$	774		$	—		$	689,406
Intersegment		11,316		(2,715	)		55,176			(63,777	)		—
Total revenues	$	580,793	$	116,440		$	55,950		$	(63,777	)	$	689,406
Income before income taxes:
Unaffiliated customers	$	477,972	$	28,709		$	(31,102	)	$	—		$	475,579
Intersegment		14,100		(2,819	)		54,004			(65,285	)		—
Total income before income taxes	$	492,072	$	25,890		$	22,902		$	(65,285	)	$	475,579
Identifiable assets	$	8,791,608	$	7,961,957		$	97,941		$	—		$	16,851,506
2003:
Revenues:
Unaffiliated customers	$	493,191	$	116,152		$	3,039		$	—		$	612,382
Intersegment		2,988		(2,653	)		44,800			(45,135	)		—
Total revenues	$	496,179	$	113,499		$	47,839		$	(45,135	)	$	612,382
Income before income taxes:
Unaffiliated customers	$	429,312	$	7,046		$	(34,452	)	$	—		$	401,906
Intersegment		4,009		(1,747	)		43,948			(46,210	)		—
Total income before income taxes	$	433,321	$	5,299		$	9,496		$	(46,210	)	$	401,906
Identifiable assets	$	7,787,223	$	8,822,514		$	187,562		$	—		$	16,797,299

The following table summarizes unaffiliated gross premiums written and net premiums earned and other credit enhancement fees included in the financial guarantee segment by location of risk for the three and six months ended June 30, 2004 and 2003:

(Dollars in thousands)	Three Months				Six Months
	Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees		Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees
2004:
United States	$	306,014	$	146,019	$	480,297	$	272,279
United Kingdom		25,525		16,552		53,376		30,352
Japan		6,581		7,731		13,515		15,211
Italy		6,207		1,929		7,619		3,876
Mexico		3,774		1,732		7,731		3,548
Australia		687		2,115		924		3,534
Germany		519		1,510		1,100		3,182
Internationally diversified (1)		7,581		15,228		13,835		28,534
Other international		6,308		8,586		11,233		17,757
Total	$	363,196	$	201,402	$	589,630	$	378,273
2003:
United States	$	286,530	$	122,466	$	440,357	$	229,321
United Kingdom		66,590		7,354		78,644		14,277
Japan		6,576		6,683		13,168		12,301
Italy		5,860		1,403		9,035		2,803
Mexico		3,614		1,754		7,969		3,761
Australia		194		1,378		4,347		2,712
Germany		390		1,493		822		2,879
Internationally diversified (1)		9,519		15,417		16,012		29,275
Other international		6,732		6,338		12,870		12,073
Total	$	386,005	$	164,286	$	583,224	$	309,402

1) Internationally diversified includes guarantees with multiple locations of risk and includes components of United States exposure.

9

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

(3) Stock Options

Ambac sponsors the “1997 Equity Plan”, where awards are granted to eligible employees of Ambac in the form of non-qualified stock options and other stock-based awards. Prior to 2003, Ambac accounted for such awards under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees”. Effective January 1, 2003, Ambac adopted the fair value recognition provisions of SFAS Statement No. 123, “Accounting for Stock-Based Compensation”, prospectively to all employee awards granted after January 1, 2003. The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period:

(Dollars in thousands, except per share information)	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Net income, as reported	$	180,710		$	162,571		$	352,321		$	300,494
Add: Stock-based employee compensation included in reported net income, net of tax		1,129			850			2,244			1,621
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of tax		(2,995	)		(3,601	)		(5,975	)		(7,124	)
Pro-forma net income	$	178,844		$	159,820		$	348,590		$	294,991
Earnings per share:
As reported	$	1.67		$	1.53		$	3.26		$	2.83
Pro-forma	$	1.65		$	1.50		$	3.22		$	2.78
Earnings per diluted share:
As reported	$	1.63		$	1.48		$	3.18		$	2.75
Pro-forma	$	1.61		$	1.46		$	3.15		$	2.71

10

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

(4) Special Purpose and Variable Interest Entities

In January 2003, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN 46”). In December 2003, the FASB released a revision of FIN 46 (“FIN 46-R”), which includes substantial changes from the original FIN 46. Ambac adopted FIN 46-R as of December 31, 2003. FIN 46 and FIN 46-R provides accounting and disclosure rules for determining whether certain entities should be consolidated in Ambac’s consolidated financial statements. An entity is subject to FIN 46 and FIN 46-R, and is called a Variable Interest Entity (“VIE”), if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support or (ii) equity investors that cannot make significant decisions about the entity’s operations or that do not absorb the expected losses or receive the expected returns of the entity. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE or both. FIN 46 requires disclosures for companies that have either a primary or significant variable interest in a VIE. All other entities not considered VIEs are evaluated for consolidation under SFAS No. 94, “Consolidation of all Majority-Owned Subsidiaries”.

Ambac has involvement with special purpose entities, including VIEs in two ways. First, Ambac is a provider of financial guarantee insurance for various securitized asset-backed debt obligations, including mortgage-backed security obligations, collateralized debt obligations (“CDO”) and other asset-backed securitization obligations. Second, Ambac has sponsored two special purpose entities that issue medium-term notes (“MTNs”) to fund the purchase of certain financial assets. As discussed in detail below, these Ambac sponsored special purpose entities are considered Qualifying Special Purpose Entities (“QSPEs”).

Financial Guarantees:

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

Ambac is the primary beneficiary of one VIE with assets and liabilities of $150,779 at June 30, 2004 and $189,482 at December 31, 2003. Ambac consolidated this entity since the structural financial protections are outside the VIE. This VIE is a bankruptcy remote special purpose financing entity created to facilitate the sale of floating rate notes. This VIE was capitalized in 2002 through the issuance of $299,600 of floating rate notes, guaranteed by Ambac Assurance. The proceeds of the VIE note issuance were used to purchase senior mortgage-backed floating

11

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

rate notes of a Korean mortgage-backed securities issuer. Ambac’s creditors do not have rights with regard to the assets of the VIE. Protections afforded Ambac Assurance in this transaction were in the form of a reserve fund and first loss protection through subordinated debt issued of approximately $40,000. Ambac Assurance will pay claims under its financial guarantee only in the event that losses on the mortgage assets of the Korean issuer reduce the reserve fund to zero and exceed the principal amount of the subordinated notes.

The following table provides supplemental information about assets and liabilities associated with this entity under the balance sheet caption “Variable interest entity”:

	At June 30, 2004		At December 31, 2003
Assets:
Cash	$	199	$	90
Investment in mortgage-backed security		150,357		189,151
Investment income due and accrued		223		241
Total	$	150,779	$	189,482
Liabilities:
Floating rate notes payable	$	150,357	$	189,151
Accrued interest payable		183		294
Other		239		37
Total	$	150,779	$	189,482

Qualified Special Purpose Entities:

Ambac has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with Statement of Financial Accounting Standards 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). QSPEs are not subject to the requirements of FIN 46-R and accordingly are not consolidated in Ambac’s financial statements. However, see the discussion below on the Exposure Draft issued by the FASB that could change the accounting rules for QSPEs in the future. The QSPEs are legal entities that are demonstrably distinct from Ambac. Ambac, its affiliates or its agents cannot unilaterally dissolve the QSPEs. The QSPEs permitted activities are limited to those outlined below.

As of June 30, 2004, there have been 14 individual transactions (1 in 2004) processed through the QSPEs of which 10 are outstanding. In each case, Ambac sells fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPE and the absence of any agreement or obligation for Ambac to repurchase or redeem assets of the QSPE. The purchase by the QSPE is financed through the issuance of MTNs, which are collateralized by the purchased assets. The cash flows of the MTNs approximately match the cash flows of the assets purchased. Derivative contracts (interest rate and currency swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchase, executing derivative hedges and related administrative services. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued or both. As of June 30, 2004, Ambac Assurance had financial guarantee insurance policies issued for all assets and MTNs owned and outstanding by the QSPEs.

Ambac’s exposures under these financial guarantee insurance policies as of December 31, 2003 is included in the disclosure in Note 12 “Guarantees in Force” of Ambac’s 2003 Annual Report. Pursuant to the terms of Ambac Assurance’s insurance policy, insurance premiums are paid to Ambac Assurance by the QSPEs and are earned in a manner consistent

12

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

with other insurance policies, over the risk period. Any losses incurred would be included in Ambac’s Consolidated Statements of Operations. Under the terms of an Administrative Agency Agreement, Ambac provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.

Assets sold to the QSPEs during the six months ended June 30, 2004 and the year ended December 31, 2003 were $195,000 and $250,000, respectively. No gains or losses were recognized on these sales. As of June 30, 2004, the estimated fair value of financial assets, MTN liabilities and derivative hedge liabilities were $1,868,368, $1,759,178 and $88,509, respectively. When market quotes are not available, estimated fair value is determined utilizing valuation models. These models include estimates, made by Ambac management, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $2,838 and $5,278 for the six months ended June 30, 2004 and the year ended December 31, 2003, respectively. Ambac also received fees for providing other services amounting to $197 and $461 for the six months ended June 30, 2004 and the year ended December 31, 2003, respectively.

In June 2003, the FASB issued an Exposure Draft for proposed Statement of Financial Accounting Standards entitled “Qualifying Special-Purposes Entities and Isolation of Transferred Assets”, an amendment of FASB Statement No. 140 (“The Exposure Draft”). The Exposure Draft is a proposal that is subject to change and as such, is not yet authoritative. If the proposal is enacted in its current form, it will amend and clarify SFAS 140. The Exposure Draft would prohibit an entity from being a QSPE if it enters into an agreement that obligates a transferor of financial assets, its affiliates, or its agents to deliver additional cash or other assets to fulfill the SPE’s obligations to beneficial interest holders. If this Exposure Draft becomes enacted as currently proposed and if the QSPEs issue new beneficial interests after the effective date and receive assets other than those they are committed to receive under commitments to beneficial interest holders made before the effective date of the final statement, management believes Ambac would be required to consolidate. This conclusion is based upon the fact that Ambac provides financial support to these entities such as financial guarantees and liquidity commitments. Should Ambac be required to consolidate under this Exposure Draft if enacted as proposed, the financial statement impact would be to gross up Ambac’s consolidated balance sheet for the assets and liabilities held by the QSPEs that approximate $1,800,000 at June 30, 2004. Additionally, fees received by Ambac from the QSPEs (primarily insurance premiums) would be eliminated in consolidation and essentially reclassified to net interest income. The risk characteristics of these transactions are not impacted by consolidation.

(5) Pension and Postretirement Benefits

Pensions:

Ambac has a defined benefit pension plan covering substantially all employees of Ambac. The benefits are based on years of service and the employee’s highest salary during five consecutive years of employment within the last ten years of employment. Ambac’s funding policy is to contribute annually the maximum amount that can be deducted for Federal income tax purposes. Contributions for 2004 are estimated to be approximately $2,300. Contributions are intended to provide not only for benefits attributed to service-to-date, but also for those expected to be earned in the future.

13

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

Net periodic pension costs for the three and six months ended June 30 include the following components:

	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Service cost	$	409		$	414		$	817		$	827
Interest cost		332			287			663			575
Expected return on plan assets		(488	)		(416	)		(975	)		(832	)
Amortization of prior service cost		(36	)		(33	)		(72	)		(66	)
Recognized net loss		51			10			102			19
Net periodic pension cost		268			262			535			523
Other		—			—			136			—
Total pension expense	$	268		$	262		$	671		$	523

Postretirement and Other Benefits:

Ambac provides certain medical and life insurance benefits for retired employees and eligible dependents. All plans are contributory. None of the plans are currently funded. Post retirement benefit expense was $82 and $130 for the three and six months ended June 30, 2004, respectively, compared to $36 and $79 for the three and six months ended June 30, 2003, respectively.

(6) Stockholders’ Equity

Ambac is authorized to issue 350,000,000 shares of Common Stock, par value $0.01 per share, of which 108,788,873 were issued as of June 30, 2004. Ambac is also authorized to issue 4,000,000 shares of Preferred Stock, $0.01 par value per share, none of which was issued and outstanding as of June 30, 2004.

(7) Accounting Standards

In January 2004, the FASB issued FASB Staff Position No. FAS 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“FSP FAS 106-1”), in response to the December 2003 enactment of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). The Act introduces a prescription drug benefit for individuals under Medicare (Medicare Part D) as well as a federal subsidy equal to 28% of prescription drug claims for sponsors of retiree health care plans with drug benefits that are at least actuarially equivalent to those to be offered under Medicare Part D. FSP FAS 106-1 allows plan sponsors the option of accounting for the effects of the Act in financial statements for periods that cover the date of enactment or making a one-time election to defer the accounting for the effects of the Act. Ambac plans to recognize the effects of the Act later in 2004. Measurements of the accumulated projected benefit obligation or net periodic postretirement benefit cost in the financial statements or accompanying notes do not reflect the effects of the Act on Ambac’s postretirement benefit plans. The Act is not expected to have a material effect on Ambac’s operating results.

14

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

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 Financial Group provides financial guarantees for public finance and structured finance obligations through its principal operating subsidiary, Ambac Assurance Corporation. Through its financial services subsidiaries, Ambac Financial Group provides financial and investment products including investment agreements, interest rate and total return swaps and funding conduits, principally to its clients which include municipalities and other public entities, health care organizations and asset-backed issuers. Additional information about Ambac Financial Group is available through our website at http://www.ambac.com. In addition, our press releases and filings with the Securities and Exchange Commission (“SEC”) are available free of charge on the investor relations portion of our website.

Ambac Assurance, which serves the global capital markets, is primarily engaged in guaranteeing public finance and structured finance debt obligations and is the successor to the founding financial guarantee insurance company, which wrote the first bond insurance policy in 1971. Financial guarantee insurance policies written by Ambac Assurance generally guarantee payment when due of the principal of and interest on the guaranteed obligation. Ambac Assurance seeks to minimize the risk inherent in its financial guarantee portfolio by maintaining a diverse portfolio which spreads its risk across a number of criteria, including issue size, type of obligation, geographic area and obligor.

Ambac Assurance has earned triple-A ratings, the highest ratings available from Moody’s Investors Service, Inc. (“Moody’s”), Standard & Poor’s Ratings Services (“S&P”), Fitch, Inc. (“Fitch”) and Rating and Investment Information, Inc. (“R&I”). These ratings are an essential part of Ambac Assurance’s ability to provide credit enhancement.

Ambac Credit Products LLC, a wholly owned subsidiary of Ambac Assurance, provides credit protection in the global markets in the form of structured credit derivatives. These structured credit derivatives, which are privately negotiated contracts, provide the counterparty with credit protection against the occurrence of a specific event such as a payment default or bankruptcy relating to an underlying obligation (generally a fixed income obligation). Upon a credit event, Ambac Credit Products is required to either (i) purchase the underlying obligation at its par value and a realize a loss for the difference between the par and market value of the underlying obligation or (ii), make a payment equivalent to the difference between the par value and market value of the underlying obligation. Substantially all of Ambac’s structured credit derivative contracts are structured with first loss protection. Structured credit derivatives issued by Ambac Credit Products are guaranteed by Ambac Assurance.

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

15

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Ambac Financial Group’s investment agreement business, conducted through its subsidiary, Ambac Capital Funding, Inc., provides investment agreements primarily to municipalities and their authorities, issuers of structured finance obligations and international issuers. Investment agreements are primarily used by issuers to invest bond proceeds until the proceeds can be used for their intended purpose. The investment agreement provides for the guaranteed return of principal invested, and for the payment of interest thereon at a guaranteed rate.

Ambac Financial Group provides interest rate swaps through its subsidiary Ambac Financial Services, LLC, primarily to states, municipalities and their authorities, issuers of asset-backed securities and other entities in connection with their financings. Ambac Financial Group also enters into total return swaps with professional counterparties through its subsidiary Ambac Capital Services LLC. Total return swaps are only used for fixed income obligations which meet Ambac Assurance’s credit underwriting criteria.

Critical Accounting Policies

Management has identified the accounting for loss and loss expenses and the valuation of financial instruments as critical accounting policies.

The liability for loss and loss expenses consists of active credit reserves and case basis credit reserves. Active credit reserves are established based upon estimated probable debt service defaults resulting from losses, as a result of credit deterioration. Reserve amounts are reasonably estimated based on management’s review of the financial guarantee portfolio. When defaults occur, case basis credit loss reserves are established in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default and estimated expenses associated with settling the claims, less estimated recoveries under salvage or subrogation rights. These reserves are discounted in accordance with discount rates prescribed or permitted by state regulatory authorities. All or parts of case basis credit loss reserves are allocated from any active credit reserves available. Management believes that the reserves for loss and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are necessarily based on estimates and there can be no assurance that the ultimate liability will not exceed such estimates.

The following financial instruments are carried in the accompanying balance sheets at fair value: fixed income investment securities, derivatives used for hedging purposes, derivatives held for trading purposes and certain hedged investment agreements. The fair values of fixed income investment securities are based primarily on quoted market prices received from a nationally recognized pricing service or dealer quotes. When quotes are not available, fair values are estimated based upon internal valuation models. The fair values of all derivatives are based on quoted dealer prices or pricing valuation models. All valuation models include estimates, made by management, which utilize current and historical market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market.

16

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Forward-Looking Statements

Materials in this Form 10-Q may contain information that includes or is based upon forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give Ambac’s expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts and relate to future operating or financial performance.

Any or all of Ambac’s forward-looking statements here or in other publications may turn out to be wrong and are based on current expectations and the current economic environment. Ambac’s actual results may vary materially, and there are no guarantees about the performance of our securities. Among factors that could cause actual results to differ materially are: (1) changes in the economic, credit or interest rate environment in the United States and abroad; (2) the level of activity within the national and worldwide debt markets; (3) competitive conditions and pricing levels; (4) legislative and regulatory developments; (5) changes in tax laws; (6) the policies and actions of the United States and other governments; and (7) other risks and uncertainties that have not been identified at this time. Ambac is not obligated to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in Ambac’s reports to the Securities and Exchange Commission.

Results of Operations

The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for the three and six month periods ended June 30, 2004 and 2003, and its financial condition as of June 30, 2004 and December 31, 2003. These results are presented for Ambac’s two reportable segments: Financial Guarantee and Financial Services.

Income From Continuing Operations

Ambac’s income from continuing operations for the three months ended June 30, 2004 was $180.9 million or $1.63 per diluted share, an increase of $18.1 million, compared to $162.8 million or $1.48 per diluted share. Ambac’s income before income taxes was $244.5 million for the three months ended June 30, 2004, an increase of 11% from income before income taxes of $220.2 million in the three months ended June 30, 2003. Of the $244.5 million of income before income taxes in the second quarter of 2004, $250.8 million was from Financial Guarantee, $9.3 million from Financial Services and $(15.6) million from Corporate, compared to $237.0 million, $(2.1) million and $(14.7) million for Financial Guarantee, Financial Services and Corporate, respectively in the second quarter of 2003.

Ambac’s income from continuing operations for the six months ended June 30, 2004 was $352.7 million or $3.18 per diluted share, an increase of $51.9 million, compared to $300.8 million or $2.75 per diluted share. Ambac’s income before income taxes was $475.6 million for the six months ended June 30, 2004, an increase of 18% from income before income taxes of $401.9 million in the six months ended June 30, 2003. Of the $475.6 million of income before income taxes in the first half of 2004, $478.0 million was from Financial Guarantee, $28.7 million from Financial Services and $(31.1) million from Corporate, compared to $429.3 million, $7.0 million and $(34.4) million for Financial Guarantee, Financial Services and Corporate, respectively in the first half of 2003.

17

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Corporate consists primarily of Ambac’s interest expense and other expenses, partially offset by investment income. Financial Guarantee income before income taxes for the three months ended June 30, 2004 increased as a result of (i) higher net premiums earned and other credit enhancement fees and (ii) higher net investment income, partially offset by (i) lower net mark-to-market gains on credit derivative contracts, (ii) lower net realized investment gains, (iii) a higher provision for loss and loss expenses, and (iii) higher underwriting and operating expenses. The Financial Services increase in the second quarter of 2004 is primarily attributable to higher derivative product revenues driven by a $12.0 million mark-to-market adjustment in the second quarter of 2003, partially offset by lower arbitrage business revenues. Financial Guarantee income before income taxes for the first half of 2004 increased as a result of (i) higher net premiums earned and other credit enhancement fees and (ii) higher net investment income, and (iii) higher net mark-to-market gains on credit derivative contracts, partially offset by (i) lower net realized investment gains, (ii) increased other loss, (iii) a higher provision for loss and loss expenses, and (iv) higher underwriting and operating expenses. The Financial Services increase in the first half of 2004 is primarily attributable to higher derivative product revenues as mentioned above and higher arbitrage business revenues.

Included in the second quarter and six months income from continuing operations in the Financial Guarantee segment, is the impact of cancellations of certain reinsurance contracts with two reinsurers that had been downgraded by the rating agencies in 2003. Included in ceded premiums written in the Consolidated Statement of Operations is $64.8 million in returned premiums from the cancellation, of which approximately $54.4 million was deferred. The difference, $10.4 million included in net earned premiums, results from the difference between the negotiated amount of returned premiums and the associated unearned premium remaining on the underlying guarantees. In addition to the $10.4 million in earned premiums, expenses were increased by approximately $3.5 million of reinsurance commissions. The net impact of this cancellation to the Consolidated Statements of Operations in 2004 amounted to approximately $7.0 million, $4.5 million after-tax, or $0.04 per diluted share.

Net Loss From Discontinued Operations

As previously disclosed, Ambac had entered into an agreement during the fourth quarter of 2003 to sell the operations of Cadre Financial Services, Inc. and Ambac Securities, Inc., its former investment advisory and cash management business. The transaction closed during the first quarter of 2004. This business had been part of the Financial Services segment. The net loss from discontinued operations for the three and six months ended June 30, 2004 were $0.2 million and $0.3 million, flat compared to the three and six months ended June 30, 2003.

Financial Guarantee

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

Ambac Assurance guaranteed $31.8 billion in par value bonds during the three months ended June 30, 2004, a decrease of 6% from $33.8 billion in par value bonds guaranteed during the comparable prior year period. During the six months ended June 30, 2004, Ambac Assurance guaranteed $53.6 billion in par value bonds, a 15% decrease from $63.4 billion in par during the first six months of 2003.

18

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The following table provides a breakdown of guaranteed net par outstanding by market sector at June 30, 2004 and December 31, 2003:

(Dollars in billions)	June 30, 2004		December 31, 2003
Public Finance	$	230.8	$	215.3
Structured Finance		123.0		124.1
International Finance		83.7		86.4
Total net par outstanding (1)	$	437.5	$	425.8

(1) Net par outstanding increased by $8.5 billion in 2004 as a result of the reinsurance cancellation noted above.

The following table provides a rating distribution of financial guarantee net par based upon internal Ambac Assurance credit ratings at June 30, 2004 and December 31, 2003:

	Percentage of Guaranteed Portfolio (1)
	June 30, 2004	December 31, 2003
AAA	8	10
AA	22	22
A	48	47
BBB	21	20
Below investment grade	1	1
Total	100	100

(1) Internal Ambac Assurance credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac and may differ from ratings determined by the ratings agencies. They are subject to revision at any time and do not constitute investment advice. Ambac Assurance, or one of its affiliates, has insured the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.

Public Finance:

Public finance obligations are bonds issued by states, municipalities and other governmental or not-for-profit entities located in the United States (“Public Finance”). Bond proceeds are used to finance or refinance a broad spectrum of public purpose initiatives, including education, utility, transportation, health care and other general purpose projects. Airport obligations are generally supported by (i) terminal lease revenues, parking and other concession revenues; (ii) passenger facility charges; or (iii) payments in respect of specific airport facilities. Although Ambac guarantees the full range of Public Finance obligations, Ambac concentrates on those projects that require more structuring skills. Certain projects, which had been financed by the local or U.S. government alone, are now being financed through public-private partnerships. In these transactions, debt service on the bonds, rather than being paid solely by tax revenues or other governmental funds, is being paid from a variety of revenue sources, including revenues derived from the project itself. Examples of these transactions include stadium financings, student housing and military housing. Included in transportation obligations is exposure to U.S. airports.

Public Finance bond obligations par value written for the second quarter of 2004 was $14.1 billion, compared to $12.7 billion of par value written for the second quarter of 2003. During the six months ended June 30, 2004, par value written was $22.0 billion, compared to

19

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

$20.5 billion in the six months ended June 30, 2003. The increase in guaranteed Public Finance obligations for the three and six months ended June 30, 2004 compared to June 30, 2003 was primarily due to an increase in Ambac’s market share, from 19% in the three and six months ended June 30, 2003 to 22% in the three and six months ended June 30, 2004. Although municipal issuance was down modestly for the three and six months ended June 30, 2004 compared with their comparative prior year periods, insured market penetration rose to nearly 60% in the second quarter of 2004 compared to 52% in the second quarter of 2003. The insured market penetration for the six months ended June 30, 2004 was 54% compared with 53% for the six months ended June 30, 2003.

Structured Finance:

Structured finance obligations include the securitization of a variety of asset types such as mortgages, home equity loans, leases and pooled debt obligations originated in the United States (“Structured Finance”). Included within Structured Finance are exposures to Enhanced Equipment Trust Certificates which are secured financings used by the airline industry to finance aircraft. The financings are tranched to create a priority of interests in the aircraft collateral. Ambac issues a financial guarantee on the most senior tranche of the structures. Currently, the largest component of Ambac’s Structured Finance business relates to the securitization of mortgages and home equity loans. Another component in Structured Finance is the credit enhancement of pooled debt obligations including structured credit derivatives. These transactions involve the securitization of a diverse portfolio of corporate bonds and loan obligations and asset-backed securities (the “Securitized Assets”). Ambac’s exposure to these Securitized Assets is mitigated through first loss protection. Typically, first loss protection is in the form of over-collateralization (i.e., the principal amount of the Securitized Assets exceeds the principal amount of the structured finance obligations guaranteed by Ambac Assurance), or excess spread (i.e., interest cash flows on the Securitized Assets is in excess of the interest on the debt obligations guaranteed by Ambac Assurance), which allows the transaction to experience defaults among the Securitized Assets before a default is experienced on the structured finance obligations.

Structured Finance bond obligations par value written for the second quarter of 2004 was $12.7 billion, compared to $17.1 billion of par value written for the second quarter of 2003. During the six months ended June 30, 2004, par value written was $19.6 billion, compared to $30.7 billion in the six months ended June 30, 2003. The decrease in Structured Finance obligations guaranteed for the three and six months ended June 30, 2004 as compared to the three and six months ended June 30, 2003 resulted primarily from significantly lower par written in the mortgage-backed and asset-backed sectors of the market.

International Finance:

International finance obligations include public purpose infrastructure projects and asset-backed securities originated outside the United States (“International Finance”). Ambac’s emphasis internationally has been on Western Europe, Japan and Australia. In the United Kingdom, Ambac has participated extensively in the Private Finance Initiative whereby the government has been privatizing certain infrastructure finance activities. Ambac also participates in less developed markets through certain structures such as pooled debt obligations or future flow transactions. Future flow transactions essentially securitize future revenue streams derived from operating receivables or the sale of commodities.

20

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

International Finance bond obligations par value written for the second quarter of 2004 was $5.0 billion, compared to $4.0 billion of par value written for the second quarter of 2003. During the six months ended June 30, 2004, par value written was $12.0 billion, compared to $12.2 billion in the six months ended June 30, 2003. International Finance obligations guaranteed during the three months ended June 30, 2004 increased from its comparable 2003 period primarily due to higher mortgage-backed bonds guaranteed, partially offset by lower pooled debt obligations guaranteed. International Finance obligations guaranteed during the six months ended June 30, 2004 is relatively flat as compared with the six months ended June 30, 2003 where decreases in pooled debt obligations and transportation revenue obligations were partially offset by higher asset-backed, and mortgage-backed obligations guaranteed.

Gross Premiums Written. Ambac receives insurance premiums either upfront at policy issuance or on an installment basis over the life of the transaction. The collection method is determined at the time of policy issuance. Gross premiums written for the three and six months ended June 30, 2004 were $363.2 million and $589.6 million, respectively, a decrease of $22.8 million or 6% from 386.0 million in the three months ended June 30, 2003 and an increase of $6.4 million or 1% from $583.2 million in the six months ended June 30, 2003. Up-front premiums written during the three and six months ended June 30, 2004 were $236.3 million and $355.5 million, respectively, a decrease of 17% from $283.5 million in the three months ended June 30, 2003 and a decrease of 8% from $385.1 million in the six months ended June 30, 2003. The decreases in up-front gross premiums written was primarily a result of decreased up-front premiums written in both the Structured and International Finance sector, partially offset by higher up-front gross premiums written in the Public Finance sector.

Installment premiums written for the three and six months ended June 30, 2004 were $126.9 million and $234.1 million, respectively, an increase of 24% from $102.5 million in the three months ended June 30, 2003, and an increase of 18% from $198.1 million in the six months ended June 30, 2003.

The following tables set forth the amounts of gross premiums written and the related gross par written by type:

	Three Months Ended June 30,
(Dollars in Millions)	2004				2003
	Gross Premiums Written		Gross Par Written		Gross Premiums Written		Gross Par Written
Public Finance:
Up-front	$	231.5	$	14,020	$	204.9	$	12,526
Installment		6.0		112		3.2		195
Total Public Finance		237.5		14,132		208.1		12,721
Structured Finance:
Up-front		3.0		331		17.5		852
Installment		65.5		12,366		61.0		16,209
Total Structured Finance		68.5		12,697		78.5		17,061
International Finance:
Up-front		1.8		228		61.1		1,196
Installment		55.4		4,758		38.3		2,773
Total International Finance		57.2		4,986		99.4		3,969
Total	$	363.2	$	31,815	$	386.0	$	33,751
Total up-front	$	236.3	$	14,579	$	283.5	$	14,574
Total installment		126.9		17,236		102.5		19,177
Total	$	363.2	$	31,815	$	386.0	$	33,751

21

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

	Six Months Ended June 30,
(Dollars in Millions)	2004				2003
	Gross Premiums Written		Gross Par Written		Gross Premiums Written		Gross Par Written
Public Finance:
Up-front	$	326.2	$	21,819	$	282.4	$	20,310
Installment		12.5		189		7.9		211
Total Public Finance		338.7		22,008		290.3		20,521
Structured Finance:
Up-front		15.0		1,103		33.2		1,892
Installment		126.6		18,486		116.9		28,856
Total Structured Finance		141.6		19,589		150.1		30,748
International Finance:
Up-front		14.3		2,073		69.5		1,828
Installment		95.0		9,902		73.3		10,329
Total International Finance		109.3		11,975		142.8		12,157
Total	$	589.6	$	53,572	$	583.2	$	63,426
Total up-front	$	355.5	$	24,995	$	385.1	$	24,030
Total installment		234.1		28,577		198.1		39,396
Total	$	589.6	$	53,572	$	583.2	$	63,426

Reinsurance. Ambac’s reinsurance program is principally comprised of a surplus share treaty and facultative reinsurance. The surplus share treaty requires Ambac to cede covered transactions while retaining flexibility to cede those transactions within a predefined range. Certain types of transactions are excluded from the surplus share treaty and management may use facultative reinsurance to cede such risks. Ceded premiums written for the three and six months ended June 30, 2004 were ($15.9) million and $17.9 million, respectively, a decrease from $42.3 million in the three months ended June 30, 2003 and a decrease from $73.5 million in the six months ended June 30, 2003.

In the second quarter of 2004, Ambac completed the cancellation of certain reinsurance contracts with two reinsurers, AXA Re Finance S.A. and American Re-Insurance Company, both of which had been downgraded by the rating agencies in 2003. The net par that was recaptured totaled approximately $8.5 billion. Included in ceded premiums written is $64.8 million in return premiums from the cancellations. Excluding the return premiums, ceded premiums as a percentage of gross premiums written were 14% for both the three and six months ended June 30, 2004, compared with 11% and 13% for the three and six months ended June 30, 2003, respectively. The increase in ceded premiums as a percentage of gross premiums resulted from higher cessions of Public Finance transactions.

The reinsurance of risk does not relieve Ambac of its original liability to its policyholders. In the event that any of Ambac’s reinsurers are unable to meet their obligations under reinsurance contracts, Ambac would nonetheless, be liable to its policyholders in the full amount of its policy. To minimize exposure to significant losses from reinsurers, Ambac (i) monitors the financial condition of its reinsurers; (ii) has collateral provisions in certain reinsurance contracts; and (iii) has certain termination triggers that can be exercised by Ambac in the event of a rating downgrade of a reinsurer. Ambac held letters of credit and collateral at June 30, 2004 amounting to approximately $92.4 million from its reinsurers. The following table provides ceded par outstanding by financial strength rating of Ambac’s reinsurers, on a Standard and Poor’s (“S&P) basis:

(Dollars in billions)	June 30, 2004		December 31, 2003
AAA	$	19.3	$	19.3
AA		17.2		15.9
A		2.7		7.7
Not rated		2.3		6.7
Total	$	41.5	$	49.6

22

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Net Premiums Earned and Other Credit Enhancement Fees. Net premiums earned and other credit enhancement fees for the three and six months ended June 30, 2004 were $201.4 million and $378.3 million, an increase of 23% from $164.3 million for the three months ended June 30, 2003 and an increase of 22% from $309.4 million for the six months ended June 30, 2003. These increases were primarily the result of the larger Financial Guarantee book of business and higher refundings, calls and other accelerations of previously insured obligations (collectively referred to as “accelerated earnings”).

When an issue insured by Ambac Assurance has been refunded or called, any remaining unearned premium (net of refunding credits, if any) is earned at that time. The level of refundings or calls vary depending upon a number of conditions, primarily the relationship between current interest rates and interest rates on outstanding debt. The current relatively low interest rate environment continues to prompt the high levels of refundings. When interest rates rise in the future, refundings should decline. Net premiums earned during the three and six months ended June 30, 2004 included $33.1 million and $48.3 million, respectively, from accelerated earnings as compared to $21.1 million and $33.2 million for the three and six months ended June 30, 2003, respectively. Included in the three and six months ended June 30, 2004 accelerated earnings amounts was approximately $10.4 million from the cancellation of certain reinsurance contracts as previously mentioned. This is a result of the difference between the negotiated amount of returned premiums ($64.8 million) and the associated unearned premium remaining on the underlying guarantees ($54.4 million).

Excluding the effect of accelerated earnings, normal net premiums earned (which is defined as net premiums earned less accelerated earnings and reconciled to total net premiums earned in the table below) increased 20% from $130.9 million in the second quarter of 2003 to $156.5 million in the second quarter of 2004. Normal net premiums earned for the six months ended June 30, 2004 were $306.8 million, an increase of 21% from $253.5 million in the six months ended June 30, 2003. The increases in normal net premiums earned resulted primarily from the continued growth in the insured book of business in all markets. Normal net premiums earned during the three months ended June 30, 2004 increased 19%, 14% and 29% for Public, Structured and International Finance, respectively, from the three months ended June 30, 2003. Normal net premiums earned during the six months ended June 30, 2004 increased 19%, 18% and 28% for Public, Structured and International Finance, respectively, from the six months ended June 30, 2003. The growth in normal earned premiums in Structured Finance and International Finance that has been exhibited over the past several years has moderated as those lines of business have grown significantly, resulting in more difficult comparisons quarter on quarter. Additionally, in the mortgage-backed sector, financial guarantors have faced increased competition from senior/subordinated debt structures over the past few quarters resulting in lower premiums written. This combined with the continued high level of run-off in the mortgage-backed securities book adversely impacted earned premiums. Similarly, due to a tight credit spread environment in International Finance, the pooled debt obligation market has decreased significantly, adversely impacting earned premium growth and other credit enhancement fee growth. Competitive and credit trends such as the ones we are currently experiencing in domestic mortgage-backed securities and international pooled debt obligations are a normal part of Ambac’s business.

23

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The mortgage-backed securities and pooled debt obligation exposures have relatively short average lives. As a result, the earnings from those types of exposures are recognized quickly and can bring some volatility to the traditionally stable earned premium line. A significant portion of the recent premium writings in public finance and for certain bond types within structured finance and international are for longer-term transactions. While the earned premium impact from such writings is not as immediate as the mortgage-backed or pooled debt obligations, they do contribute to some stability of the earned premiums over time.

Other credit enhancement fees, which is primarily comprised of fees received from the structured credit derivatives product, during the three and six months ended June 30, 2004 were $11.8 million and $23.2 million, respectively, a decrease of 4% from $12.3 million in the three months ended June 30, 2003 and an increase of 2% from $22.7 million in the six months ended June 30, 2003. Credit spreads on corporate credits in the current environment have narrowed and this has had a significant adverse impact on new credit derivative business in the last few quarters (when credit spreads are narrow, the demand for guaranteed products is reduced).

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

(Dollars in Millions)	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2003		2004		2003
Public Finance	$	50.7	$	42.4	$	99.8	$	83.7
Structured Finance		65.8		57.6		129.7		109.7
International Finance		40.0		30.9		77.3		60.1
Total normal premiums earned		156.5		130.9		306.8		253.5
Accelerated earnings		33.1		21.1		48.3		33.2
Total net premiums earned		189.6		152.0		355.1		286.7
Other credit enhancement fees		11.8		12.3		23.2		22.7
Total net premiums earned and other credit enhancement fees	$	201.4	$	164.3	$	378.3	$	309.4

Net Investment Income. Net investment income for the three and six months ended June 30, 2004 was $88.1 million and $174.8 million, an increase of 10% from $79.9 million in the three months ended June 30, 2003 and an increase of 12% from $156.5 million in the six months ended June 30, 2003. These increases were primarily attributable to (i) the growth of the investment portfolio resulting from the growth in the Financial Guarantee book of business and (ii) capital contributions from Ambac Financial Group, Inc. totaling approximately $210 million during 2003. The growth in investment income was partially offset by lower reinvestment rates. Investments in tax-exempt securities amounted to 73% of the total fair value of the portfolio as of June 30, 2004, versus 72% at June 30, 2003. The average pre-tax yield-to-maturity on the investment portfolio was 4.77% as of June 30, 2004 compared with 5.04% at June 30, 2003.

24

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Net Realized Investment Gains. Net realized investment gains in the three and six months ended June 30, 2004 were $3.3 million and $15.2 million, respectively, compared to net realized gains of $12.8 million and $26.7 million for the three and six months ended June 30, 2003, respectively. The following table details amounts included in net realized investment gains:

(Dollars in Millions)	Three Months Ended June 30,				Six Months Ended June 30,
	2004		2003		2004		2003
Net gains on securities sold	$	1.1	$	5.8	$	12.8	$	19.8
Foreign exchange gains on investments		2.2		7.0		2.4		6.9
Net securities gains	$	3.3	$	12.8	$	15.2	$	26.7

Net Mark-to-Market Gains (Losses) on Credit Derivative Contracts. Net mark-to-market gains on credit derivative contracts for the three and six months ended June 30, 2004 were $3.3 million and $10.2 million, respectively, compared to net mark-to-market gains (losses) of $10.0 million and ($2.2) million in the three and six months ended June 30, 2003, respectively. The changes in estimated fair value of structured credit derivative contracts reflects net mark-to-market gains and losses due to changes in credit spreads on the underlying obligations. Net losses paid on structured credit derivatives in the three and six months ended June 30, 2004 was 0 as compared to $1.2 million for the three and six months ended June 30, 2003.

Other Income (Loss). Other income (loss) for the three and six months ended June 30, 2004 was $1.4 million and ($10.9) million, respectively, compared to other income of $1.9 million and $2.8 million for the three and six months ended June 30, 2003, respectively. Included in other income are deal structuring fees, commitment fees and income from Ambac’s QSPEs. Ambac provides clients, on a limited basis the ability to fund through a medium-term note (“MTN”) conduit vehicle. This conduit issues MTNs and purchases client issued fixed income securities with the proceeds. An equity loss of approximately $15 million was recorded during the first quarter from this funding conduit. The loss relates to a mark-to-market on certain derivative contracts used to hedge interest rate risk associated with underlying investments and MTN liabilities. The derivatives serve as effective economic hedges; however, they did not meet the requirements of effective accounting hedges as defined in FASB No. 133, as amended (“FAS 133”). Therefore, the change in the market value of the derivatives was recorded through the income statement without taking the offsetting gain from the hedged instruments.

Loss and Loss Expenses. Loss and loss expenses for the three and six months ended June 30, 2004 were $17.5 million and $35.0 million, respectively, compared to $10.9 million and $20.7 million for the three and six months ended June 30, 2003. Losses and expenses are based upon estimates of the ultimate aggregate losses inherent in the Financial Guarantee portfolio. In most instances, claim payments are forecasted in advance as a result of Ambac’s active surveillance of the insured book of business. Based upon company and industry experience, claim payments become probable and estimable once the issuer’s credit profile has migrated to certain impaired credit levels. The insured party has the right to a claim under Ambac’s financial insurance policy at the first scheduled debt service date of the defaulted obligation. The trustee for the insured obligation notifies Ambac of the payment default so that a claim payment can be made. The trustee reports payment defaults at or prior to the scheduled payment date. Subsequent claims would be paid if payment defaults continue and would be based on the interest and principal payment schedule.

25

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The liability for loss and loss expenses consists of case basis credit and active credit reserves. Case basis credit reserves are established for losses on guaranteed obligations that have already defaulted. These reserves are established in an amount that is sufficient to cover the present value of the anticipated defaulted debt service payments over the expected period of default and estimated expenses associated with settling the claims, less estimated recoveries under collateral and subrogation rights. As noted above, the payment pattern and ultimate costs are fixed and determinable on an individual claim basis (i.e., the scheduled debt service of the insured obligation). Ambac discounts these reserves in accordance with discount rates prescribed or permitted by state regulatory authorities. Consistent with industry practice, Ambac establishes and accrues an active credit reserve, which is separate from the case basis credit reserves noted above. Ambac believes, based on our active surveillance of the insured portfolio, along with historical defaults and related loss data and current economic factors, that additional losses are probable and estimable in our portfolio. Current economic factors considered include estimates of current defaults and recovery values from collateral or subrogation rights. The active credit reserves are established based upon probable debt service defaults from losses, as a result of credit deterioration. Reserve amounts are reasonably estimated based on management’s review of the financial guarantee portfolio. Active surveillance of the insured portfolio enables Ambac to track credit migration of insured obligations from period to period. Our Surveillance group, which is comprised of senior credit professionals, all of whom are independent from transaction execution, is responsible for ongoing monitoring of the insured portfolio on a regular basis to identify deteriorating credits. Senior Management meets with Surveillance to review the status of their work to determine the adequacy of Ambac’s loss reserves and makes any necessary adjustments. The following table summarizes Ambac’s loss reserves split between case basis credit loss reserves and active credit reserves at June 30, 2004 and December 31, 2003.

(Dollars in millions)	June 30, 2004		December 31, 2003
Net loss and loss expense reserves:
Case basis reserves (*)	$	85.2	$	54.7
Active credit reserves		150.8		132.2
Total	$	236.0	$	186.9

(*) After netting reinsurance recoverable amounting to $2.1 million and $2.5 million at June 30, 2004 and December 31, 2003, respectively.

The following table summarizes the changes in the total net loss reserves for the six months ended June 30, 2004 and the year-ended December 31, 2003:

(Dollars in millions)	June 30, 2004			December 31, 2003
Beginning balance of net loss reserves	$	186.9		$	167.6
Additions to loss reserves		35.0			53.4
Losses paid		(20.7	)		(45.6	)
Recoveries of losses paid from reinsurers		1.9			4.0
Other recoveries, net of reinsurance		32.9			7.5
Ending balance of net loss reserves	$	236.0		$	186.9

Additions (reductions) made to the case basis credit reserve totaled $30.5 million and $5.7 million for the six months ended June 30, 2004 and the year ended December 31, 2003, respectively. The increase during the six months was primarily due to $33.0 million of recoveries (net of reinsurance) received and an increase of $18.0 million in reserves for a healthcare credit, offset by $18.8 million in net claim payments.

26

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The following tables provide details of losses paid, net of recoveries received for the six months ended June 30, 2004 and 2003 and net case basis credit reserves at June 30, 2004 and December 31, 2003 by market sector:

(Dollars in millions)	June 30, 2004			June 30, 2003
Net losses paid:
Public Finance	$	0.8		$	1.8
Structured Finance		(16.7	)		8.4
International Finance		1.8			0.2
Total	$	(14.1	)	$	10.4
(Dollars in millions)	June 30, 2004			December 31, 2003
Net case basis credit reserves (*):
Public Finance	$	41.1		$	22.6
Structured Finance		37.4			26.7
International Finance		6.7			5.4
Total	$	85.2		$	54.7

(*) After netting reinsurance recoverable amounting to $2.1 million and $2.5 million at June 30, 2004 and December 31, 2003, respectively.

At June 30, 2004 future estimated claim payments, net of estimated recoveries, through 2018 for exposures with case basis credit reserves totaled $95.0 million. Related future payments are $19.6 million, $37.2 million, $18.5 million, $12.0 million and $11.6 million for the remainder of 2004, 2005, 2006, 2007 and 2008, respectively.

Underwriting and Operating Expenses. Underwriting and operating expenses for the three and six months ended June 30, 2004 were $29.2 million and $54.9 million, respectively, an increase of 39% from $21.0 million in the three months ended June 30, 2003 and an increase of 27% from $43.2 million in the six months ended June 30, 2003. Underwriting and operating expenses consist of gross underwriting and operating expenses, less the deferral to future periods of expenses related to the acquisition of new insurance contracts and reinsurance commissions, plus the amortization of previously deferred expenses and reinsurance commissions. The increases in gross underwriting and operating expenses reflects the overall increased business activity and is primarily attributable to higher compensation costs related to the addition of staff. Included in the 2004 numbers above are approximately $3.5 million of reinsurance commissions returned in excess of the unamortized reinsurance commissions previously deferred as a result of the cancellation of certain reinsurance contracts, previously mentioned under the heading “Income From Continuing Operations”. For the three and six months ended June 30, 2004, gross underwriting and operating expenses were $37.9 million and $73.4 million, respectively, an increase of 6% from $35.6 million for the three months ended June 30, 2003 and an increase of 9% from $67.3 million for the six months ended June 30, 2003. Underwriting and operating expenses deferred for the three and six months ended June 30, 2004 were $22.6 million and $42.6 million, respectively, compared to $21.8 million and $40.6 million for the three and six months ended June 30, 2003. The amortization of previously deferred expenses and reinsurance commissions for the three and six months ended June 30, 2004 were ($4.6) million and $5.5 million, respectively, compared to $9.7 million and $19.0 million for the three and six months ended June 30, 2003, respectively.

27

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Financial Services

Through its Financial Services subsidiaries, Ambac provides financial and investment products including investment agreements, interest rate swaps, total return swaps and funding conduits, which includes municipalities and their authorities, health care organizations and asset-backed issuers.

Net Revenues. Financial Services net revenue is defined and analyzed by management as gross interest income less gross interest expense from investment and payment agreements plus revenue from derivative products, and excludes net realized and net mark-to-market gains and losses. Net revenues for the three and six months ended June 30, 2004 was $12.8 million and $29.8 million, respectively, an increase from ($4.2) million in the three months ended June 30, 2003 and an increase from $6.9 million in the six months ended June 30, 2003. The increases are primarily driven by a ($12.0) million mark-to-market adjustment in the second quarter of 2003 resulting from the increase in the ratio of tax-exempt interest rates to taxable interest rates. During the second quarter of 2003, the ratio had risen higher than historical averages, impacted by the historically low interest rate environment and large supply of municipal debt. The ratio has largely come back down to historical levels since that time and the mark-to-market was largely reversed in later periods.

Net realized investment (losses) gains were ($0.1) million and $5.8 million for the three and six months ended June 30, 2004, respectively, compared to $4.6 million and $4.9 million for the three and six months ended June 30, 2003, respectively. Gains and losses from investment securities are due to the normal operations of the investment agreement business, and shaping of the investment portfolio to maximize yield within our defined risk guidelines. Ambac does not maintain a trading portfolio.

Other Expenses. Other expenses for the three and six months ended June 30, 2004 were $3.4 million and $7.1 million, respectively, up 31% from $2.6 million in the three months ended June 30, 2003 and up 29% from $5.5 million in the six months ended June 30, 2003. The increases are primarily attributable to increased business activity in the derivative products business.

Corporate Items

Interest Expense. Interest expense for the three and six months ended June 30, 2004 was $13.5 million and $27.1 million, respectively, a decrease of 7% from $14.5 million in the three months ended June 30, 2003 and is flat compared to $27.0 million in the six months ended June 30, 2003. The decrease in the second quarter of 2004 is primarily attributable to interest expense on the redemption at par of Ambac’s $200 million, 7.08% Debentures in April 2003.

Corporate Expense. Corporate expenses include the operating expenses of Ambac Financial Group. Corporate expenses for the three and six months ended June 30, 2004 were $2.6 million and $4.8 million, respectively, compared to $2.2 million and $10.5 million for the three and six months ended June 30, 2003, respectively. The decrease in expenses during the first half of 2004 is primarily attributable to a $6.5 million write-off of previously deferred debt issuance expenses in the first quarter of 2003, related to the 1998 issuance of $200 million, 7.08% Debentures, that was redeemed at par at the end of April 2003.

28

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Income Taxes. Income taxes for the three and six months ended June 30, 2004 were at an effective rate of 26.0% and 25.8%, respectively, compared to 26.1% and 25.2% for the three and six months ended June 30, 2003, respectively. The increase in the six month effective rate is caused predominantly from an increase in the ratio of taxable underwriting profits to tax-exempt investment income.

Liquidity and Capital Resources

Ambac Financial Group, Inc. Liquidity. Ambac’s liquidity, both on a short-term basis (for the next twelve months) and a long-term basis (beyond the next twelve months), is largely dependent upon (i) Ambac Assurance’s ability to pay dividends or make other payments to Ambac; (ii) external financings; and (iii) investment income from its investment portfolio. Pursuant to Wisconsin insurance laws, Ambac Assurance may declare dividends, provided that, after giving effect to the distribution, it would not violate certain statutory equity, solvency and asset tests. During the six months ended June 30, 2004, Ambac Assurance paid dividends of $51.5 million on its common stock to Ambac.

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

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

Financial Services Liquidity. The principal uses of liquidity by Financial Services subsidiaries are payment of investment and payment agreement obligations pursuant to defined terms, net obligations under interest rate and total return swaps, operating expenses, and income taxes. Management believes that its Financial Services liquidity needs can be funded primarily from its operating cash flow and the maturity of its invested assets. The principal sources of this segment’s liquidity are proceeds from issuance of investment agreements, net investment income, maturities of securities from its investment portfolio (which are invested with the objective of matching the maturity schedule of its obligations under the investment agreements) and net receipts from interest rate and total return swaps. Additionally, from time to time, liquidity needs of the Financial Services subsidiaries are satisfied by short-term inter

29

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

company loans from Ambac Assurance. The investment objectives with respect to investment agreements are to achieve the highest after-tax total return, subject to a minimum average credit quality rating of Aa/AA on invested assets, and to maintain cash flow matching of invested assets to funded liabilities to minimize interest rate and liquidity exposure. Financial Services subsidiaries maintain a portion of their assets in short-term investments and repurchase agreements in order to meet unexpected liquidity needs.

Credit Facilities. Beginning in July 2004, Ambac and Ambac Assurance have a new revolving credit facility with six major international banks for $300 million, which expires in July 2005 and provides a two-year term loan provision. The facility is available for general corporate purposes, including the payment of claims. This new facility’s financial covenants require that Ambac: (i) maintain as of the end of each fiscal quarter a debt to capital ratio of not more than 30% and (ii) maintain at all times total stockholders’ equity equal to or greater than $2.0 billion.

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

From time to time Ambac accesses the capital markets to support the growth of its businesses. In April 2003, Ambac filed Form S-3 with the SEC utilizing a “shelf” registration process. Under this process, Ambac may issue up to $500 million of the securities described in the prospectus filed as part of the registration, namely, common stock, preferred stock and debt securities of Ambac.

Shares Repurchased. The Board of Directors of Ambac has authorized the establishment of a stock repurchase program that permits the repurchase of up to 12,000,000 shares of Ambac’s Common Stock. The following table summarizes Ambac’s repurchase program during the first half of 2004:

(In thousands, except per share amounts)	Total Shares Repurchased	Average Price Per Share		Shares Remaining for Repurchase
January 2004	—	$	—	3,150
February 2004	20	$	74.09	3,130
March 2004	298	$	78.90	2,832
First quarter 2004	318	$	78.60	2,832
April 2004	339	$	73.19	2,493
May 2004	27	$	64.61	2,466
June 2004	—	$	—	2,466
Second quarter 2004	366	$	72.55	2,466

30

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Balance Sheet. Total assets as of June 30, 2004 were $16.85 billion, an increase of 1% from total assets of $16.75 billion at December 31, 2003. This increase was due primarily to cash generated from business written during the period, partially offset by a decline in the unrealized gains in the investment portfolio driven by higher interest rates during the period. As of June 30, 2004, stockholders’ equity was $4.46 billion, a 5% increase from year-end 2003 stockholders’ equity of $4.25 billion. The increase stemmed primarily from net income during the period, partially offset by the reduction in “Accumulated Other Comprehensive Income” driven by higher interest rates during the period.

Investments. The Financial Guarantee and the Financial Services investment portfolios are subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits. Ambac has a review process for all securities in its investment portfolio, including a review for impairment losses. Factors considered when assessing impairment include: (i) securities whose fair values have declined by 20% or more below amortized cost for a continuous period of at least six months; (ii) recent credit downgrades by rating agencies; (iii) the financial condition of the issuer; (iv) whether scheduled interest payments are past due; and (v) whether Ambac has the ability and intent to hold the security for a sufficient period of time to allow for anticipated recoveries in fair value. If we believe a decline in the value of a particular investment is temporary, we record the decline as an unrealized loss, net of tax, in Accumulated Other Comprehensive Income in stockholders’ equity on our Consolidated Balance Sheets. If we believe the decline is “other than temporary”, we write-down the carrying value of the investment and record a loss on our Consolidated Statements of Operations. Ambac’s assessment of a decline in value includes management’s current judgment of the factors noted above. If that judgment changes in the future, Ambac may ultimately record a loss after having originally concluded that the decline in value was temporary. The following table summarizes, for all securities in an unrealized loss position as of June 30, 2004 and December 31, 2003, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position:

31

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

	June 30, 2004				December 31, 2003
(Dollars in millions)	Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses
Municipal obligations in continuous unrealized loss for:
0 – 6 months	$	2,086.4	$	49.7	$	208.8	$	1.2
7 – 12 months		14.3		0.5		225.1		4.8
Greater than 12 months		107.0		6.6		6.5		0.4
		2,207.7		56.8		440.4		6.4
Corporate obligations in continuous unrealized loss for:
0 – 6 months		38.5		0.8		100.6		1.8
7 – 12 months		—		—		—		—
Greater than 12 months		42.5		4.7		100.8		4.6
		81.0		5.5		201.4		6.4
Foreign government obligations in continuous unrealized loss for:
0 – 6 months		35.0		0.3		36.6		0.7
7 – 12 months		36.5		1.2		—		—
Greater than 12 months		—		—		—		—
		71.5		1.5		36.6		0.7
U.S. government obligations in continuous unrealized loss for:
0 – 6 months		92.5		2.7		50.2		0.4
7 – 12 months		—		—		—		—
Greater than 12 months		—		—		—		—
		92.5		2.7		50.2		0.4
Mortgage and asset-backed securities in continuous unrealized loss for:
0 – 6 months		1,560.2		29.7		969.6		10.7
7 – 12 months		306.5		8.3		616.2		9.6
Greater than 12 months		495.4		11.9		166.0		1.7
		2,362.1		49.9		1,751.8		22.0
Other in continuous unrealized loss for:
0 – 6 months		0.4		—		—		—
7 – 12 months		—		—		0.2		—
Greater than 12 months		1.2		0.3		1.5		0.4
		1.6		0.3		1.7		0.4
Total	$	4,816.4	$	116.7	$	2,482.1	$	36.3

There were no impairment write-downs during the six months ended June 30, 2004 and 2003. The net realized investment gains in the three and six months ended June 30, 2004 and 2003 were the result of security sales made in the usual course of business in order to achieve Ambac’s investment objectives for the Financial Guarantee and Financial Services investment portfolios. The unrealized loss on these securities reflects the current interest rate environment.

32

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The amortized cost and estimated fair value of investments in fixed income securities and short-term investments at June 30, 2004 were as follows:

(Dollars in thousands)	Amortized Cost		Estimated Fair Value
Fixed income securities:
Municipal obligations	$	5,995,361	$	6,145,697
Corporate obligations		703,737		729,386
Foreign government obligations		166,570		181,025
U.S. government obligations		123,371		121,560
Mortgage and asset-backed securities (includes U.S. government agency obligations)		5,875,439		5,880,013
Short-term		238,184		238,184
		13,102,662		13,295,865
Fixed income securities pledged as collateral:
Mortgage and asset-backed securities (includes U.S. government agency obligations)		661,637		656,938
Total	$	13,764,299	$	13,952,803

Approximately 47% of the mortgage and asset-backed securities in the investment portfolio is composed of securities issued by the Government National Mortgage Association (“GNMA”), the Federal National Mortgage Association (“FNMA”), and the Federal Home Loan Mortgage Corporation (“FHLMC”), as of June 30, 2004 and December 31, 2003.

The following table provides the ratings distribution of the Financial Guarantee investment portfolio, at fair values of $7.83 billion and $7.33 billion at June 30, 2004 and December 31, 2003, respectively:

Rating (1)	June 30, 2004		December 31, 2003
AAA(2)	80	%	75	%
AA	16		16
A	1		6
BBB	1		1
Below investment grade	<1		<1
Not Rated	1		1
	100	%	100	%

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

(2) Includes U.S. Treasury and agency obligations (including GNMA’s, FNMA’s and FHLMC’s), which comprised approximately 20% and 15% of the Financial Guarantee investment portfolio as of June 30, 2004 and December 31, 2003, respectively.

Short-term investments in the Financial Guarantee portfolio consisted primarily of money market funds, and foreign and domestic time deposits.

The Financial Services investment portfolio consists primarily of assets funded with the proceeds from the issuance of investment agreement liabilities. The investment objectives of the portfolio are to match the investment security maturity schedule to the maturity schedule of related liabilities under the investment agreements and achieve the highest after-tax net investment income.

33

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

The following table provides the ratings distribution of the Financial Services investment portfolio, at fair values of $6.06 billion and $6.39 billion at June 30, 2004 and December 31, 2003, respectively:

Rating (1)	June 30, 2004		December 31, 2003
AAA(2)	90	%	92	%
AA	3		2
A	4		3
BBB	3		2
Below investment grade	<1		<1
	100	%	100	%

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

(2) Includes U.S. Treasury and agency obligations (including GNMA’s, FNMA’s and FHLMC’s), which comprised approximately 26% and 31% of the Financial Services investment portfolio as of June 30, 2004 and December 31, 2003, respectively.

Special Purpose and Variable Interest Entities. In January 2003, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN 46”). In December 2003, the FASB released a revision of FIN 46 (“FIN 46-R”), which includes substantial changes from the original FIN 46. Ambac adopted FIN 46-R as of December 31, 2003. FIN 46 and FIN 46-R provides accounting and disclosure rules for determining whether certain entities should be consolidated in Ambac’s consolidated financial statements. An entity is subject to FIN 46 and FIN 46-R, and is called a Variable Interest Entity (VIE), if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support or (ii) equity investors that cannot make significant decisions about the entity’s operations or that do not absorb the expected losses or receive the expected returns of the entity. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE or both. FIN 46 requires disclosures for companies that have either a primary or significant variable interest in a VIE. All other entities not considered VIEs are evaluated for consolidation under SFAS No. 94, “Consolidation of all Majority-Owned Subsidiaries”.

Ambac has involvement with special purpose entities, including VIEs in two ways. First, Ambac is a provider of financial guarantee insurance for various securitized asset-backed debt obligations, including mortgage-backed security obligations, collateralized debt obligations (“CDO”) and other asset-backed securitization obligations. Second, Ambac has sponsored two special purpose entities that issue medium-term notes (“MTNs”) to fund the purchase of certain financial assets. As discussed in detail below, these Ambac sponsored special purpose entities are considered Qualifying Special Purpose Entities (“QSPEs”).

Financial Guarantees:

Ambac provides financial guarantee insurance to securitized asset-backed debt obligations of special purpose entities, including VIEs. Ambac’s primary variable interest exists through this financial guarantee insurance contract. The transaction structure provides certain financial protection to Ambac. This financial protection can take several forms, however, the most common are over-collateralization, first loss retention and excess spread. In the case of over-collateralization (i.e., the principal amount of the securitized assets exceeds the principal amount of the structured finance obligations guaranteed by Ambac Assurance), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the structured finance obligations that have been guaranteed by Ambac. In the

34

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

case of first loss retention, the financial guarantee insurance policy only covers a senior layer of losses on debt issued by the special purpose entities, including VIEs. The first loss with regards to the assets is either retained by the seller or sold off in the form of equity or mezzanine debt to other investors. In the case of excess spread, the financial assets contributed to special purpose entities, including VIEs, generate interest cash flows that are in excess of the interest payments on the related debt. All or a portion of this excess spread accumulates and is available to absorb losses in the transaction or is applied to create over-collateralization.

Ambac is the primary beneficiary of one VIE with assets and liabilities of $150.8 million at June 30, 2004 and $189.5 million at December 31, 2003. Ambac consolidated this entity since the structural financial protections are outside the VIE. This VIE is a bankruptcy remote special purpose financing entity created to facilitate the sale of floating rate notes. This VIE was capitalized in 2002 through the issuance of $299.6 million of floating rate notes, guaranteed by Ambac Assurance. The proceeds of the VIE note issuance were used to purchase senior mortgage-backed floating rate notes of a Korean mortgage-backed securities issuer. Ambac’s creditors do not have rights with regard to the assets of the VIE. Protections afforded Ambac Assurance in this transaction were in the form of a reserve fund and first loss protection through subordinated debt issued of approximately $40 million. Ambac Assurance will pay claims under its financial guarantee only in the event that losses on the mortgage assets of the Korean issuer reduce the reserve fund to zero and exceed the principal amount of the subordinated notes.

Ambac does not consolidate other VIEs since we are not the primary beneficiary. It is possible in the future that Ambac will consolidate other entities for which it will issue a financial guarantee insurance policy. If Ambac issues a financial guarantee insurance policy for the obligations of a VIE and does not receive structural financial protection adequate to absorb the majority of expected loss, Ambac may be required to consolidate the related VIE in accordance with FIN 46-R. Ambac underwrites its insurance to a remote loss standard and normally demands structural financial protection that absorbs the majority of expected loss in a transaction. However, management is committed to take actions to reduce economic loss regardless of any requirement to consolidate. Consolidation is an important accounting concept, however, it does not change the economic risk profile of the insurance exposure.

Qualified Special Purpose Entities. Ambac has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with Statement of Financial Accounting Standards 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). QSPEs are not subject to the requirements of FIN 46-R and accordingly are not consolidated in Ambac’s financial statements. However, see the discussion below on the Exposure Draft issued by the FASB that could change the accounting rules for QSPEs in the future. The QSPEs are legal entities that are demonstrably distinct from Ambac. Ambac, its affiliates or its agents cannot unilaterally dissolve the QSPEs. The QSPEs permitted activities are limited to those outlined below.

As of June 30, 2004, there have been 14 individual transactions processed through the QSPEs of which 10 remain. In each case, Ambac sells fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPE and the absence of any agreement or obligation for Ambac to repurchase or redeem assets of the QSPE. The purchase by the QSPE is financed through the issuance of MTNs, which are collateralized by the purchased assets. The cash flows of the MTNs approximately match the cash flows of the assets purchased. Derivative contracts (interest rate and currency

35

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchase, executing derivative hedges and related administrative services. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued or both. As of June 30, 2004, Ambac Assurance had financial guarantee insurance policies issued for all assets and MTNs owned and outstanding by the QSPEs.

Ambac’s exposures under these financial guarantee insurance policies as of December 31, 2003 is included in the disclosure in Note 12 “Guarantees in Force” of Ambac’s 2003 Annual Report. Pursuant to the terms of Ambac Assurance’s insurance policy, insurance premiums are paid to Ambac Assurance by the QSPEs and are earned in a manner consistent with other insurance policies, over the risk period. Any losses incurred would be included in Ambac’s Consolidated Statements of Operations. Under the terms of an Administrative Agency Agreement, Ambac provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.

Assets sold to the QSPEs during the six months ended June 30, 2004 and the year ended December 31, 2003 were $195.0 million and $250.0 million, respectively. No gains or losses were recognized on these sales. As of June 30, 2004, the estimated fair value of financial assets, MTN liabilities and derivative hedge liabilities were $1,868.4 million, $1,759.2 million and $88.5 million, respectively. When market quotes are not available, estimated fair value is determined utilizing valuation models. These models include estimates, made by Ambac management, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $2.8 million and $5.3 million for the six months ended June 30, 2004 and the year ended December 31, 2003, respectively. Ambac also received fees for providing other services amounting to $0.2 million and $0.5 million for the six months ended June 30, 2004 and the year ended December 31, 2003, respectively.

In June 2003, the FASB issued an Exposure Draft for proposed Statement of Financial Accounting Standards entitled “Qualifying Special-Purposes Entities and Isolation of Transferred Assets”, an amendment of FASB Statement No. 140 (“The Exposure Draft”). The Exposure Draft is a proposal that is subject to change and as such, is not yet authoritative. If the proposal is enacted in its current form, it will amend and clarify SFAS 140. The Exposure Draft would prohibit an entity from being a QSPE if it enters into an agreement that obligates a transferor of financial assets, its affiliates, or its agents to deliver additional cash or other assets to fulfill the SPE’s obligations to beneficial interest holders. If this Exposure Draft becomes enacted as currently proposed and if the QSPEs issue new beneficial interests after the effective date and receive assets other than those they are committed to receive under commitments to beneficial interest holders made before the effective date of the final Statement, management believes Ambac would be required to consolidate. This conclusion is based upon the fact that Ambac provides financial support to these entities such as financial guarantees and liquidity commitments. Should Ambac be required to consolidate under this Exposure Draft, if enacted as proposed, the financial statement impact would be to gross up Ambac’s consolidated balance sheet for the assets and liabilities held by the QSPEs that approximate $1.8 billion at June 30, 2004. Additionally, fees received by Ambac from the QSPEs (primarily insurance premiums) would be eliminated in consolidation and essentially reclassified to net interest income. The risk characteristics of these transactions are not impacted by consolidation.

36

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Cash Flows. Net cash provided by operating activities was $541.0 million and $508.8 million during the six months ended June 30, 2004 and 2003, respectively. These cash flows were primarily provided by Financial Guarantee operations.

Net cash (used in) provided by financing activities was ($262.7) million and $64.4 million during the six months ended June 30, 2004 and 2003, respectively. Financing activities for the six months ended June 30, 2004 included ($284.0) million in net investment and payment agreement draws paid (net of investment and payment agreement issued). Financing activities for the six months ended June 30, 2003 included ($106.7) million in net investment and payments agreements draws paid (net of investment and payment agreement issued). Financing activities for the six month ended June 30, 2003 also included proceeds from the issuance of debentures of $363.2 million, partially offset by $200 from the redemption of debentures.

Net cash used in investing activities was $269.6 million during the six months ended June 30, 2004, of which $2,776.1 million was used to purchase bonds, partially offset by the proceeds from sales and maturities of bonds of $2,454.6 million. For the six months ended June 30, 2003, $572.0 million was used in investing activities, of which $3,849.5 million was used to purchase bonds, partially offset by the proceeds and maturities of bonds of $3,175.0 million.

Net cash provided by operating, investing and financing activities was $8.7 million and $1.2 million during the six months ended June 30, 2004 and 2003, respectively.

Material Commitments. Ambac has no material changes in the contractual obligations table as presented in Ambac’s 2003 Annual Report.

37

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

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

Financial instruments that may be adversely affected by changes in interest rates consist primarily of investment securities, investment agreement liabilities, obligations under certain payment agreements, debentures, and certain derivative contracts (primarily interest rate swaps and futures) used for hedging purposes.

Ambac, through its affiliate Ambac Financial Services, is a provider of interest rate swaps to states, municipalities and their authorities and other entities in connection with their financings. Ambac Financial Services manages its municipal interest rate swap business with the goal of being market neutral to changes in overall interest rates, while seeking to profit from retaining some basis risk. Ambac’s municipal interest rate swap portfolio may be adversely affected by changes in basis. If actual or projected tax-exempt interest rates change in relation to taxable interest rates, Ambac will experience a mark-to-market gain or loss. Most municipal interest rate swaps transacted by Ambac Financial Services contain provisions that are designed to protect Ambac against certain forms of tax reform, thus mitigating its basis risk. The estimation of potential losses arising from adverse changes in market relationships, known as VaR, is a key element in management’s monitoring of basis risk for the municipal interest rate swap portfolio. Ambac has developed a VaR methodology to estimate potential losses over a specified holding period and based on certain probabilistic assessments. Ambac’s methodology estimates VaR using a 300-day historical “look back” period. This means that changes in market values are simulated using market inputs from the past 300 days. Ambac supplements its VaR methodology, which is a good risk management tool in normal markets, by performing rigorous stress testing to measure the potential for losses in abnormally volatile markets. These stress tests include (i) parallel and non-parallel shifts in the yield curve and (ii) immediate changes in normal basis relationships, such as those between taxable and tax-exempt markets.

Financial instruments that may be adversely affected by changes in credit spreads include Ambac’s outstanding structured credit derivative contracts. Ambac, through its affiliate, Ambac Credit Products, enters into structured credit derivative contracts. These contracts require Ambac Credit Products to make payments upon the occurrence of certain defined credit events relating to underlying obligations (generally a fixed income obligation). If credit spreads of the underlying obligations change, the market value of the related structured credit derivative changes. As such, Ambac Credit Products could experience mark-to-market gains or losses.

38

Item 3. Quantitative and Qualitative Disclosures About Market Risk (Continued)

Market liquidity could also impact valuations. Changes in credit spreads are generally caused by changes in the market’s perception of the credit quality of the underlying obligations. Ambac Credit Products structures its contracts with partial hedges from various financial institutions or with first loss protection. Such structuring mitigates Ambac Credit Products’ risk of loss and reduces the price volatility of these financial instruments. Management models the potential impact of credit spread changes on the value of its contracts.

Other financial instruments that may be adversely affected by changes in credit spreads include total return swap contracts, which are entered into by Ambac through its affiliate, Ambac Capital Services. These contracts require Ambac Capital Services to pay a specified spread in excess of LIBOR in exchange for receiving the total return of an underlying fixed income obligation over a specified period of time. If credit spreads of the underlying obligations change, the market value of the related total return swaps changes and Ambac Capital Services could experience mark-to-market gains or losses.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures. Ambac Financial Group’s management, with the participation of Ambac Financial Group’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Ambac Financial Group’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on this evaluation, Ambac Financial Group’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Ambac Financial Group’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Ambac Financial Group (including its consolidated subsidiaries) in the reports that it files or submits under the Exchange Act.

(b) Changes in Internal Control Over Financial Reporting. There have not been any changes in Ambac Financial Group’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during Ambac Financial Group’s fiscal quarter ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, Ambac Financial Group’s internal control over financial reporting.

39

PART II – OTHER INFORMATION

Items 1, 2, 3, and 5 are omitted either because they are inapplicable or because the answer to such question is negative.

Item 4 – Submission of Matters to a Vote of Security Holders

The following matters were voted upon at the Annual Meeting of Stockholders of the Company held on May 4, 2004, and received the votes set forth below:

Proposal 1. The following directors were elected to serve on Ambac’s Board of Directors:

	Number of Votes Cast
	For	Withheld
Phillip B. Lassiter	92,784,963	2,747,824
Michael A. Callen	92,262,233	3,270,554
Renso L. Caporali	93,016,698	2,516,089
Jill M. Considine	93,036,915	2,495,872
Richard Dulude	92,217,005	3,315,782
Robert J. Genader	92,814,040	2,718,747
W. Grant Gregory	92,261,913	3,270,874
Laura S. Unger	93,062,721	2,470,066
Henry D. G. Wallace	93,594,197	1,938,590

There were no broker non-votes for this proposal.

Proposal 2. The proposal to ratify an amendment to the Charter to increase the number of authorized shares of common stock from 200 million to 350 million was adopted, with 84,899,327 votes in favor, 9,970,441 votes against and 660,619 votes abstaining. There were no broker non-votes for this proposal.

Proposal 3. The proposal to ratify the amendments to the Ambac 1997 Non-Employee Directors Equity Plan was adopted, with 80,284,476 votes in favor, 7,386,515 votes against and 698,536 votes abstaining. There were 7,163,260 broker non-votes for this proposal.

Proposal 4. The proposal to ratify the selection of KPMG LLP, an independent registered public accounting firm, as auditors of Ambac and its subsidiaries for 2004 was adopted, with 93,776,837 votes in favor, 1,280,349 votes against and 473,022 votes abstaining. There were no broker non-votes for this proposal.

40

PART II - OTHER INFORMATION (Continued)

Item 6 - Exhibits and Reports on Form 8-K

(a) The following are annexed as exhibits:

Exhibit Number	Description
10.33	U.S. $300,000,000 Revolving Credit Agreement dated as of July 29, 2004 among Ambac Financial Group, Inc. and Ambac Assurance Corporation as the Borrowers, the banks, financial institutions and other institutional lenders, as the Initial Lenders, Barclay’s Bank PLC as the Syndication Agent and Citibank, N.A., as the Administrative Agent.
10.34	Employment Agreement dated as of July 19, 2004 by and between Ambac Financial Group, Inc. and William T. McKinnon.
31.1	Certification of CEO Pursuant to Exchange Act Rules 13a-14 and 15d-14.
31.2	Certification of CFO Pursuant to Exchange Act Rules 13a-14 and 15d-14.
32.1	Certification of CEO Pursuant to 18 U.S.C. Section 1350.
32.2	Certification of CFO Pursuant to 18 U.S.C. Section 1350.
99.05	Ambac Assurance Corporation and Subsidiaries Consolidated Unaudited Financial Statements as of June 30, 2004 and December 31, 2003 and for the periods ended June 30, 2004 and 2003.

(b) Reports on Form 8-K:

On July 22, 2004, Ambac Financial Group, Inc. filed a Current Report on Form 8-K with its July 21, 2004 press release containing unaudited financial information and accompanying discussion for the three and six months ended June 30, 2004.

41

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

	Ambac Financial Group, Inc.
	(Registrant)
Dated: August 9, 2004	By:	/s/ Thomas J. Gandolfo
		Thomas J. Gandolfo
		Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Officer)

42

INDEX TO EXHIBITS

Exhibit Number	Description
10.33	U.S. $300,000,000 Revolving Credit Agreement dated as of July 29, 2004 among Ambac Financial Group, Inc. and Ambac Assurance Corporation as the Borrowers, the banks, financial institutions and other institutional lenders, as the Initial Lenders, Barclay’s Bank PLC as the Syndication Agent and Citibank, N.A., as the Administrative Agent.
10.34	Employment Agreement dated as of July 19, 2004 by and between Ambac Financial Group, Inc. and William T. McKinnon.
31.1	Certification of CEO Pursuant to Exchange Act Rules 13A-14 and 15D-14, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of CFO Pursuant to Exchange Act Rules 13A-14 and 15D-14, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.05	Ambac Assurance Corporation and Subsidiaries Consolidated Unaudited Financial Statements as of June 30, 2004 and December 31, 2003 and for the periods ended June 30, 2004 and 2003.

43

EX-10.33

EXHIBIT 10.33

EXECUTION COUNTERPART

U.S. $300,000,000

REVOLVING CREDIT AGREEMENT

Dated as of July 29, 2004

Among

AMBAC FINANCIAL GROUP, INC. and

AMBAC ASSURANCE CORPORATION,

as Borrowers,

CERTAIN COMMERCIAL LENDING INSTITUTIONS,

as Lenders,

CITIBANK, N.A.,

as Administrative Agent,

BARCLAYS BANK PLC,

as Syndication Agent,

THE BANK OF NEW YORK,

as Documentation Agent,

BARCLAYS CAPITAL and

CITIGROUP GLOBAL MARKETS INC.,

as Joint Lead Arrangers

and

CITIGROUP GLOBAL MARKETS INC.,

as Sole Book Runner

TABLE OF CONTENTS

		Page
ARTICLE I DEFINITIONS AND ACCOUNTING TERMS		1
SECTION 1.01	Certain Defined Terms	1
SECTION 1.02	Computation of Time Periods	12
SECTION 1.03	Accounting Terms	12
ARTICLE II AMOUNTS AND TERMS OF THE ADVANCES		12
SECTION 2.01	The Advances	12
SECTION 2.02	Making the Revolving Credit Advances	13
SECTION 2.03	Fees	14
SECTION 2.04	Termination or Reduction of the Commitments	15
SECTION 2.05	Repayment	15
SECTION 2.06	Interest	15
SECTION 2.07	Interest Rate Determination	16
SECTION 2.08	Optional Conversion of Advances	16
SECTION 2.09	Optional Prepayments	17
SECTION 2.10	Increased Costs	17
SECTION 2.11	Illegality	18
SECTION 2.12	Payments and Computations	18
SECTION 2.13	Taxes	19
SECTION 2.14	Sharing of Payments, Etc.	22
SECTION 2.15	Use of Proceeds	22
SECTION 2.16	Extension of Commitment Termination Date	22
SECTION 2.17	Increase of Commitments	23
SECTION 2.18	Right to Replace a Lender	24
SECTION 2.19	Term Loan Conversion	25
ARTICLE III CONDITIONS TO EFFECTIVENESS AND LENDING		25
SECTION 3.01	Conditions Precedent to Initial Borrowing	25
SECTION 3.02	Conditions Precedent to Each Borrowing	27
SECTION 3.03	Conditions Precedent to Term Loan Conversion	27
ARTICLE IV REPRESENTATIONS AND WARRANTIES		28
SECTION 4.01	Representations and Warranties of each Borrower	28
ARTICLE V COVENANTS OF THE BORROWERS		30
SECTION 5.01	Affirmative Covenants	30
SECTION 5.02	Negative Covenants	33
SECTION 5.03	Financial Covenants	34

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ARTICLE VI EVENTS OF DEFAULT		34
SECTION 6.01	Events of Default	34
ARTICLE VII THE AGENTS		36
SECTION 7.01	Authorization and Action	36
SECTION 7.02	Agents’ Reliance, Etc.	37
SECTION 7.03	Agents and Affiliates	37
SECTION 7.04	Lender Credit Decision	37
SECTION 7.05	Indemnification	38
SECTION 7.06	Successor	38
ARTICLE VIII MISCELLANEOUS		39
SECTION 8.01	Amendments, Etc.	39
SECTION 8.02	Notices, Etc.	39
SECTION 8.03	No Waiver; Remedies	41
SECTION 8.04	Costs and Expenses	41
SECTION 8.05	Right of Set-off	42
SECTION 8.06	Binding Effect	42
SECTION 8.07	Assignments and Participations	42
SECTION 8.08	Confidentiality	45
SECTION 8.09	Governing Law	45
SECTION 8.10	Execution in Counterparts	45
SECTION 8.11	Waiver of Jury Trial	45
SECTION 8.12	Jurisdiction, Etc.	45
SECTION 8.13	Nature of Obligations	46

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Schedules

Schedule I -	Commitments
Schedule II -	List of Applicable Lending Offices
Schedule 4.01(h) -	Contingent Liabilities
Schedule 5.02(a) -	Ongoing Debt

Exhibits

Exhibit A-1 -	Form of Revolving Credit Note
Exhibit A-2 -	Form of Term Note
Exhibit B -	Form of Notice of Borrowing
Exhibit C -	Form of Assignment and Acceptance
Exhibit D -	Form of Compliance Certificate
Exhibit E -	Form of Opinion of Anne Gill Kelly, Managing Director, Assistant General Counsel and Secretary of Ambac Financial
Exhibit F -	Form of Opinion of Kevin J. Doyle, Managing Director and General Counsel of Ambac Assurance
Exhibit G -	Form of Opinion of DeWitt, Ross & Stevens, S.C., Wisconsin Special Counsel to Ambac Assurance
Exhibit H -	Form of Opinion of Shearman & Sterling LLP, Special New York Counsel to the Borrowers
Exhibit I -	Form of Opinion of Milbank, Tweed, Hadley & McCloy LLP, Special New York Counsel to the Administrative Agent

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REVOLVING CREDIT AGREEMENT

Dated as of July 29, 2004

AMBAC FINANCIAL GROUP, INC., a Delaware corporation (“Ambac Financial”), AMBAC ASSURANCE CORPORATION, a Wisconsin stock insurance corporation (“Ambac Assurance” and, together with Ambac Financial, the “Borrowers”), the banks, financial institutions and other institutional lenders listed on the signature pages hereof (the “Initial Lenders”), BARCLAYS BANK PLC (“Barclays”), as syndication agent (the “Syndication Agent”) and CITIBANK, N.A. (“Citibank”), as administrative agent for the Lenders, (the “Administrative Agent”), agree as follows:

ARTICLE I

DEFINITIONS AND ACCOUNTING TERMS

SECTION 1.01 Certain Defined Terms.

As used in this Agreement, the following terms shall have the following meanings (such meanings to be equally applicable to both the singular and plural forms of the terms defined):

“ABC Securities” means securities issued by a Finance Trust representing an undivided beneficial interest in assets acquired by a Finance Trust from Ambac Assurance with the net proceeds of such issuance.

“Administrative Agent” has the meaning specified in the preamble.

“Administrative Agent’s Account” means the account of the Administrative Agent maintained by the Administrative Agent at Citibank, N.A., 2 Penns Way, Suite 110, New Castle, Delaware 19720, Account No. 36852248, Attention: Mr. Keith Carter (fax: 212-994-0961).

“Advance” means a Revolving Credit Advance or a Term Loan.

“Affected Person” has the meaning specified in Section 2.18.

“Affiliate” means, as to any Person, any other Person that, directly or indirectly, controls, is controlled by or is under common control with such Person or is a director or officer of such Person. For purposes of this definition, the term “control” (including the terms “controlling”, “controlled by” and “under common control with”) of a Person means the possession, direct or indirect, of the power to vote 10% or more of the Voting Stock of such Person or to direct or cause the direction of the management and policies of such Person, whether through the ownership of Voting Stock, by contract or otherwise.

“Agent” means, as the context may require, the Syndication Agent or the Administrative Agent and “Agents” means the Syndication Agent and the Administrative Agent.

“Aleutian” means Aleutian Investments LLC, a Delaware limited liability company.

“Ambac Assurance” has the meaning specified in the preamble.

“Ambac Financial” has the meaning specified in the preamble.

“Applicable Lending Office” means, with respect to each Lender, such Lender’s Domestic Lending Office in the case of a Base Rate Advance and such Lender’s Eurodollar Lending Office in the case of a Eurodollar Rate Advance.

“Applicable Margin” means, as of any date, a percentage per annum determined by reference to the Financial Strength Rating in effect on such date as set forth below:

	Financial Strength Rating S&P/Moody’s	Applicable Margin for Base Rate Advances	Applicable Margin for Eurodollar Rate Advances
Level 1	Aaa/AAA or above	0.000%	0.180%
Level 2	Aa1/AA+	0.000%	0.220%
Level 3	Aa2/AA	0.000%	0.250%
Level 4	Lower than Level 3	0.000%	0.300%

provided, that in the case of each Term Loan the Applicable Margin determined as provided above shall be increased by 0.100% per annum; and provided further, that upon the occurrence and during the continuance of any Event of Default, the Applicable Margin determined as provided above shall be increased by 2% per annum.

“Asset Disposition” has the meaning specified in Section 5.02(c).

“Assignment and Acceptance” means an assignment and acceptance entered into by a Lender and an Eligible Assignee, and accepted by the Administrative Agent, in substantially the form of Exhibit C hereto.

“Barclays” has the meaning specified in the preamble.

“Base Rate” means a fluctuating interest rate per annum in effect from time to time, which rate per annum shall at all times be equal to the higher of:

(a) the rate of interest announced publicly by Citibank in New York City from time to time as Citibank’s base rate; and

(b) the Federal Funds Rate plus 0.5% per annum.

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“Base Rate Advance” means an Advance that bears interest as provided in Section 2.06(a)(i).

“Borrowers” has the meaning specified in the preamble.

“Borrowing” means a borrowing consisting of Revolving Credit Advances of the same Type made to a Borrower on the same day by the Lenders.

“Business Day” means a day of the year on which banks are not required or authorized by law to close in New York City and, if the applicable Business Day relates to any Eurodollar Rate Advances, on which dealings are carried on in the London interbank market.

“Change of Control” means any of the following events:

(a) Ambac Financial shall (i) cease to own, beneficially and of record, directly or indirectly, 51% of the shares of capital stock of Ambac Assurance (other than directors’ qualifying shares) or (ii) cease to have the ability to elect a majority of the board of directors of Ambac Assurance; or

(b) any “person” or “group” (as such terms are used for purposes of Sections 13(d) and 14(d) of the Exchange Act, whether or not applicable, except that for purposes of this paragraph (b) such person or group shall be deemed to have “beneficial ownership” of all shares that such person or group has the right to acquire, whether such right is exercisable immediately or only after the passage of time), other than any “person” or “group” that is a wholly-owned Subsidiary of either Borrower, is or becomes the “beneficial owner” (as such term is used in Rule 13d-3 promulgated pursuant to the Exchange Act), directly or indirectly, of more than 30% of the aggregate voting power of all Voting Stock of Ambac Financial.

“Citibank” has the meaning specified in the preamble.

“Closing Date” means the first date on which the Administrative Agent notifies each Borrower and the Initial Lenders that all of the conditions set forth in Section 3.01 have been satisfied.

“Code” means the Internal Revenue Code of 1986, as amended from time to time.

“Commitment” has the meaning specified in Section 2.01.

“Commitment Date” has the meaning specified in Section 2.17.

“Commitment Termination Date” means the earlier of (a) the date which is 364 days after the date hereof, as such date may be extended pursuant to Section 2.16, and (b) the date of termination in whole of the Commitments pursuant to Section 2.04 or 6.01; provided, that if such day is not a Business Day, the Commitment Termination Date shall be the immediately preceding Business Day.

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“Compliance Certificate” means a certificate duly completed and executed by an Responsible Officer of Ambac Financial, substantially in the form of Exhibit D hereto.

“Confidential Information” means written information that either Borrower furnishes to either Agent or any Lender labeled or marked in a manner clearly deeming such information as confidential, but does not include any such information that is or becomes generally available to the public.

“Consolidated” refers to the consolidation of accounts in accordance with GAAP.

“Contingent Liability” means any agreement, undertaking or arrangement by which any Person guarantees, endorses or otherwise becomes or is contingently liable upon (by direct or indirect agreement, contingent or otherwise, to provide funds for payment, to supply funds to, or otherwise to invest in, a debtor, or otherwise to assure a creditor against loss) the Indebtedness of any other Person (other than by endorsements of instruments in the course of collection), or guarantees the payment of dividends or other distributions upon the shares of any other Person. The amount of any Person’s obligation under any Contingent Liability at any time shall (subject to any limitation set forth therein) be deemed to be the outstanding amount at such time (or, except in the case of the Indebtedness or obligation guaranteed thereby being unutilized credit lines for Derivative Transactions, if larger, the maximum amount) of the Indebtedness or obligation guaranteed thereby.

“Controlled Group” means all members of a controlled group of corporations and all members of a controlled group of trades or businesses (whether or not incorporated) under common control which, together with either Borrower, are treated as a single employer under Section 414(b) or 414(c) of the Code or Section 4001 of ERISA.

“Convert”, “Conversion” and “Converted” each refers to a conversion of Advances of one Type into Advances of the other Type pursuant to Section 2.07 or 2.08.

“Debt” of any Person means, without duplication, all Indebtedness of such Person of any type described in clause (a), (b) or (c) of the definition of “Indebtedness” and all Contingent Liabilities of such Person in respect of any Indebtedness of any other Person of any such type.

“Declining Lender” has the meaning specified in Section 2.16.

“Default” means any Event of Default or any event that would constitute an Event of Default but for the requirement that notice be given or time elapse or both.

“Derivative Transactions” means, with respect to any Person, interest rate swap agreements, interest rate cap agreements, interest rate collar agreements, interest rate options, interest rate futures, foreign currency swap agreements, foreign currency cap agreements, foreign currency collar agreements, foreign currency options, foreign currency futures and all other similar agreements or arrangements and all liabilities of such Person thereunder.

“Dollars” and “$” mean the lawful money of the United States of America.

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“Domestic Lending Office” means, with respect to any Lender, the office of such Lender specified as its “Domestic Lending Office” opposite its name on Schedule II hereto or in the Assignment and Acceptance pursuant to which it became a Lender, or such other office of such Lender as such Lender may from time to time specify to the Borrowers and the Administrative Agent.

“Eligible Assignee” means (a) the Federal Reserve Bank of the United States; and (b) an Eligible Transferee; provided, however, that neither Borrower nor an Affiliate of the Borrowers shall qualify as an Eligible Assignee.

“Eligible Transferee” means a commercial bank or other financial institution having the Required Lender Rating.

“ERISA” means the Employee Retirement Income Security Act of 1974, as amended from time to time, and the regulations promulgated and rulings issued thereunder.

“Eurocurrency Liabilities” has the meaning assigned to that term in Regulation D of the Board of Governors of the Federal Reserve System, as in effect from time to time.

“Eurodollar Lending Office” means, with respect to any Lender, the office of such Lender specified as its “Eurodollar Lending Office” opposite its name on Schedule II hereto or in the Assignment and Acceptance pursuant to which it became a Lender (or, if no such office is specified, its Domestic Lending Office), or such other office of such Lender as such Lender may from time to time specify to the Borrowers and the Administrative Agent.

“Eurodollar Rate” means, for any Interest Period for each Eurodollar Rate Advance comprising part of the same Borrowing, an interest rate per annum appearing on Page 3750 of the Telerate Service (or on any successor or substitute page of such Service, or any successor to or substitute for such Service, providing rate quotations comparable to those currently provided on such page of such Service, as determined by the Administrative Agent from time to time for purposes of providing quotations of interest rates applicable to deposits in Dollars in the London interbank market) as of 11:00 A.M. (London time) on the date two Business Days prior to the first day of such Interest Period as the rate for Dollar deposits having a term comparable to such Interest Period, or in the event such offered rate is not available from said Page 3750, the average (rounded to the nearer whole multiple of 1/16 of 1% per annum, if such average is not such a multiple) of the rate per annum at which Dollar deposits are offered by the principal office of each of the Reference Banks in London, England to prime banks in the London interbank market at 11:00 A.M. (London time) two Business Days before the first day of such Interest Period in an amount substantially equal to such Reference Bank’s Eurodollar Rate Advance comprising part of such Borrowing to be outstanding during such Interest Period and for a period equal to such Interest Period.

“Eurodollar Rate Advance” means an Advance that bears interest as provided in Section 2.06(a)(ii).

“Eurodollar Rate Reserve Percentage” means, for any Interest Period for all Eurodollar Rate Advances comprising part of the same Borrowing, the reserve percentage applicable two Business Days before the first day of such Interest Period under regulations

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issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) for determining the maximum reserve requirement (including, without limitation, any emergency, supplemental or other marginal reserve requirement) for a member bank of the Federal Reserve System in New York City with respect to liabilities or assets consisting of or including Eurocurrency Liabilities (or with respect to any other category of liabilities that includes deposits by reference to which the interest rate on Eurodollar Rate Advances is determined) having a term equal to such Interest Period.

“Events of Default” has the meaning specified in Section 6.01.

“Extending Lender” has the meaning specified in Section 2.16.

“Extension Request” has the meaning specified in Section 2.16.

“Existing Commitment Termination Date” has the meaning specified in Section 2.16.

“Facility Fee Rate” means, as of any date, a percentage per annum determined by reference to the Financial Strength Rating in effect on such date as set forth below:

	Financial Strength Rating S&P/Moody’s	Facility Fee Rate
Level 1	Aaa/AAA or above	0.070%
Level 2	Aa1/AA+	0.080%
Level 3	Aa2/AA	0.100%
Level 4	Lower than Level 3	0.150%

“Federal Funds Rate” means, for any period, a fluctuating interest rate per annum equal for each day during such period to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day that is a Business Day, the average of the quotations for such day on such transactions received by the Administrative Agent from three Federal funds brokers of recognized standing selected by it.

“Finance Trust” means a trust formed for the purpose of issuing ABC Securities, using the proceeds of such issuance to purchase assets from Ambac Assurance and entering into a Put Agreement with Ambac Assurance.

“Financial Strength Rating” means, as of any date, the rating that has been most recently announced by either S&P or Moody’s, as the case may be, for the financial strength or insurance financial strength, as the case may be, of Ambac Assurance. For purposes of the

6

foregoing, (a) if the ratings established by S&P and Moody’s shall fall within different levels, the Applicable Margin and the Facility Fee Rate shall be based upon the lower rating; (b) if any rating established by S&P or Moody’s shall be changed, such change shall be effective as of the date on which such change is first announced publicly by the rating agency making such change; and (c) if S&P or Moody’s shall change the basis on which ratings are established, each reference to the Financial Strength Rating announced by S&P or Moody’s, as the case may be, shall refer to the then equivalent rating by S&P or Moody’s, as the case may be.

“GAAP” has the meaning specified in Section 1.03.

“Increase Date” has the meaning specified in Section 2.17.

“Increase Request” has the meaning specified in Section 2.17.

“Increasing Lender” has the meaning specified in Section 2.17.

“Increasing Extending Lender” has the meaning specified in Section 2.16.

“Indebtedness” of any Person means, without duplication: (a) all obligations of such Person for borrowed money and all obligations of such Person evidenced by bonds, debentures, notes or other similar instruments; (b) all obligations, contingent or otherwise, relative to the face amount of all letters of credit, whether or not drawn, and banker’s acceptances issued for the account of such Person; (c) all obligations of such Person as lessee under leases which have been or should be, in accordance with GAAP, recorded as capitalized lease liabilities; (d) net obligations of such Person under all Derivative Transactions (other than Derivative Transactions that are designated by such Person as hedges in accordance with GAAP); (e) whether or not so included as liabilities in accordance with GAAP, all obligations of such Person to pay the deferred purchase price of property or services (other than trade payables not overdue by more than 60 days incurred in the ordinary course of such Person’s business); (f) all obligations (excluding prepaid interest thereon) of any other Person of any type described in any of clauses (a) through (e) of this definition which is secured by a Lien on property owned by such Person (including obligations arising under conditional sales or other title retention agreements), even though such Person has not assumed or become liable for the payment of such obligations of such other Person; and (g) all Contingent Liabilities of such Person; provided, however, that the following shall not constitute Indebtedness of either Borrower or any Subsidiary of either Borrower: (i) obligations under securities reverse repurchase agreements of either Borrower or any Subsidiary of either Borrower as the buyer of securities to deliver such securities to the seller thereunder, (ii) obligations of an insurance company under insurance policies in the nature of financial guarantees and financial guarantees, in each case from time to time issued in the ordinary course of such insurance company’s business, (iii) obligations of any Subsidiary of Ambac Financial in the business of issuing investment contracts, under Specified Investment Contracts issued by such Subsidiary, (iv) obligations of such Person under any Specified Swaps and Specified Hedges, (v) obligations of Ambac Assurance to pay Put Premiums pursuant to any Put Agreement and (vi) obligations of either Borrower or any Subsidiary of either Borrower under or in respect of any preferred stock issued, or to be issued, by such Borrower or Subsidiary. For all purposes of this Agreement, the Indebtedness of any

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Person shall include the Indebtedness of any partnership in which such Person is a general partner.

“Interest Period” means, for each Eurodollar Rate Advance, the period commencing on (and including) the date of such Eurodollar Rate Advance or the date of the Conversion of any Base Rate Advance into such Eurodollar Rate Advance and ending on (but excluding) the final day of the period selected by either Borrower pursuant to the provisions below and, thereafter, each subsequent period commencing on the final of the next preceding Interest Period and ending on the final day of the period selected by such Borrower pursuant to the provisions below. The duration of each such Interest Period shall be one, two, three or six months, as such Borrower may, upon notice received by the Administrative Agent not later than 11:00 A.M. (New York City time) on the third Business Day prior to the first day of such Interest Period, select; provided, however, that:

(a) any Interest Period with respect to any Eurodollar Rate Advance that would otherwise end after the Commitment Termination Date or the Maturity Date shall end on the Commitment Termination Date or the Maturity Date, as the case may be;

(b) whenever the final day of any Interest Period would otherwise occur on a day other than a Business Day, the final day of such Interest Period shall be extended to occur on the next succeeding Business Day; provided, however, that, if such extension would cause the final day of such Interest Period to occur in the next succeeding calendar month, the final day of such Interest Period shall occur on the next preceding Business Day;

(c) whenever the first day of any Interest Period occurs on a day of an initial calendar month for which there is no numerically corresponding day in the calendar month that succeeds such initial calendar month by the number of months equal to the number of months in such Interest Period, such Interest Period shall end on the final Business Day of such succeeding calendar month; and

(d) neither Borrower shall be permitted to select Interest Periods to be in effect at any one time with respect to Eurodollar Rate Advances made to such Borrower which have expiration dates occurring on more than five different dates.

“Juneau” means Juneau Investments LLC, a Delaware limited liability company.

“Lenders” means the Initial Lenders and each Person that shall become a party hereto pursuant to Section 2.16, 2.17, 2.18 or 8.07.

“Leverage Ratio” means, at any time, the ratio of (a) the aggregate amount of Debt of Ambac Financial and its Subsidiaries (other than Aleutian and Juneau), on a Consolidated basis, at such time to (b) the sum of (i) the stockholders’ equity of Ambac Financial and its Subsidiaries (other than Aleutian and Juneau), on a Consolidated basis (excluding unrealized gains on investments and unrealized losses on investments), computed as of the end of the most recently completed fiscal quarter (or if such time is the final day of any fiscal quarter, as of such day) and (ii) the aggregate amount of Debt of Ambac Financial and its Subsidiaries (other than Aleutian and Juneau), on a Consolidated basis, at such time.

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“Lien” means any security interest, mortgage, pledge, hypothecation, assignment, encumbrance, lien (statutory or otherwise), charge against or interest in property to secure payment or performance of an obligation, interest of any vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement or other priority or preferential arrangement of any kind or nature whatsoever; provided, however, that “Lien” shall not include (a) any reserve established in respect of insurance obligations on the books of either Borrower or any of its Subsidiaries, provided that such reserve shall not create any preferential claim or priority on any asset of such Person and (b) any reserve established in respect of Specified Swaps on the books of either Borrower or any of its Subsidiaries, provided that such reserve shall not create any preferential claim or priority on any asset of such Person.

“Loan Documents” means this Agreement and the Notes.

“Material Adverse Change” means any material adverse change in the business, financial condition or operations of Ambac Financial and its Subsidiaries, taken as a whole.

“Material Adverse Effect” means a material adverse effect (a) on the business, financial condition or operations of Ambac Financial and its Subsidiaries, taken as a whole, (b) on the rights and remedies of the Administrative Agent or any Lender under any Loan Document or (c) on the ability of either Borrower to perform its obligations under any Loan Document.

“Material Subsidiary” means, at any date of determination, any Subsidiary of either Borrower that, together with its Subsidiaries, as of the end of the most recent fiscal year, was the owner of (or, in the case of any Subsidiary that is acquired following such fiscal year end, would have been the owner of) at least 10% of the Consolidated assets of such Borrower and its Subsidiaries at the end of such fiscal year, all as set forth on the most recently available Consolidated financial statements of such Borrower for such fiscal year.

“Maturity Date” means the second anniversary of the Commitment Termination Date; provided, that if such day is not a Business Day, the Maturity Date shall be the immediately preceding Business Day.

“Moody’s” means Moody’s Investors Service, Inc., and its successors.

“Notes” means, collectively, the Revolving Credit Notes and the Term Notes.

“Notice of Borrowing” has the meaning specified in Section 2.02.

“Ongoing Debt” has the meaning specified in Section 5.02(a).

“Other Taxes” has the meaning specified in Section 2.13(b).

“Pension Plan” means a “pension plan”, as such term is defined in Section 3(2) of ERISA, which is subject to Title IV of ERISA (other than a multiemployer plan as defined in section 4001(a) (3) of ERISA), and to which either Borrower or any corporation, trade or business that is, along with such Borrower, a member of a Controlled Group, may have liability, including any liability by reason of having been a substantial employer within the meaning of

9

section 4063 of ERISA at any time during the preceding five years, or by reason of being deemed to be a contributing sponsor under section 4069 of ERISA.

“Permitted Liens” means: (a) Liens for taxes, assessments and governmental charges or levies; (b) Liens imposed by law, such as materialmen’s, mechanics’, carriers’, workmen’s and repairmen’s Liens and other similar Liens arising in the ordinary course of business securing obligations that are not overdue for a period of more than 60 days; (c) pledges or deposits to secure obligations under workers’ compensation laws or similar legislation or to secure public or statutory obligations; and (d) encumbrances on title to real property that do not render title to the property encumbered thereby unmarketable or materially adversely affect the use of such property for its intended purposes.

“Person” means an individual, partnership, corporation (including a business trust), joint stock company, trust, unincorporated association, joint venture, limited liability company or other entity, or a government or any political subdivision or agency thereof.

“Put Agreement” means an agreement between Ambac Assurance and a Finance Trust pursuant to which Ambac Assurance has the right, at its option, to compel a Finance Trust to purchase preferred stock issued, or to be issued, by Ambac Assurance.

“Put Premium” means a premium payable by Ambac Assurance under a Put Agreement.

“Reference Banks” means Citibank, Barclays and The Bank of New York (and any successors thereof).

“Register” has the meaning specified in Section 8.07(c).

“Replacement Lenders” has the meaning specified in Section 2.16.

“Required Lenders” means, at any time, Lenders owed at least a majority in interest of the then aggregate outstanding principal amount of the Advances, or, if no such principal amount is then outstanding, Lenders having at least a majority in interest of the Commitments.

“Required Lender Rating” means an unsecured short-term senior debt rating of not less than A-1 from Moody’s and P-1 from S&P.

“Responsible Officer” means, with respect to a Borrower, the president, chief financial officer or treasurer of such Borrower.

“Revolving Credit Advance” has the meaning specified in Section 2.01.

“Revolving Credit Note” means a promissory note of a Borrower payable to the order of a Lender, substantially in the form of Exhibit A-1 hereto, evidencing the aggregate indebtedness of such Borrower to such Lender resulting from Revolving Credit Advances made by such Lender to such Borrower.

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“S&P” means Standard & Poor’s Ratings Services, a division of The McGraw-Hill Companies, Inc., and its successors.

“Solvent” means, with respect to any Person on a particular date, that (i) the fair value of the total assets of such Person is greater than the total amount of the liabilities, including, without limitation, contingent liabilities, of such Person, (ii) the present fair saleable value of the assets of such Person is not less than the amount that will be required to pay the probable liability of such Person on its debts as they become absolute and matured, (iii) such Person does not intend to, and does not believe that it will, incur debts or liabilities beyond such Person’s ability to pay such debts and liabilities as they mature, and (iv) such Person is not engaged in business, and is not about to engage in business, for which such Person’s property would constitute unreasonably small capital.

“Specified Hedge” means any derivative transaction, securities repurchase agreement or other similar agreement or arrangement entered into by any Person that, in each case, is entered into as a hedge.

“Specified Investment Contract” means any investment contract entered into by Ambac Assurance or any Subsidiary of Ambac Financial in the ordinary course of Ambac Assurance’s or such Subsidiary’s respective businesses.

“Specified Swap” means any interest rate swap agreement or other similar agreement or arrangement entered into by any Person, as to which interest rate risk is substantially hedged.

“Subsidiary” of any Person means any corporation, partnership, joint venture, limited liability company, trust or estate of which (or in which) more than 50% of (a) the issued and outstanding capital stock having ordinary voting power to elect a majority of the Board of Directors of such corporation (irrespective of whether at the time capital stock of any other class or classes of such corporation shall or might have voting power upon the occurrence of any contingency), (b) the interest in the capital or profits of such limited liability company, partnership or joint venture or (c) the beneficial interest in such trust or estate is at the time directly or indirectly owned or controlled by such Person, by such Person and one or more of its other Subsidiaries or by one or more of such Person’s other Subsidiaries.

“Syndication Agent” has the meaning specified in the preamble.

“Taxes” has the meaning specified in Section 2.13(a).

“Term Loan” has the meaning specified in Section 2.19(a).

“Term Loan Conversion” has the meaning specified in Section 2.19(a).

“Term Loan Conversion Date” has the meaning specified in Section 2.19(a).

“Term Note” means a promissory note of a Borrower payable to the order of a Lender, substantially in the form of Exhibit A-2 hereto, evidencing the Term Loan (if any) of such Lender.

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“Type” refers to, for any Advance, its nature as a Base Rate Advance or Eurodollar Rate Advance.

“Utilization Fee Rate” means, for any day, a percentage per annum determined by reference to the Financial Strength Rating in effect on such date as set forth below:

	Financial Strength Rating S&P/Moody’s	Utilization Fee Rate
Level 1	Aaa/AAA or above	0.100%
Level 2	Aa1/AA+	0.100%
Level 3	Aa2/AA	0.100%
Level 4	Lower than Level 3	0.150%

“Voting Stock” means capital stock issued by a corporation, or equivalent interests in any other Person, the holders of which are ordinarily, in the absence of contingencies, entitled to vote for the election of directors (or persons performing similar functions) of such Person, even if the right so to vote has been suspended by the happening of such a contingency.

“Welfare Plan” means a “welfare plan”, as such term is defined in section 3(1) of ERISA.

SECTION 1.02 Computation of Time Periods. In this Agreement in the computation of periods of time from a specified date to a later specified date, the word “from” means “from and including” and the words “to” and “until” each mean “to but excluding”.

SECTION 1.03 Accounting Terms. All accounting terms not specifically defined herein shall be construed in accordance with generally accepted accounting principles consistent with those applied in the preparation of the financial statements referred to in Section 4.01(e) (“GAAP”).

ARTICLE II

AMOUNTS AND TERMS OF THE ADVANCES

SECTION 2.01 The Advances. (a) Each Lender severally agrees, on the terms and conditions hereinafter set forth, to make advances to each Borrower under this Section 2.01 (each, a “Revolving Credit Advance”) from time to time on any Business Day during the period from the date hereof until the Commitment Termination Date in an aggregate amount at any one time outstanding up to but not exceeding (in the aggregate for both Borrowers) the amount set forth opposite such Lender’s name on Schedule I or, if such Lender has entered into any Assignment and Acceptance, set forth for such Lender in the Register maintained by the

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Administrative Agent pursuant to Section 8.07(c), as such amount may be reduced pursuant to Section 2.04 or increased pursuant to Section 2.16 or 2.17 (such Lender’s “Commitment”).

(b) Each Borrowing of Revolving Credit Advances shall be in an aggregate amount of $15,000,000 or an integral multiple of $1,000,000 in excess thereof and shall consist of Revolving Credit Advances of the same Type made on the same day by the Lenders ratably according to their respective Commitments. Within the limits of each Lender’s Commitment, each Borrower may borrow under this Section 2.01, prepay pursuant to Section 2.09 and reborrow under this Section 2.01.

(c) The Administrative Agent shall maintain a written record of each Advance made by a Lender to a Borrower, and of each repayment of principal of, and payment of interest on, such Advance made by such Borrower for the amount of such Lender. Upon the prior written request of any Lender delivered by such Lender to the Administrative Agent and the Borrowers, each of the Borrowers shall execute and deliver to such Lender a Revolving Credit Note to the order of such Lender.

SECTION 2.02 Making the Revolving Credit Advances. (a) Each Borrowing of Revolving Credit Advances shall be made on notice, given not later than 12:00 Noon (New York City time) on the third Business Day next preceding the date of the proposed Borrowing in the case of a Borrowing consisting of Eurodollar Rate Advances, or 11:30 A.M. (New York City time) on the Business Day of the proposed Borrowing in the case of a Borrowing consisting of Base Rate Advances, by either Borrower to the Administrative Agent, which shall give to each Lender prompt notice thereof by telecopier. Each such notice of a Borrowing (a “Notice of Borrowing”) shall be by telephone, confirmed immediately in writing or by telecopier, in substantially the form of Exhibit B, specifying therein the requested (i) date of such Borrowing, (ii) Type of Advances comprising such Borrowing, (iii) aggregate amount of such Borrowing and (iv) in the case of a Borrowing consisting of Eurodollar Rate Advances, initial Interest Period for each such Advance. Each Lender shall, before 10:00 A.M. (New York City time) on the date of such Borrowing in the case of a Borrowing consisting of Eurodollar Rate Advances, or 1:00 P.M. (New York City time) on the date of such Borrowing in the case of a Borrowing consisting of Base Rate Advances, make available for the account of its Applicable Lending Office to the Administrative Agent at the Administrative Agent’s Account, in same day funds, such Lender’s ratable portion of such Borrowing. After the Administrative Agent’s receipt of such funds and upon fulfillment of the applicable conditions set forth in Article III, the Administrative Agent will, not later than 11:00 A.M. (New York City time) on the date of such Borrowing in the case of a Borrowing consisting of Eurodollar Rate Advances, or 2:00 P.M. (New York City time) on the date of such Borrowing in the case of a Borrowing consisting of Base Rate Advances, make such funds available to such Borrower at the Administrative Agent’s address referred to in Section 8.02.

(b) Anything in subsection (a) above to the contrary notwithstanding, neither Borrower may select Eurodollar Rate Advances for any Borrowing if the obligation of the Lenders to make Eurodollar Rate Advances shall then be suspended pursuant to Section 2.07 or 2.11.

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(c) In the case of any Borrowing that the related Notice of Borrowing specifies is to be comprised of Eurodollar Rate Advances, the Borrower that has requested such Borrowing shall indemnify each Lender against any loss, cost or expense incurred by such Lender as a result of any failure to fulfill on or before the date specified in such Notice of Borrowing for such Borrowing the applicable conditions set forth in Article III, including any loss (excluding loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by such Lender to fund the Advance to be made by such Lender as part of such Borrowing when such Advance, as a result of such failure, is not made on such date.

(d) Unless the Administrative Agent shall have received notice from a Lender prior to the date of any Borrowing that such Lender will not make available to the Administrative Agent such Lender’s ratable portion of such Borrowing, the Administrative Agent may assume that such Lender has made such portion available to the Administrative Agent on the date of such Borrowing in accordance with subsection (a) of this Section 2.02 and the Administrative Agent may, in reliance upon such assumption, make available to the Borrower that has requested such Borrowing on such date a corresponding amount. If and to the extent that such Lender shall not have so made such ratable portion available to the Administrative Agent, such Lender and such Borrower severally agree to repay to the Administrative Agent forthwith on demand such corresponding amount together with interest thereon, for each day from the date such amount is made available to such Borrower until the date such amount is repaid to the Administrative Agent, at (i) in the case of such Borrower, the interest rate applicable at the time to Advances comprising such Borrowing and (ii) in the case of such Lender, the Federal Funds Rate. If such Lender shall repay to the Administrative Agent such corresponding amount, such amount so repaid shall constitute such Lender’s Advance as part of such Borrowing for purposes of this Agreement.

(e) The failure of any Lender to make the Revolving Credit Advance to be made by it as part of any Borrowing shall not relieve any other Lender of its obligation, if any, hereunder to make its Revolving Credit Advance on the date of such Borrowing, but no Lender shall be responsible for the failure of any other Lender to make the Revolving Credit Advance to be made by such other Lender on the date of any Borrowing.

SECTION 2.03 Fees. (a) Facility Fee. The Borrowers jointly and severally agree to pay to the Administrative Agent for the account of each Lender a facility fee, for each day from the date hereof, if such Lender shall be a party hereto on the date hereof, or from the effective date specified in the Assignment and Acceptance pursuant to which it became a Lender or from the date it became a Lender pursuant to Section 2.16, 2.17 or 2.18, if such Lender shall become a party hereto after the date hereof, until the Commitment Termination Date, computed at the Facility Fee Rate for such date on the amount of such Lender’s Commitment, whether or not utilized, for such date; in each case payable in arrears quarterly on the final day of each March, June, September and December, commencing on the first of such dates to occur after the date hereof, and on the Commitment Termination Date.

(b) Administrative Agent’s Fees. The Borrowers jointly and severally agree to pay to the Administrative Agent for its own account such fees as may from time to time be agreed between the Borrowers and the Administrative Agent.

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(c) Utilization Fee. The Borrowers jointly and severally agree to pay to the Administrative Agent for the account of each Lender a utilization fee, for each day on which the aggregate outstanding principal amount of Advances exceeds 50% of the aggregate amount of Commitments, computed at the Utilization Fee Rate for such date on the unpaid principal amount of the Advances made to the Borrowers by such Lender, payable in arrears on each day on which a payment of interest is due under Section 2.06.

SECTION 2.04 Termination or Reduction of the Commitments. The Borrowers shall have the right, upon at least three Business Days’ notice signed by both Borrowers to the Administrative Agent (which shall promptly notify each Lender), to terminate in whole or reduce ratably in part the unused portions of the respective Commitments of the Lenders, provided that each partial reduction shall be in the aggregate amount of $15,000,000 or an integral multiple of $1,000,000 in excess thereof.

SECTION 2.05 Repayment. Each Borrower shall repay to the Administrative Agent for the account of each Lender (i) the full principal amount of each Revolving Credit Advance of such Lender made to such Borrower and outstanding on the Commitment Termination Date (subject to the provisions of Section 2.19) and (ii) the full principal amount of the Term Loan of such Lender made to such Borrower and outstanding on the Maturity Date.

SECTION 2.06 Interest. (a) Each Borrower shall pay interest on the unpaid principal amount of each Advance made to such Borrower from the date of such Advance until such principal amount shall be paid in full, at the following rates per annum:

(i) Base Rate Advances. While such Advance is a Base Rate Advance, a rate per annum equal at all times to the sum of the (A) Base Rate in effect from time to time plus (B) the Applicable Margin for Base Rate Advances, payable in arrears quarterly on the final Business Day of each March, June, September and December, on the date such Base Rate Advance shall be Converted or paid in full and on the Term Loan Conversion Date, if any.

(ii) Eurodollar Rate Advances. While such Advance is a Eurodollar Rate Advance, a rate per annum equal at all times during each Interest Period for such Advance to the sum of (A) the Eurodollar Rate for such Interest Period for such Advance plus (B) the Applicable Margin for Eurodollar Rate Advances, payable in arrears on the final day of such Interest Period and, if such Interest Period has a duration of more than three months, on each day that occurs during such Interest Period every three months from the first day of such Interest Period on the date such Eurodollar Rate Advance shall be Converted or paid in full and on the Term Loan Conversion Date, if any.

(b) Additional Interest on Eurodollar Rate Advances. Each Borrower shall pay to each Lender, so long as and to the extent such Lender shall be required under regulations of the Board of Governors of the Federal Reserve System to maintain reserves with respect to liabilities or assets consisting of or including Eurocurrency Liabilities, additional interest on the unpaid principal amount of each Eurodollar Rate Advance of such Lender made to such Borrower, from the date of such Eurodollar Rate Advance until such principal amount is paid in full, at an interest rate per annum equal at all times to the remainder obtained by subtracting (i)

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the Eurodollar Rate for the then existing Interest Period for such Advance from (ii) the rate obtained by dividing such Eurodollar Rate by a percentage equal to 100% minus the Eurodollar Rate Reserve Percentage of such Lender for such Interest Period, payable on each date on which interest is payable on such Advance. Each Lender shall, as promptly as practicable after an authorized officer of such Lender having direct and ongoing involvement in the decisions made in respect of this Agreement obtains knowledge of such circumstances and the determination of such Lender to request additional interest from such Borrower pursuant to this Section 2.06(b), provide notice to the Administrative Agent and such Borrower of the circumstances entitling such Lender to such additional interest, which notice shall (A) specify the amount of any such additional interest incurred in connection with such Eurodollar Rate Advance made to such Borrower and/or to be incurred in connection with Eurodollar Rate Advances made by such Lender from time to time thereafter to such Borrower and (B) certify that such Lender’s claim for payment of such additional interest is not inconsistent with its treatment of other borrowers that, as a credit matter, are substantially similar to such Borrower and that are subject to comparable provisions in the loan or other credit documentation to which such borrowers are parties; provided, however, that no Lender shall be entitled to additional interest on any Eurodollar Rate Advance pursuant to this Section 2.06(b) for any Interest Period ending more than 120 days prior to the date that notice of such additional interest is first provided by such Lender to such Borrower. A notice delivered by any Lender to either Borrower pursuant to the terms of this Section 2.06(b) shall be conclusive and binding, absent manifest error. A Lender that delivers a notice under this Section 2.06(b) shall promptly notify the Administrative Agent and such Borrower if the circumstances that gave rise to such notice no longer exist.

SECTION 2.07 Interest Rate Determination. (a) The Administrative Agent shall give prompt notice to each Borrower and the Lenders of the applicable interest rate determined by the Administrative Agent for purposes of Section 2.06(a)(i) or (ii).

(b) If either Borrower shall fail to select the duration of any Interest Period for any Eurodollar Rate Advances to be made to such Borrower in accordance with the provisions contained in the definition of “Interest Period” in Section 1.01, the Administrative Agent will forthwith so notify such Borrower and the Lenders and such Advances will automatically, on the final day of the then existing Interest Period therefor, Convert into Base Rate Advances.

(c) On the date on which the aggregate unpaid principal amount of Eurodollar Rate Advances having the same Interest Period shall be reduced, by payment or prepayment or otherwise, to less than $5,000,000, such Advances shall automatically Convert into Base Rate Advances.

(d) Upon the occurrence and during the continuance of any Event of Default, (i) each Eurodollar Rate Advance will automatically, on the final day of the then existing Interest Period therefor, Convert into a Base Rate Advance and (ii) the obligation of the Lenders to make, or to Convert Advances into, Eurodollar Rate Advances shall be suspended.

SECTION 2.08 Optional Conversion of Advances. Each Borrower may on any Business Day, upon notice given to the Administrative Agent not later than 12:00 A.M. (New York City time) on the third Business Day prior to the date of the proposed Conversion and subject to the provisions of Sections 2.07 and 2.11, Convert all Advances of one Type made to

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such Borrower comprising the same Borrowing into Advances of the other Type; provided, however, that (a) any Conversion of Eurodollar Rate Advances into Base Rate Advances shall be made only on the final day of an Interest Period for such Eurodollar Rate Advances and (b) no Conversion of any Advances shall result in more separate Interest Periods with respect to Eurodollar Rate Advances made to such Borrower than permitted under the definition of the term “Interest Period” in Section 1.01; provided, further, that no Base Rate Advance may be Converted to a Eurodollar Rate Advance when any Event of Default has occurred and is continuing. Each such notice of a Conversion shall, within the restrictions specified above, specify (i) the date of such Conversion, (ii) the Advances to be Converted, and (iii) if such Conversion is into Eurodollar Rate Advances, the duration of the initial Interest Period for each such Advance.

SECTION 2.09 Optional Prepayments. Each Borrower may, in the case of Eurodollar Rate Advances upon at least two Business Days’ notice, or, in the case of Base Rate Advances upon same day’s prior notice, to the Administrative Agent (which shall promptly notify each Lender) stating the proposed date and aggregate principal amount of the prepayment, and if such notice is given, such Borrower shall prepay the outstanding principal amount of the Advances made to such Borrower comprising part of the same Borrowing in whole or ratably in part, together with accrued interest to the date of such prepayment on the principal amount prepaid; provided, however, that all such partial prepayments shall be in an aggregate minimum amount of $10,000,000 or an integral multiple of $1,000,000 in excess thereof. Each prepayment of any Advances made pursuant to this Section 2.09 shall be without premium or penalty, subject, however, to Section 8.04(c).

SECTION 2.10 Increased Costs. If, due to either (a) the introduction of or any change after the date hereof in or in the interpretation of any law or regulation or (b) the compliance with any guideline or request promulgated after the date hereof from any central bank or other governmental authority (whether or not having the force of law), there shall be any increase in (i) the cost to any Lender of agreeing to make or making, funding or maintaining Eurodollar Rate Advances (excluding for purposes of this Section 2.10 any such increased costs resulting from Taxes or Other Taxes or from changes in the basis or rate of taxation of net income or gross income by the United States or by the foreign jurisdiction or state under the laws of which such Lender is subject to tax as a result of a present or former connection between such Lender and such foreign jurisdiction or state) or (ii) the amount of capital required to be maintained by such Lender or any corporation controlling such Lender based on the existence of its Commitment hereunder, then the Borrowers jointly and severally agree from time to time, within five Business Days after receipt by both Borrowers of a written demand by such Lender (with a copy of such demand to the Administrative Agent), to pay to the Administrative Agent for the account of such Lender additional amounts as shall accrue from and after the date of demand by such Lender to compensate such Lender for such increased cost or such increase of capital; provided, however, that before making any such demand, each Lender agrees to use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to minimize such additional amounts and to designate a different Applicable Lending Office if the making of such a designation would avoid the need for, or reduce the amount of, such increased cost or such increase of capital and would not, in the reasonable judgment of such Lender, be otherwise disadvantageous to such Lender; and provided, further, that the Borrowers shall be required jointly and severally to pay to such Lender only such additional amounts as shall be

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required to compensate such Lender for such increased cost or such increase of capital as shall accrue from and after the date of demand by such Lender. In determining such additional amounts, such Lender will act reasonably and in good faith and will use averaging and attribution methods which are reasonable, provided that such Lender’s determination of compensation owing under this Section 2.10 shall be conclusive and binding, absent manifest error. Each Lender, upon determining that any additional amounts will be payable pursuant to this Section 2.10, will give prompt written notice thereof to the Borrowers, which notice shall show the basis for the calculation of such additional amounts. Notwithstanding anything herein to the contrary, either Borrower shall have the right to unilaterally terminate the Commitment of any Lender demanding additional amounts under this Section 2.10 sixty (60) days after providing to such Lender a notice of termination; provided that such termination shall not result in a reduction in amounts required to be paid pursuant to this Section 2.10. Each of the Borrowers shall, concurrent with such termination, pay or prepay, as the case may be, to such Lender the aggregate amount, if any at such time, of all Advances and other amounts payable by such Borrower to such Lender under this Agreement. Notwithstanding any provision of this Agreement to the contrary, Section 2.13 shall provide the exclusive remedy to the Lenders in respect of Taxes and Other Taxes.

SECTION 2.11 Illegality. Notwithstanding any other provision of this Agreement, if any Lender shall notify the Administrative Agent that the introduction of or any change after the date hereof in or in the interpretation of any law or regulation makes it unlawful, or any central bank or other governmental authority asserts after the date hereof that it is unlawful, for any Lender or its Eurodollar Lending Office to perform its obligations hereunder to make Eurodollar Rate Advances or to fund or maintain Eurodollar Rate Advances hereunder, (i) each Eurodollar Rate Advance will automatically, upon such demand, Convert into a Base Rate Advance and (ii) the obligation of the Lenders to make, or to Convert Advances into, Eurodollar Rate Advances shall be suspended until the Administrative Agent shall notify the Borrower that has requested such Advance and the Lenders that the circumstances causing such suspension no longer exist; provided, however, that before making any such demand, each Lender agrees to use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to designate a different Eurodollar Lending Office if the making of such a designation would allow such Lender or its Eurodollar Lending Office to continue to perform its obligations to make Eurodollar Rate Advances or to continue to fund or maintain Eurodollar Rate Advances and would not, in the reasonable judgment of such Lender, be otherwise disadvantageous to such Lender.

SECTION 2.12 Payments and Computations. (a) Each Borrower shall make each payment to be made by it hereunder and under the Notes not later than 11:00 A.M. (New York City time) on the day when due in Dollars to the Administrative Agent at the Administrative Agent’s Account in same day funds and without set-off or counterclaim. The Administrative Agent will promptly thereafter cause to be distributed like funds relating to the payment of principal or interest ratably (other than amounts payable pursuant to Section 2.10, 2.13 or 8.04(c)) to the Lenders for the account of their respective Applicable Lending Offices, and like funds relating to the payment of any other amount payable to any Lender to such Lender for the account of its Applicable Lending Office, in each case to be applied in accordance with the terms of this Agreement. Upon its acceptance of an Assignment and Acceptance and recording of the information contained therein in the Register pursuant to Section 8.07(d), from

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and after the effective date specified in such Assignment and Acceptance, the Administrative Agent shall make all payments hereunder and under the Notes in respect of the interest assigned thereby to the Lender assignee thereunder, and the parties to such Assignment and Acceptance shall make all appropriate adjustments in such payments for periods prior to such effective date directly between themselves.

(b) All computations of interest based on the Base Rate, when the Base Rate is determined by reference to Citibank’s base rate, shall be made by the Administrative Agent on the basis of a year of 365 or 366 days, as the case may be, and all other computations of interest and of facility fees and utilization fees shall be made by the Administrative Agent on the basis of a year of 360 days, in each case for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest or facility fees are payable. Each determination by the Administrative Agent of an interest rate hereunder shall be conclusive and binding, absent manifest error.

(c) Whenever any payment hereunder or under the Notes shall be stated to be due on a day other than a Business Day, such payment shall be made on the next succeeding Business Day, and such extension of time shall in such case be included in the computation of payment of interest or facility fee, as the case may be; provided, however, that, if such extension would cause payment of interest on or principal of Eurodollar Rate Advances to be made in the next succeeding calendar month, such payment shall be made on the next preceding Business Day.

(d) Unless the Administrative Agent shall have received notice from either Borrower prior to the date on which any payment is due to the Lenders hereunder that such Borrower will not make such payment in full, the Administrative Agent may assume that such Borrower has made such payment in full to the Administrative Agent on such date and the Administrative Agent may, in reliance upon such assumption, cause to be distributed to each Lender on such due date an amount equal to the amount then due such Lender. If and to the extent such Borrower shall not have so made such payment in full to the Administrative Agent, each Lender shall repay to the Administrative Agent forthwith on demand such amount distributed to such Lender together with interest thereon, for each day from the date such amount is distributed to such Lender until the date such Lender repays such amount to the Administrative Agent, at the Federal Funds Rate.

SECTION 2.13 Taxes. (a) Any and all payments by each Borrower hereunder or under the Notes shall be made, in accordance with Section 2.12, free and clear of and without deduction for any and all present or future taxes, levies, imposts, deductions, charges or withholdings imposed by the United States or by any political subdivision thereof or therein with respect to such payments, and all penalties and interest with respect thereto, excluding, in the case of each Lender and the Administrative Agent, taxes imposed on or measured by its net income or net profit, and branch profit taxes, franchise taxes, taxes on doing business and taxes measured by or imposed upon its capital or net worth, in each case imposed as a result of a present or former connection between the Administrative Agent or such Lender and the jurisdiction imposing such tax or any political subdivision or taxing authority thereof or therein (other than any such connection arising solely from the Administrative Agent or such Lender having executed, delivered or performed its obligations or received a payment under, or enforced

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this Agreement or the Notes) (all such non-excluded taxes, levies, imposts, deductions, charges, withholdings and liabilities in respect of payments hereunder or under the Notes being hereinafter referred to as “Taxes”). If either Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable by such Borrower hereunder or under any Note to any Lender or the Administrative Agent, (i) the sum payable shall be increased as may be necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 2.13) such Lender or the Administrative Agent (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) such Borrower shall make such deductions and (iii) such Borrower shall pay the full amount deducted to the relevant taxation authority or other authority in accordance with applicable law.

(b) In addition, the Borrowers jointly and severally agree to pay any present or future stamp or documentary taxes or any other excise or property taxes, charges or similar levies that arise from the execution, delivery or registration of this Agreement or the Notes (hereinafter referred to as “Other Taxes”); provided, however, that the Borrowers shall have no obligation to pay Other Taxes that may arise as a result of a participation referred to in Section 2.14 or 8.07.

(c) Each of the Borrowers shall indemnify each Lender and the Administrative Agent for and hold it harmless against the full amount of Taxes with respect to payments by such Borrower hereunder or under the Notes imposed on or paid by such Lender or the Administrative Agent (as the case may be) and any liability for penalties, interest and expenses arising therefrom or with respect thereto. The Borrowers shall jointly and severally indemnify each Lender and the Administrative Agent for and hold it harmless against the full amount of Other Taxes imposed on or paid by such Lender or the Administrative Agent (as the case may be) and any liability for penalties, interest and expenses arising therefrom or with respect thereto. Any indemnification under this Section 2.13(c) shall be made within 30 days from the date such Lender or the Administrative Agent (as the case may be) makes written demand therefor.

(d) Each Lender that is not a “United States person” within the meanings specified in Section 7701 of the Code, on or prior to the date of its execution and delivery of this Agreement or on the date of the Assignment and Acceptance pursuant to which it becomes a Lender, as the case may be, and from time to time thereafter as requested in writing by either Borrower (but only so long as such Lender remains lawfully able to do so), shall provide each of the Administrative Agent and such Borrower with (i) two accurate and complete original signed copies of Internal Revenue Service Form W-8BEN or W-8ECI, as appropriate, or any successor or other form prescribed by the Internal Revenue Service, certifying to such Lender’s entitlement to a complete exemption from United States withholding tax with respect to payments to be made under this Agreement or the Notes on account of such Lender being entitled to benefits under an income tax treaty or such payments being effectively connected with such Lender’s conduct of a United States trade or business or (ii) if the Lender is not a “bank” within the meaning of Section 881(c)(3)(A) of the Code and cannot deliver either Internal Revenue Service Form W-8BEN or W-8ECI pursuant to clause (i) above, (A) a certificate in form and substance satisfactory to the Administrative Agent and such Borrower stating that such Lender is not a “person” described in Section 871(h)(3) or Section 881(c)(3) of the Code (a “Foreign Lender

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Certificate”) and (B) two accurate and complete original signed copies of Internal Revenue Service Form W-8BEN (or successor form) certifying to such Lender’s entitlement to a complete exemption from United States withholding tax with respect to payments to be made under this Agreement and under any Note. In addition, each Lender agrees that from time to time, when a lapse in time or change in circumstances renders the previous certification obsolete or inaccurate in any material respect, it will deliver to such Borrower and the Administrative Agent two new accurate and complete original signed copies of Internal Revenue Service Form W-8BEN or W-8ECI, or Form W-8BEN and a Foreign Lender Certificate, as the case may be, and such other forms as may be required in order to confirm or establish the entitlement of such Lender to a continued exemption from United States withholding tax with respect to payments under this Agreement and any Note or it shall immediately notify such Borrower and the Administrative Agent of its inability to deliver any such form or certificate, in which case such Lender shall not be required to deliver any such form or certificate pursuant to this Section 2.13(d) for so long as such payments may be made free from United States withholding tax. Notwithstanding the foregoing, no Lender shall be required to deliver any such form or certificate described in the immediately preceding sentence if a change in treaty, law or regulation has occurred prior to the date on which such delivery would otherwise be required that renders any such form or certificate inapplicable or would prevent the Lender from duly completing and delivering any such form or certificate with respect to it and such Lender so advises such Borrower.

(e) For any period with respect to which a Lender has failed to provide either Borrower with the appropriate form described in Section 2.13(d), such Lender shall not be entitled to indemnification under Section 2.13(a) or (c) with respect to Taxes or Other Taxes imposed by the United States by reason of such failure.

(f) Any Lender claiming additional amounts payable pursuant to this Section 2.13 agrees to use reasonable efforts (consistent with its internal policy and legal and regulatory restrictions) to minimize such additional amounts and to change the jurisdiction of its Applicable Lending Office if the making of such a change would avoid the need for, or reduce the amount of, any such additional amounts that may thereafter accrue and would not, in the reasonable determination of such Lender, be otherwise disadvantageous to such Lender.

(g) If a Lender changes its Applicable Lending Office (other than pursuant to subsection (f) above or Section 2.11 or 2.12 or otherwise at the request of either Borrower) and the effect of such change, as of the date of such change, would be to cause either Borrower to become obligated to pay any additional amounts under this Section 2.13, such Borrower shall not be obligated to pay such additional amounts.

(h) If either Borrower is required to pay any amounts pursuant to the provisions of this Section 2.13 to or for the account of any Lender or the Administrative Agent, and if thereafter such Lender or the Administrative Agent, as the case may be, shall receive a refund of any Taxes or Other Taxes paid by or on behalf of such Lender or the Administrative Agent, as the case may be, that such Lender or the Administrative Agent, as the case may be, reasonably determines to relate solely to the amounts so paid by such Borrower, such Lender or the Administrative Agent, as the case may be, shall to the extent that it can do so without prejudice to the retention of the amount of such refund, pay to such Borrower within twenty days after the date on which such Lender or the Administrative Agent, as the case may be, actually

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receives such refund in an amount which such Lender or the Administrative Agent, as the case may be, determines to be the proportion of the refunded amount as will leave it, after such remittance, in no better or worse position than it would have been if the Taxes or Other Taxes had not been imposed and the corresponding additional amounts or indemnification payment not been made. Nothing in this Section 2.13(h) shall be construed as requiring any Lender or the Administrative Agent to conduct its business or to arrange or alter in any respect its tax or financial affairs so that it is entitled to receive such refund. Neither a Lender nor the Administrative Agent shall be obligated to disclose information regarding its tax affairs or computations to either Borrower in connection with this clause (h).

SECTION 2.14 Sharing of Payments, Etc. If any Lender shall obtain any payment (whether voluntary, involuntary, through the exercise of any right of set-off, or otherwise) on account of the Advances owing to it (other than pursuant to Section 2.10, 2.13 or 8.04(c)) in excess of its ratable share of payments on account of the Advances obtained by all the Lenders, such Lender shall forthwith purchase from the other Lenders such participations in the Advances owing to them as shall be necessary to cause such purchasing Lender to share the excess payment ratably with each of them; provided, however, that if all or any portion of such excess payment is thereafter recovered from such purchasing Lender, such purchase from each Lender shall be rescinded and such Lender shall repay to the purchasing Lender the purchase price to the extent of such recovery together with an amount equal to such Lender’s ratable share (according to the proportion of (a) the amount of such Lender’s required repayment to (b) the total amount so recovered from the purchasing Lender) of any interest or other amount paid or payable by the purchasing Lender in respect of the total amount so recovered. The Borrowers agree that any Lender so purchasing a participation from another Lender pursuant to this Section 2.14 may, to the fullest extent permitted by law, exercise all its rights of payment (including the right of set-off) with respect to such participation as fully as if such Lender were the direct creditor of either Borrower in the amount of such participation.

SECTION 2.15 Use of Proceeds. Each Borrower shall use the proceeds of each Revolving Credit Advance for working capital and general corporate or company purposes of such Borrower and its Subsidiaries.

SECTION 2.16 Extension of Commitment Termination Date. (a) Not earlier than 45 nor later than 30 days prior to the then scheduled Commitment Termination Date (the “Existing Commitment Termination Date”), the Borrowers may make a written request (an “Extension Request”) to the Administrative Agent, who shall forward a copy to each Lender, that the Commitment Termination Date be extended to the date that occurs exactly 364 days after the Existing Commitment Termination Date. Such Extension Request shall include a certification by a senior officer of each Borrower that no Default has occurred and is continuing and all representations and warranties contained herein are true and correct in all material aspects on and as of the date of the Extension Request (it being understood and agreed that any representation or warranty which expressly refers by its terms to a specified date shall be required to be true and correct in all material respects only as of such date). Each Lender that agrees to such Extension Request shall so notify the Administrative Agent in writing not earlier than 30 days nor later than 20 days prior to the Existing Commitment Termination Date by indicating such agreement on counterparts of the Extension Request and delivering such counterpart to the Administrative Agent and the Borrowers; provided that any failure to so notify the Administrative Agent and the

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Borrowers shall be deemed to be a disapproval by such Lender of the Borrowers’ Extension Request. The Administrative Agent shall notify the Borrowers in writing of the Lenders’ decisions with respect to such Extension Request not later than 15 days prior to the Existing Commitment Termination Date. The Commitment of any Lender which does not so agree shall terminate upon the Existing Commitment Termination Date. No Lender shall be obligated to grant any extension pursuant to this Section 2.16 and any such extension shall be in the sole discretion of each Lender.

(b) If less than all of the Lenders consent to an Extension Request (each Lender that has not so consented being a “Declining Lender”, and each other Lender being an “Extending Lender”), the Borrowers shall have the right to require any Declining Lender to assign in full its rights and obligations under this Agreement (i) to any one or more Extending Lenders designated by the Borrowers that have offered in their returned counterpart of the Extension Request to increase their respective Commitments in an aggregate amount at least equal to the amount of such Declining Lender’s Commitment (each such Extending Lender being an “Increasing Extending Lender”) and (ii) to the extent of any shortfall in the aggregate amount of extended Commitments, to any one or more Eligible Transferees designated by the Borrowers that agree to assume all of such rights and obligations (each such Eligible Transferees being a “Replacement Lender”), provided that (A) such Declining Lender shall have received payment of all amounts owing under its Revolving Credit Note and this Agreement on the effective date of such assignment, (B) such assignment shall otherwise have occurred in compliance with Section 8.07 and (C) the effective date of such assignment shall be the date specified by the Borrowers and agreed to by the Replacement Lender or Increasing Extending Lender, as the case may be, which date shall be on or prior to the applicable Existing Commitment Termination Date.

(c) If (and only if) the sum of (i) the Commitments of the Extending Lenders and the Replacement Lenders plus (ii) the additional Commitments of the Increasing Extending Lenders shall be greater than 50% of the aggregate amount of the Commitments in effect on the Existing Commitment Termination Date, then, effective as of the Existing Commitment Termination Date, the “Commitment Termination Date” shall be extended to the date occurring 364 days after the Existing Commitment Termination Date (except that, if such date is not a Business Day, such Commitment Termination Date as so extended shall be the next preceding Business Day) and each Replacement Lender shall thereupon become a “Lender” for all purposes of this Agreement.

SECTION 2.17 Increase of Commitments. (a) The Borrowers may, at any time but in any event not more than two times during any calendar year, make a written request (an “Increase Request”) to the Administrative Agent (who shall forward a copy to each Lender) that the Commitments of the Lenders be increased, in integral multiples of $15,000,000, by an aggregate amount, together with the aggregate amount by which the Commitments of the Lenders were previously increased pursuant to this Section 2.17, not to exceed $100,000,000 in excess of the aggregate amount of the Commitments as of the date of this Agreement. Such Increase Request shall include a certification by a senior officer of each Borrower that (i) on and as of the date of the Increase Request and after giving effect to the requested increase in Commitments, Ambac Financial’s long-term senior unsecured non-credit-enhanced debt ratings by Moody’s and S&P are better than or equal to Aa3 and AA-, respectively, and (ii) no Default

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has occurred and is continuing and all representations and warranties contained herein are true and correct in all material respects on and as of the date of the Increase Request (it being understood and agreed that any representation or warranty which expressly refers by its terms to a specified date shall be required to be true and correct in all material respects only as of such date). Any such increase in Commitments shall be effective as of a date (the “Increase Date”) specified in the related Increase Notice that is (i) prior to the Commitment Termination Date and (ii) at least 10 days after the date of such Increase Notice. Each Increase Notice shall specify the date by which Lenders who wish to increase their Commitments must consent to such increase (the “Commitment Date”), which date shall be no later than five Business Days prior to the related Increase Date. Each Lender that is willing to increase its Commitment (each an “Increasing Lender”), shall notify the Administrative Agent on or prior to the Commitment Date of the amount by which it is willing to increase its Commitment, which amount shall not exceed the respective amount specified in the relevant Increase Notice. No Lender shall be obligated to increase its Commitment pursuant to this Section 2.17 and any such increase shall be in the sole discretion of each Lender. If the Lenders notify the Administrative Agent that they are willing to increase the amount of their respective Commitments by an aggregate amount that exceeds the amount of the requested increase, the requested increase shall be allocated among the Lenders willing to participate therein ratably in accordance with the amount by which they offered to increase their respective Commitments on the Commitment Date.

(b) Promptly following each Commitment Date, the Administrative Agent shall notify the Borrowers as to the amount, if any, by which the Lenders are willing to participate in the requested increase. If the aggregate amount by which the Lenders are willing to increase their Commitments on any such Commitment Date is less than the requested amount, then any one or more Eligible Transferees designated by the Borrowers that agree to provide Commitments for the shortfall may become party to this Agreement by executing and delivering, together with the Borrowers, an accession agreement pursuant to which such Eligible Transferee shall become a party to this Agreement and, to the extent provided therein, shall have the rights and obligations of a Lender hereunder; provided that each such Eligible Transferee shall provide a Commitment in a minimum amount of $10,000,000 or an integral multiple of $1,000,000 in excess thereof.

(c) On each Increase Date, each Eligible Transferee that accepts an offer to participate in a requested Commitment increase in accordance with Section 2.17(b) shall become a Lender party to this Agreement as of such Increase Date and the Commitment of each Increasing Lender shall be increased as of such Increase Date by the amount set forth in its notice delivered to the Administrative Agent in accordance with Section 2.17(a) (or by the amount allocated to such Lender pursuant to the last sentence of Section 2.17(a)).

SECTION 2.18 Right to Replace a Lender. If either Borrower is required to make any additional payment pursuant to Section 2.10 or 2.13 to any Lender or if any Lender’s obligation to make, or to Convert Advances into, Eurodollar Rate Advances shall be suspended pursuant to Section 2.11 (in each case, such Lender being an “Affected Person”), the Borrowers may elect, if such amounts continue to be charged or such suspension is still effective, to replace such Affected Person as a party to this Agreement, provided that no Default shall have occurred and be continuing at the time of such replacement and, provided, further, that concurrently with such replacement, (i) one or more Eligible Transferees reasonably satisfactory to the Borrowers

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and the Administrative Agent shall agree, as of such date, to become a Lender for all purposes under this Agreement and to assume all obligations (including the Commitment) of the Affected Person to be terminated as of such date and to comply with the requirements of Section 8.07 applicable to assignments, (ii) such Affected Person shall have received payment of all amounts then due and owing to such Affected Person hereunder to and including the date of termination, including without limitation payments due such Affected Person under Section 2.10 and 2.13, and (iii) such Borrower shall pay to the Administrative Agent an administrative fee in the amount of $3,500 for each such replacement in the event that the replacing Lender in respect thereof is not a Lender at the time of such replacement.

SECTION 2.19 Term Loan Conversion. (a) The Revolving Credit Advances of each Lender to each Borrower outstanding at the close of business (New York City time) on the Commitment Termination Date shall, at the option of such Borrower, subject to clause (b) below and to Section 3.03, be converted on such date (the “Term Loan Conversion Date”) into a term loan (each, a “Term Loan”) to such Borrower in a principal amount equal to the aggregate outstanding principal amount of such Revolving Credit Advances at such time (such conversion, the “Term Loan Conversion”).

(b) Each Borrower shall give the Administrative Agent irrevocable notice if such Borrower intends to convert its Revolving Credit Advances to Term Loans pursuant to this Section 2.19 (which notice must be received by the Administrative Agent prior to 10:00 A.M., (New York City time) (i) three Business Days prior to the Commitment Termination Date, if all or any part of the Term Loans to such Borrowers are to be initially Eurodollar Rate Advances or (ii) otherwise, on the Commitment Termination Date. Such notice shall specify (i) whether the resulting Term Loans are to be initially Eurodollar Rate Advances, Base Rate Advances or a combination thereof and (ii) if the Term Loans are to be entirely or partly Eurodollar Rate Advances, the respective lengths of the initial Interest Periods therefor. Upon receipt of any such notice the Administrative Agent shall promptly notify each Lender thereof.

(c) On the Term Loan Conversion Date, each Lender shall mark any Revolving Credit Note held by it “cancelled” and deliver the same to the Administrative Agent, which shall forward the same to the relevant Borrower. Upon the prior written request of any Lender delivered by such Lender to the Administrative Agent and the Borrowers, each of the Borrowers shall execute and deliver to such Lender a Term Note to the order of such Lender, dated the Term Loan Conversion Date and in an amount equal to such Lender’s Term Loan to such Borrower.

ARTICLE III

CONDITIONS TO EFFECTIVENESS AND LENDING

SECTION 3.01 Conditions Precedent to Initial Borrowing. The obligation of each Lender to make its Revolving Credit Advance on the occasion of the initial Borrowing shall be subject to the satisfaction, on or before July 29, 2004 of the following conditions precedent:

(a) The Administrative Agent shall have received counterparts of this Agreement executed by the parties hereto.

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(b) The following statements shall be true on the Closing Date and the Administrative Agent shall have received, with a copy for each Lender, a certificate signed by a duly authorized officer of each Borrower, dated the Closing Date, stating that:

(i) the representations and warranties made by such Borrower and contained in Section 4.01 are true and correct on and as of the Closing Date (it being understood and agreed that any representation or warranty which expressly refers by its terms to a specified date shall be required to be correct in all material respects only as of such date), and

(ii) no Default has occurred and is continuing on and as of the Closing Date.

(c) The Administrative Agent shall have received the following, each dated the Closing Date, in form and substance satisfactory to the Administrative Agent and (except for the Notes) in sufficient copies for each Lender:

(i) If requested by any Lender pursuant to Section 2.01(c), a Revolving Credit Note for the account of such Lender, duly executed by each Borrower, in the amount of such Lender’s Commitment as in effect on the Closing Date.

(ii) Certified copies of the certificate of incorporation and by-laws of each Borrower as in effect on the Closing Date.

(iii) Certified copies of the resolutions of the Board of Directors of each of the Borrowers approving this Agreement and the Notes, and of all documents evidencing other necessary corporate action, third-party and governmental approvals and consents, if any, with respect to this Agreement and the Notes.

(iv) A certificate of the Secretary or an Assistant Secretary of each of the Borrowers certifying the names and true signatures of the officers of each of the Borrowers, respectively, authorized to sign this Agreement and the Notes and the other documents to be delivered hereunder.

(v) Evidence of the termination of all the outstanding commitments and payment in full of all outstanding obligations of the Borrowers under the Credit Agreement dated as of August 1, 2002, as amended, among the Borrowers, the Lenders named therein, The Bank of New York, as Syndication Agent, and The Bank of Nova Scotia, as Administrative Agent.

(vi) An opinion of Anne Gill Kelly, Managing Director, Assistant General Counsel and Secretary of Ambac Financial, substantially in the form of Exhibit E hereto.

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(vii) An opinion of Kevin J. Doyle, Managing Director and General Counsel of Ambac Assurance, substantially in the form of Exhibit F hereto.

(viii) An opinion of DeWitt, Ross & Stevens, S.C., Wisconsin special counsel to Ambac Assurance, substantially in the form of Exhibit G hereto.

(ix) An opinion of Shearman & Sterling LLP, special New York counsel for the Borrowers, substantially in the form of Exhibit H hereto.

(x) An opinion of an external counsel for the Borrowers saying that neither Borrower is an “investment company” within the meaning of the Investment Company Act of 1940, as amended, in form and substance satisfactory to the Administrative Agent.

(xi) An opinion of Milbank, Tweed, Hadley & McCloy LLP, special New York counsel to the Administrative Agent, substantially in the form of Exhibit I hereto.

(d) The Administrative Agent shall have received payment of all fees, costs and expenses due and payable by the Borrowers on the Closing Date pursuant to this Agreement.

SECTION 3.02 Conditions Precedent to Each Borrowing. The obligation of each Lender to make a Revolving Credit Advance on the occasion of each Borrowing shall be subject to the conditions precedent that (i) the Effective Date shall have occurred and (ii) on the date of such Borrowing the following statements shall be true (and each of the giving of the applicable Notice of Borrowing and the acceptance by either Borrower of the proceeds of such Borrowing shall constitute a representation and warranty by such Borrower that on the date of such Borrowing such statements are true):

(a) the representations and warranties contained in Section 4.01 (other than subparagraphs (f) and (g) and the final sentence of subparagraph (e) thereof) are true and correct on and as of the date of such Borrowing, before and after giving effect to such Borrowing and to the application of the proceeds therefrom, as though made on and as of such date (it being understood and agreed that any representation or warranty which expressly refers by its terms to a specified date shall be required to be true and correct in all material respects only as of such date), and

(b) no Default has occurred and is continuing or would result from such Borrowing.

SECTION 3.03 Conditions Precedent to Term Loan Conversion. The occurrence of a Term Loan Conversion shall be subject to the conditions precedent that, on the Term Loan Conversion Date, the following statements shall be true (and any notice of a Term Loan Conversion by either Borrower shall constitute a representation and warranty by such Borrower that on the Term Loan Conversion Date such statements are true):

(a) the Commitments of the Lenders shall not have terminated prior to such date;

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(b) the representations and warranties contained in Section 4.01 (other than the final sentence of subparagraph (e) thereof) shall be true and correct on and as of the Term Loan Conversion Date, before and after giving effect to such Term Loan Conversion, as though made on and as of such date (it being understood and agreed that any representation or warranty which expressly refers by its terms to a specified date shall be required to be true and correct in all material respects only as of such date), and

(c) no Default shall have occurred and be continuing or would result from such Term Loan Conversion.

ARTICLE IV

REPRESENTATIONS AND WARRANTIES

SECTION 4.01 Representations and Warranties of each Borrower. Each Borrower represents and warrants as follows:

(a) Each Borrower and its Material Subsidiaries (i) is a limited liability company, corporation or partnership, as the case may be, duly formed or organized and existing and in good standing under the laws of the jurisdiction of its formation or organization, as the case may be, (ii) is duly registered or qualified to do business as a foreign limited liability company, corporation or partnership, as the case may be, in each jurisdiction where the nature of its business requires such registration or qualification and (iii) holds all requisite governmental licenses, permits and other approvals to own and hold under lease its property and to conduct its business substantially as conducted by it, except where the failure to be so qualified or hold such licenses, permits and approvals, singly or in the aggregate, could not reasonably be expected to have a Material Adverse Effect.

(b) The execution, delivery and performance by each Borrower of each Loan Document to which it is party are within such Borrower’s corporate powers, have been duly authorized by all necessary corporate action, and do not (i) contravene such Borrower’s certificate of incorporation or by-laws; (ii) contravene any contractual restriction, law or governmental regulation or court decree or order binding on or affecting such Borrower; or (iii) result in, or require the creation or imposition of, any Lien on any of such Borrower’s properties.

(c) No authorization or approval or other action by, and no notice to or filing with, any governmental authority or regulatory body or other Person is required for the due execution, delivery or performance by each Borrower of any Loan Document to which such Borrower is a party. Neither Borrower is an “investment company” within the meaning of the Investment Company Act of 1940, as amended.

(d) Each Loan Document to which each Borrower is a party constitutes the legal, valid and binding obligation of such Borrower, enforceable against such Borrower in accordance with its terms.

(e) The Consolidated balance sheets of Ambac Financial, Ambac Assurance and their Subsidiaries as at December 31, 2003, and the related Consolidated statements of operations and cash flows of Ambac Financial, Ambac Assurance and their Subsidiaries for the

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fiscal year ended on such date and the Consolidated balance sheet of Ambac Financial, Ambac Assurance and their Subsidiaries as at March 31, 2004, and the related Consolidated statements of operations and cash flows of Ambac Financial, Ambac Assurance and their Subsidiaries for the three months then ended, heretofore furnished to the Administrative Agent, have been prepared in accordance with GAAP consistently applied and fairly present, subject, in the case of such balance sheet as at March 31, 2004, and such statements of operations and cash flows for the three months then ended, to year-end audit adjustments, the Consolidated financial condition of Ambac Financial, Ambac Assurance and their Subsidiaries as at the respective dates thereof and the results of their operations for the respective periods then ended. Since December 31, 2003, there has been no Material Adverse Change.

(f) There is no pending or, to the knowledge of each Borrower, threatened litigation, action, proceedings, investigation or labor controversy affecting such Borrower or any Material Subsidiary or any of its respective properties, businesses, assets or revenues which may reasonably be expected to have a Material Adverse Effect or which purports to affect the legality, validity or enforceability of any Loan Document.

(g) Each of the Borrowers and its Material Subsidiaries has filed all tax returns and reports required by law to have been filed by it and has paid all taxes and governmental charges thereby shown to be owing, except any such taxes or charges which are being diligently contested in good faith by appropriate proceedings and for which adequate reserves in accordance with GAAP (or statutory accounting principles, as appropriate) shall have been set aside on its books and except where the failure to file said returns or reports or to pay such taxes or charges could not reasonably be expected to have a Material Adverse Effect.

(h) During the twelve-consecutive-month period prior to the date of the execution and delivery of this Agreement and prior to the date of any Borrowing hereunder, except as disclosed in Schedule 4.01(h), no steps have been taken to terminate any Pension Plan, and no contribution failure has occurred with respect to any Pension Plan sufficient to give rise to a Lien under section 302(f) of ERISA. No condition exists or event or transaction has occurred with respect to any Pension Plan which might result in the incurrence by either Borrower or any member of the Controlled Group of any material liability, fine or penalty other than a non-defaulted obligation to make a contribution under Section 302 of ERISA. Except as disclosed in Schedule 4.01(h), neither Borrower nor any member of the Controlled Group have any contingent liability with respect to any post-retirement benefit under a Welfare Plan, other than liability for continuation coverage described in Part 6 of Title I of ERISA.

(i) After applying the proceeds of each Advance, and on the Term Loan Conversion Date, not more than 25% of the value of the assets of either Borrower that are subject to Section 5.02 are margin stock (as defined in Regulation U of the Board of Governors of the Federal Reserve System).

(j) The Debt of the Borrowers under this Agreement and, to the extent applicable, the Notes issued by such Borrower, will rank at least pari passu in priority of payment with all other unsecured and unsubordinated Debt of such Borrower.

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(k) Each Borrower is and, after giving effect to each Advance and to the use of proceeds thereof, will be Solvent.

ARTICLE V

COVENANTS OF THE BORROWERS

SECTION 5.01 Affirmative Covenants. So long as any principal of or interest on any Advance or any other amount payable under this Agreement shall remain unpaid or any Lender shall have any Commitment hereunder, each Borrower will:

(a) Compliance with Statutes, Etc. Comply, and cause each of its Material Subsidiaries to comply, in all material respects with all applicable laws, statutes, regulations and orders of, and all applicable restrictions imposed by, all governmental bodies, domestic or foreign, including, without limitation, ERISA and environmental laws in respect of the conduct of its business and the ownership of its property, except where noncompliance therewith could not reasonably be expected to have, in the aggregate, a Material Adverse Effect.

(b) Use of Proceeds. Apply the proceeds of each Revolving Credit Advance for working capital and general corporate or company purposes of such Borrower and its Subsidiaries.

(c) Maintenance of Insurance. Maintain, and cause each of its Material Subsidiaries to maintain, insurance with responsible and reputable insurance companies or associations in such amounts and covering such risks as is usually carried by companies engaged in similar businesses and owning similar properties in the same general areas in which such Borrower or such Material Subsidiary operates; provided, however, that each Borrower and its Material Subsidiaries may self-insure to the same extent as other companies engaged in similar businesses and owning similar properties in the same general areas in which such Borrower or such Material Subsidiary operates and to the extent consistent with prudent business practice.

(d) Preservation of Corporate Existence, Etc. Preserve and maintain, and cause each of its Material Subsidiaries to preserve and maintain, its legal existence (except as otherwise permitted by Section 5.02(b)) and its material rights, franchises and licenses; provided, however, that nothing in this Section 5.01(d) shall prevent the withdrawal, lapse or termination by either Borrower or any of its Material Subsidiaries of any right, franchise or license where such withdrawal, lapse or termination could not reasonably be expected to have a Material Adverse Effect.

(e) Keeping of Books; Visitation Rights. (i) Keep, and cause each of its Material Subsidiaries to keep, books of record and account which accurately reflect all of its business affairs and transactions; and (ii) permit, and cause each of its Material Subsidiaries to permit, officers and designated representatives of the Administrative Agent and any Lender to visit and inspect, under guidance of officers of either Borrower or such Material Subsidiary, any of the properties of such Borrower or such Material Subsidiary, and to examine the books of record and account of such Borrower or such Material Subsidiary and discuss the affairs, finances and accounts of such Borrower or such Material Subsidiary with, and be advised as to

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the same by, its and their officers and its independent public accountants (and each Borrower hereby authorizes such independent public accountant to discuss each Borrower’s financial matters with the Administrative Agent or its representatives), all at such reasonable times and intervals (and, prior to the occurrence of any Default, with reasonable prior notice given to the applicable Borrower) and to such reasonable extent as any Lender may reasonably request.

(f) Reporting Requirements. Furnish to the Administrative Agent:

(i) Quarterly Financial Statements of Ambac Financial. As soon as they are available, but in any event within 60 days after the end of each of the first three quarterly accounting periods in each fiscal year of Ambac Financial, the Consolidated balance sheets of Ambac Financial and its Consolidated Subsidiaries as at the end of such quarterly period and the related Consolidated statements of operations and cash flows for such quarterly period and for the elapsed portion of the fiscal year ended with the last day of such quarterly period all of which shall be certified by the chief financial officer or treasurer of Ambac Financial, subject to year-end audit adjustments.

(ii) Annual Financial Statements of Ambac Financial. As soon as they are available, but in any event within 120 days after the end of each fiscal year of Ambac Financial, a copy of the annual report for such fiscal year for Ambac Financial and its Consolidated Subsidiaries, including therein the Consolidated balance sheets of Ambac Financial and its Consolidated Subsidiaries as at the end of such fiscal year and the related Consolidated statements of operations, stockholders’ equity and of cash flow for such fiscal year, in each case, certified, in the case of the Consolidated financial statements, by independent certified public accountants of recognized national standing reasonably acceptable to the Administrative Agent.

(iii) Quarterly Statutory Statements of Ambac Assurance. As soon as they are available, but in any event within 60 days after the end of each of the first three quarterly accounting periods in each fiscal year of Ambac Assurance, the quarterly statement of Ambac Assurance for such quarter, as filed with the Office of Commissioner of Insurance of the State of Wisconsin, certified as to fairness of presentation, generally accepted statutory accounting principles and consistency by the Responsible Officer of Ambac Assurance as at the end of such quarterly period and the related Consolidated statements of operations and cash flows for such quarterly period and for the elapsed portion of the fiscal year ended with the last day of such quarterly period, all of which shall be certified by the chief financial officer or treasurer of Ambac Assurance, subject to year-end audit adjustments.

(iv) Annual Statutory Statements of Ambac Assurance. As soon as they are available, but in any event within 120 days after the end of each fiscal year of Ambac Assurance, a copy of the annual statement for such fiscal year for Ambac Assurance as filed with the Office of Commissioner of Insurance of the State of Wisconsin, certified as to fairness of presentation, generally accepted

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statutory accounting principles and consistency by the Responsible Officer of Ambac Assurance.

(v) Occurrence of Default. As soon as possible and in any event within ten days after a Responsible Officer of either Borrower shall obtain actual knowledge of the occurrence of a Default continuing on the date of such statement, a statement of the chief financial officer of such Borrower setting forth details of such Default and the action that such Borrower has taken and proposes to take with respect thereto.

(vi) Compliance Certificate. Concurrently with the delivery of the financial information pursuant to clauses (i) and (ii) above, a Compliance Certificate, executed by a Responsible Officer of Ambac Financial, showing compliance with the financial covenants set forth in Section 5.03 and stating that no Default has occurred and is continuing (or, if a Default has occurred, specifying the details of such Default and the action that Ambac Financial has taken or proposes to take with respect thereto).

(vii) Notice of Litigation. As soon as possible and in any event within 5 Business Days after a Responsible Officer of either Borrower obtains knowledge of the filing or commencement of any material litigation, action, proceeding or labor controversy with respect to such Borrower or any of its Material Subsidiaries, notice thereof and, to the extent the Administrative Agent requests, copies of all documentation relating thereto.

(viii) ERISA. Immediately upon becoming aware of (i) the institution of any steps by any Person to terminate any Pension Plan, (ii) the failure to make a required contribution to any Pension Plan if such failure is sufficient to give rise to a Lien under Section 302(f) of ERISA, (iii) the taking of any action with respect to a Pension Plan which could result in the requirement that either Borrower furnish a bond or other security to the Pension Benefit Guaranty Corporation (or any Person succeeding to any or all of its functions under ERISA) or such Pension Plan, or (iv) the occurrence of any event with respect to any Pension Plan which could result in the incurrence by either Borrower of any material liability, fine or penalty, notice thereof and copies of all documentation relating thereto.

(ix) Other Information. Such other financial and other information as any Lender through the Administrative Agent may from time to time reasonably request.

(g) Payment of Taxes, Etc. Pay and discharge, and cause each of its Material Subsidiaries to pay and discharge, before the same shall become delinquent, (i) all taxes, assessments and governmental charges or levies imposed upon it or upon its property and (ii) all lawful claims that, if unpaid, might by law become a Lien upon its property; provided, however, that neither Borrower nor any of its Material Subsidiaries shall be required to pay or discharge any such tax, assessment, charge or claim that is being contested in good faith and by proper

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proceedings and as to which appropriate reserves are being maintained, unless and until any Lien resulting therefrom attaches to its property and becomes enforceable against its other creditors.

(h) Maintenance of Properties. Maintain and preserve, and cause each of its Subsidiaries to maintain and preserve, all of its properties that are used or useful in the conduct of its business in good working order and condition, ordinary wear and tear excepted, except where failure to do so could not reasonably be expected to have a Material Adverse Effect.

SECTION 5.02 Negative Covenants. So long as any principal of or interest on any Advance or any other amount payable under this Agreement shall remain unpaid or any Lender shall have any Commitment hereunder, each Borrower agrees that:

(a) Liens. It will not, and will not permit any of its Material Subsidiaries to, create, incur, assume or suffer to exist any Lien upon any of its property, revenues or assets, whether now owned or hereafter acquired, to secure Debt of such Borrower or such Material Subsidiary except: (i) Liens granted prior to the date hereof securing Debt existing as of the date hereof which is identified in Schedule 5.02(a) (“Ongoing Debt”); (ii) any Lien on any asset granted to secure payment of Debt incurred or assumed for the purpose of financing the acquisition of such asset, provided that such Lien attaches to such asset no later than the ninetieth day after such acquisition; (iii) any Lien existing on any asset prior to the acquisition thereof by such Borrower or any Material Subsidiary thereof and not created in contemplation of such acquisition; (iv) any Lien arising out of the refinancing, extension, renewal or refunding of any Debt secured by any Lien permitted in clause (i), (ii) or (iii), provided that such Debt is not increased and is not secured by any additional assets; (v) Permitted Liens; (vi) any Lien consisting of a pledge by Ambac Assurance of its subrogation rights to secure Debt for borrowed money, in the aggregate amount outstanding not to exceed $50,000,000 at any time; and (vii) other Liens where the aggregate principal amount of Debt secured thereby at any time outstanding does not exceed $50,000,000 in the aggregate.

(b) Mergers, Etc. It will not, and will not permit any of its Material Subsidiaries to, liquidate or dissolve, consolidate with, or merge into or with, any other Person, except: (i) any such Material Subsidiary (other than Ambac Assurance) may liquidate or dissolve voluntarily into, and may consolidate and merge with and into, either Borrower or any other Material Subsidiary of either Borrower; and (ii) so long as no Default has occurred and is continuing or would occur after giving effect thereto, either Borrower may consolidate or merge with and into any other Person organized under the laws of a State of the United States if (A) such Borrower is the surviving entity and such Borrower and its Subsidiaries, as a whole, will continue to have the financial guaranty business as one of its principal businesses; or (B) all of the following are satisfied: (I) such other Person and its Subsidiaries, as a whole, shall have the financial guaranty business as one of its principal businesses, (II) such Person shall have assumed all the obligations of such Borrower pursuant to an instrument in form and substance reasonably satisfactory to the Required Lenders and shall have delivered such opinions of counsel with respect thereto as the Administrative Agent may reasonably request, (III) both immediately prior to and after giving effect to such consolidation or merger, the ratings on such Person’s senior unsecured debt and (if such Person is an insurer at such

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time) claims-paying ability shall be at least as high as the applicable Borrower immediately prior to such consolidation or merger, and (IV) such Person meets each Lender’s internal policies with respect to extensions of credit of the type contemplated hereunder.

(c) Asset Dispositions. It will not, and will not permit any of its Material Subsidiaries to, sell, transfer, lease, contribute or otherwise convey, or grant options, warrants or other rights with respect to, all or any substantial part of its property, revenues or assets (including accounts receivable and capital stock of any of its Material Subsidiaries) to any Person (any of the foregoing, an “Asset Disposition”); provided, however, that each Borrower and its Material Subsidiaries may consummate (i) Asset Dispositions in the ordinary course of their business and (ii) any Asset Disposition, to the extent that immediately after giving effect to such Asset Disposition, the aggregate fair market value (determined at the time of the applicable transactions) of all assets subject to Asset Dispositions (other than those described in clause (i) consummated by the Borrowers and their respective Subsidiaries in such fiscal year) and consummated in such fiscal year, would not exceed 25% of the stockholders’ equity of Ambac Financial and its Subsidiaries, on a Consolidated basis (excluding unrealized gains on investments and unrealized losses on investments), at the end of the next preceding fiscal year.

SECTION 5.03 Financial Covenants. So long as any principal of or interest on any Advance or any other amount payable under this Agreement shall remain unpaid or any Lender shall have any Commitment hereunder, Ambac Financial will:

(a) Leverage Ratio. Maintain as of the end of each fiscal quarter a Leverage Ratio of not more than 0.3 to 1.00.

(b) Net Worth. Maintain at all times an excess of Consolidated total assets over Consolidated total liabilities (in each case excluding the assets and liabilities of Aleutian and Juneau) of not less than $2,000,000,000.

ARTICLE VI

EVENTS OF DEFAULT

SECTION 6.01 Events of Default. If any of the following events (“Events of Default”) shall occur and be continuing:

(a) Either Borrower shall fail to pay any principal of any Advance made to such Borrower when the same becomes due and payable; or either Borrower shall fail to pay any interest on any Advance made to such Borrower or make any other payment of fees or other amounts payable by such Borrower under this Agreement or any Note within five Business Days after the same becomes due and payable by such Borrower; or

(b) Any representation or warranty made by either Borrower herein or which is contained in any certificate furnished by such Borrower at any time under or in connection with this Agreement shall prove to have been incorrect in any material respect when made or deemed made; or

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(c) Either Borrower shall fail to perform or observe any term, covenant or agreement contained in Section 5.0l(f)(v), 5.02(b), 5.02(c) or 5.03 on its part to be performed or observed, or either Borrower shall fail to perform or observe any other term, covenant or agreement contained in this Agreement on its part to be performed or observed if such failure shall remain unremedied for 30 days after written notice thereof shall have been given to such Borrower by the Administrative Agent or any Lender; or

(d) Either Borrower or any of its Material Subsidiaries shall (i) fail to pay any principal of or premium or interest on any Debt that is outstanding in a principal or notional amount of at least $30,000,000 in the aggregate (but excluding Debt outstanding hereunder) of such Borrower or such Material Subsidiary, as the case may be, when the same becomes due and payable, and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such Debt; or (ii) any other event shall occur or condition shall exist under any agreement or instrument relating to any such Debt and shall continue after the applicable grace period, if any, specified in such agreement or instrument, if the effect of such event or condition is to accelerate, or to permit the acceleration of, the maturity of such Debt; or (iii) any such Debt shall be declared to be due and payable, or required to be prepaid or redeemed (other than by a regularly scheduled required prepayment or redemption), purchased or defeased, or an offer to prepay, redeem, purchase or defease such Debt shall be required to be made, in each case prior to the stated maturity thereof; or

(e) Either Borrower or any of its Material Subsidiaries shall generally not pay its debts as such debts become due, or shall admit in writing its inability or unwillingness to pay its debts generally, or shall make a general assignment for the benefit of creditors; or

(f) Any proceeding shall be instituted by or against either Borrower or any of its Material Subsidiaries seeking to adjudicate it as bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of it or its debts under any Federal, State or foreign law relating to bankruptcy, insolvency, receivership or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, custodian or other similar official for it or for any substantial part of its property and, in the case of any such proceeding instituted against it (but not instituted by it), either such proceeding shall remain undismissed or unstayed for a period of 60 days, or any of the actions sought in such proceeding (including, without limitation, the entry of an order for relief against, or the appointment of a receiver, trustee, custodian or other similar official for, it or for any substantial part of its property) shall occur; or either Borrower or any of its Material Subsidiaries shall take any corporate action to authorize any of the actions set forth above in subsection (e) or in this subsection (f); or

(g) Any judgment or order for the payment of money individually or in the aggregate in excess of $30,000,000 at any one time in effect, shall be rendered against either Borrower or any of its Material Subsidiaries and either (i) enforcement proceedings shall have been commenced by any creditor upon such judgment or order or (ii) there shall be any period of 30 consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; provided, however, that the amount of any such judgment or order shall not be considered in determining whether a Default exists under this Section 6.01(f) if and to the extent that (i) the amount of such judgment or order is covered

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by a valid and binding policy of insurance between the defendant and the insurer covering payment thereof and (ii) such insurer, which shall be rated at least “A” by A.M. Best Company, has been notified of, and has not disputed the claim made for payment of, the amount of such judgment or order; or

(h) Any of the following events shall occur with respect to any Pension Plan: (i) the institution of any steps by either Borrower, any member of its Controlled Group or any other Person to terminate a Pension Plan if, as a result of such termination, such Borrower or any such member could be required to make a contribution to such Pension Plan, or could reasonably expect to incur a liability or obligation to such Pension Plan, in excess of $20,000,000; or (ii) a contribution failure occurs with respect to any Pension Plan sufficient to give rise to a Lien under Section 302(f) of ERISA; or

(i) A Change of Control shall occur;

then, and in any such event, the Administrative Agent (i) shall at the request, or may with the consent, of the Required Lenders, by notice to the Borrowers, declare the obligation of each Lender to make Revolving Credit Advances to be terminated, whereupon the same shall forthwith terminate, and (ii) shall at the request, or may with the consent, of the Required Lenders, by notice to the Borrowers, declare the Notes, all interest thereon and all other amounts payable under this Agreement to be forthwith due and payable, whereupon the Notes, all such interest and all such amounts shall become and be forthwith due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by each Borrower (and in either case, if the Term Loan Conversion has not occurred, if shall not thereafter occur); provided, however, that in the case of any Event of Default described in subsection (f) above, (A) the obligation of each Lender to make Revolving Credit Advances shall automatically be terminated and (B) the Notes, all such interest and all such amounts shall automatically become and be due and payable, without presentment, demand, protest or any notice of any kind, all of which are hereby expressly waived by each Borrower, and if the Term Loan Conversion has not occurred, it shall not thereafter occur.

ARTICLE VII

THE AGENTS

SECTION 7.01 Authorization and Action. Each Lender hereby appoints Barclays as the Syndication Agent and Citibank as the Administrative Agent under and for the purposes of each Loan Document. Each Lender authorizes the Administrative Agent to take such action as Administrative Agent on its behalf and to exercise such powers and discretion under this Agreement as are delegated to the Administrative Agent by the terms hereof and thereof, together with such powers and discretion as are reasonably incidental thereto. As to any matters not expressly provided for by this Agreement (including, without limitation, enforcement or collection of the Notes), the Administrative Agent shall not be required to exercise any discretion or take any action, but shall be required to act or to refrain from acting (and shall be fully protected in so acting or refraining from acting) upon the instructions of the Required Lenders or all the Lenders if applicable, and such instructions shall be binding upon all Lenders and all holders of Notes; provided, however, that the Administrative Agent shall not be required

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to take any action that exposes the Administrative Agent to personal liability or that is contrary to this Agreement or applicable law. The Administrative Agent agrees to give to each Lender prompt notice of each notice given to it by either Borrower pursuant to the terms of this Agreement. Anything in this Agreement to the contrary notwithstanding, none of the Persons identified on the cover page hereof as “Syndication Agent”, “Documentation Agent”, “Joint Lead Arrangers” or “Sole Book Runner” shall have, in their capacities as such, any responsibilities or liabilities under or in connection with this Agreement.

SECTION 7.02 Agents’ Reliance, Etc. Neither any Agent nor any of its directors, officers, agents or employees shall be liable to any Lender for any action taken or omitted to be taken by it or them under or in connection with this Agreement, except for its or their own gross negligence or willful misconduct. Without limitation of the generality of the foregoing: (i) the Administrative Agent may treat the payee of any Note as the holder thereof until the Administrative Agent receives and accepts an Assignment and Acceptance entered into by the Lender that is the payee of such Note, as assignor, and an Eligible Assignee, as assignee, as provided in Section 8.07; (ii) any Agent may consult with legal counsel (including counsel for the Borrowers), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken in good faith by it in accordance with the advice of such counsel, accountants or experts; (iii) no Agent makes any warranty or representation to any Lender and no Agent shall be responsible to any Lender for any statements, warranties or representations (whether written or oral) made in or in connection with this Agreement; (iv) no Agent shall have any duty to ascertain or to inquire as to the performance or observance of any of the terms, covenants or conditions of this Agreement on the part of the Borrowers or to inspect the property (including the books and records) of the Borrowers; (v) no Agent shall be responsible to any Lender for the due execution, legality, validity, enforceability, genuineness, sufficiency or value of, this Agreement or any other instrument or document furnished pursuant hereto; and (vi) no Agent shall incur any liability under or in respect of this Agreement by acting upon any notice, consent, certificate or other instrument or writing (which may be by telecopier) believed by it to be genuine and signed or sent by the proper party or parties.

SECTION 7.03 Agents and Affiliates. With respect to its Commitment, the Advances made by it and the Note or Notes issued to it, each Agent shall have the same rights and powers under this Agreement as any other Lender and may exercise the same as though it were not an Agent; and the term “Lender” or “Lenders” shall, unless otherwise expressly indicated, include each Agent in its individual capacity. Each Agent and its Affiliates may accept deposits from, lend money to, act as trustee under indentures of, accept investment banking engagements from and generally engage in any kind of business with, the Borrowers, any of their Subsidiaries and any Person who may do business with or own securities of either Borrower or any such Subsidiaries, all as if such Agent was not an Agent and without any duty to account therefor to the Lenders.

SECTION 7.04 Lender Credit Decision. Each Lender acknowledges that it has, independently and without reliance upon any Agent or any other Lender and based on the financial statements referred to in Section 4.01 and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon any Agent

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or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement.

SECTION 7.05 Indemnification. The Lenders agree to indemnify the Administrative Agent (to the extent not reimbursed by the Borrowers), ratably according to the respective principal amounts of the Notes then held by each of them (or if no Notes are at the time outstanding) ratably according to the respective amounts of their Commitments), from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever that may be imposed on, incurred by, or asserted against the Administrative Agent in any way arising out of this Agreement or any action taken or omitted by the Administrative Agent under this Agreement (collectively, the “Indemnified Costs”), provided that no Lender shall be liable for any portion of the Indemnified Costs resulting from the Administrative Agent’s gross negligence or willful misconduct. Without limitation of the foregoing, each Lender agrees to reimburse the Administrative Agent promptly upon demand for its ratable share of any out-of-pocket fees and expenses (including counsel fees and expenses) incurred by the Administrative Agent in connection with the preparation, execution, delivery, administration, modification, amendment or enforcement (whether through negotiations, legal proceedings or otherwise) of, or legal advice in respect of rights or responsibilities under, this Agreement, to the extent that the Administrative Agent is not reimbursed for such fees and expenses by the Borrowers. In the case of any investigation, litigation or proceeding giving rise to any Indemnified Costs, this Section 7.05 applies whether any such investigation, litigation or proceeding is brought by the Administrative Agent, any Lender or a third party.

SECTION 7.06 Successor. The Administrative Agent may resign at any time by giving written notice thereof to the Lenders and the Borrowers and may be removed at any time with or without cause by the Required Lenders. Upon any such resignation or removal, the Required Lenders shall have the right to appoint a successor Administrative Agent. If no successor Administrative Agent shall have been so appointed by the Required Lenders, and shall have accepted such appointment, within 30 days after the retiring Administrative Agent’s giving of notice of resignation or the Required Lenders’ removal of the retiring Administrative Agent, then the retiring Administrative Agent may, on behalf of the Lenders, appoint a successor Administrative Agent, which shall be a commercial bank organized under the laws of the United States of America or of any State thereof and having a combined capital and surplus of at least $500,000,000. Upon the acceptance of any appointment as Administrative Agent hereunder by a successor Administrative Agent, such successor Administrative Agent shall thereupon succeed to and become vested with all the rights, powers, discretion, privileges and duties of the retiring Administrative Agent, and the retiring Administrative Agent shall be discharged from its duties and obligations under this Agreement. After any retiring Administrative Agent’s resignation or removal hereunder as Administrative Agent, the provisions of this Article VII shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Administrative Agent under this Agreement.

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ARTICLE VIII

MISCELLANEOUS

SECTION 8.01 Amendments, Etc. No amendment or waiver of any provision of this Agreement or the Notes, nor consent to any departure by either Borrower therefrom, shall in any event be effective unless the same shall be in writing and signed by the Required Lenders, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given; provided, however, that no amendment, waiver or consent shall, unless in writing and signed by all the Lenders, do any of the following: (a) waive any of the conditions specified in Section 3.01, (b) except as provided in Sections 2.16 and 2.17, increase or extend the Commitments of the Lenders or subject the Lenders to any additional obligations, (c) reduce the principal of, or interest on, the Notes or other amounts payable hereunder, (d) except as a consequence of any extension of the Commitment Termination Date as provided in Section 2.16, postpone any date fixed for any payment of principal of, or interest on, the Notes or any fees or other amounts payable hereunder, (e) change the percentage of the Commitments or of the aggregate unpaid principal amount of the Notes, or the number of Lenders, that shall be required for the Lenders or any of them to take any action hereunder, or (f) amend this Section 8.01 or the definition of “Required Lenders”; and provided, further, that no amendment, waiver or consent shall, unless in writing and signed by the Administrative Agent in addition to the Lenders required above to take such action, affect the rights or duties of the Administrative Agent under this Agreement or any Note.

SECTION 8.02 Notices, Etc. (a) All notices and other communications provided for hereunder shall be in writing (including telecopier) and mailed, telecopied or delivered, if to either Borrower, at its address at One State Street Plaza, 19^th floor, New York, New York, 10004, Attention: Treasurer (with copy to General Counsel at same address); if to any Lender, at its Domestic Lending Office specified opposite its name on Schedule II hereto or at its Domestic Lending Office specified in the Assignment and Acceptance pursuant to which it became a Lender, as the case may be; and if to the Administrative Agent, at its address at Citibank, N.A., 2 Penns Way, Suite 110, New Castle, Delaware 19720, Attention: Mr. Keith Carter (fax: 212-994-0961); or, as to the Borrowers or the Administrative Agent, at such other address as shall be designated by such party in a written notice to the other parties and, as to each other party, at such other address as shall be designated by such party in a written notice to the Borrowers and the Administrative Agent. All such notices and communications shall, when mailed or telecopied, be effective when deposited in the mails or telecopied, respectively, except that notices and communications to the Administrative Agent pursuant to Article II, III or VII shall not be effective until received by the Administrative Agent. Delivery by telecopier of an executed counterpart of any amendment or waiver of any provision of this Agreement or the Notes or of any Exhibit hereto to be executed and delivered hereunder shall be effective as delivery of a manually executed counterpart thereof.

(b) Each Borrower hereby agrees that it will provide to the Administrative Agent all information, documents and other materials that it is obligated to furnish to the Administrative Agent pursuant to this Agreement, including, without limitation, all notices, requests, financial statements, financial and other reports, certificates and other information materials, but excluding any such communication that (i) relates to the payment of any principal

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or other amount due under this Agreement prior to the scheduled date therefor, (ii) provides notice of any Default under this Agreement or (iii) is required to be delivered to satisfy any condition precedent to the occurrence of the Closing Date and/or the Term Loan Conversion Date (all such non-excluded communications being referred to herein collectively as “Communications”), by transmitting the Communications in an electronic/soft medium in a format acceptable to the Administrative Agent to oploanswebadmin@citigroup.com. In addition, each Borrower agrees to continue to provide the Communications to the Administrative Agent in the manner specified in this Agreement but only to the extent requested by the Administrative Agent.

(c) Each Borrower further agrees that the Administrative Agent may make the Communications available to the Lenders by posting the Communications on Intralinks or a substantially similar electronic transmission system (the “Platform”). THE PLATFORM IS PROVIDED “AS IS” AND “AS AVAILABLE”. THE AGENT PARTIES (AS DEFINED BELOW) DO NOT WARRANT THE ACCURACY OR COMPLETENESS OF THE COMMUNICATIONS, OR THE ADEQUACY OF THE PLATFORM AND EXPRESSLY DISCLAIM LIABILITY FOR ERRORS OR OMISSIONS IN THE COMMUNICATIONS. NO WARRANTY OF ANY KIND, EXPRESS, IMPLIED OR STATUTORY, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, NON-INFRINGEMENT OF THIRD PARTY RIGHTS OR FREEDOM FROM VIRUSES OR OTHER CODE DEFECTS, IS MADE BY THE AGENT PARTIES IN CONNECTION WITH THE COMMUNICATIONS OR THE PLATFORM. IN NO EVENT SHALL THE ADMINISTRATIVE AGENT OR ANY OF ITS AFFILIATES OR ANY OF THEIR RESPECTIVE OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, ADVISORS OR REPRESENTATIVES (COLLECTIVELY, THE “AGENT PARTIES”) HAVE ANY LIABILITY TO EITHER BORROWER, ANY LENDER OR ANY OTHER PERSON OR ENTITY FOR DAMAGES OF ANY KIND, INCLUDING, WITHOUT LIMITATION, DIRECT OR INDIRECT, SPECIAL, INCIDENTAL OR CONSEQUENTIAL DAMAGES, LOSSES OR EXPENSES (WHETHER IN TORT, CONTRACT OR OTHERWISE) ARISING OUT OF SUCH BORROWER’S OR THE ADMINISTRATIVE AGENT’S TRANSMISSION OF COMMUNICATIONS THROUGH THE INTERNET, EXCEPT TO THE EXTENT THE LIABILITY OF ANY AGENT PARTY IS FOUND IN A FINAL NON-APPEALABLE JUDGMENT BY A COURT OF COMPETENT JURISDICTION TO HAVE RESULTED PRIMARILY FROM SUCH AGENT PARTY’S GROSS NEGLIGENCE OR WILLFUL MISCONDUCT.

(d) The Administrative Agent agrees that the receipt of the Communications by the Administrative Agent at its e-mail address set forth above shall constitute effective delivery of the Communications to the Administrative Agent for purposes of this Agreement. Each Lender agrees that notice to it (as provided in the next sentence) specifying that the Communications have been posted to the Platform shall constitute effective delivery of the Communications to such Lender for purposes of the Loan Documents. Each Lender agrees (i) to provide to the Administrative Agent in writing (including by electronic communication), promptly after the date of this Agreement, an e-mail address to which the foregoing notice may be sent by electronic transmission and (ii) that the foregoing notice may be sent to such e-mail address.

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(e) Nothing herein shall prejudice the right of either Borrower, the Administrative Agent or any Lender to give any notice or other communication pursuant to this Agreement in any other manner specified in this Agreement.

SECTION 8.03 No Waiver; Remedies. No failure on the part of any Lender or the Administrative Agent to exercise, and no delay in exercising, any right hereunder or under any Note shall operate as a waiver thereof; nor shall any single or partial exercise of any such right preclude any other or further exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law.

SECTION 8.04 Costs and Expenses. (a) The Borrowers jointly and severally agree to pay on demand all out-of-pocket costs and expenses of the Administrative Agent in connection with the preparation, execution, delivery, administration, modification and amendment of this Agreement, the Notes and the other documents to be delivered hereunder, including the reasonable fees and expenses of counsel for the Administrative Agent with respect thereto and with respect to advising the Administrative Agent as to its rights and responsibilities under this Agreement. The Borrowers further jointly and severally agree to pay on demand all out-of-pocket costs and expenses of the Administrative Agent and the Lenders, if any, in connection with the enforcement of this Agreement, the Notes and the other documents to be delivered hereunder, limited, in the case of counsel fees and expenses, to the reasonable fees and expenses of one common counsel for the Administrative Agent and the Lenders.

(b) The Borrowers jointly and severally agree to indemnify and hold harmless the Agents and each Lender and each of their Affiliates and their officers, directors, employees, agents and advisors (each, an “Indemnified Party”) from and against any and all claims, damages, losses, liabilities and expenses (including, without limitation, reasonable fees and expenses of counsel) that may be incurred by or asserted or awarded against any Indemnified Party, in each case arising out of or relating to the Notes, this Agreement, the transactions contemplated hereby or the actual or proposed use of the proceeds of the Revolving Credit Advances, whether or not such investigation, litigation or proceeding is brought by a Borrower, any of its shareholders or creditors, an Indemnified Party or any other Person, or an Indemnified Party is otherwise, a party thereto, except with respect to any Indemnified Party to the extent such claim, damage, loss, liability or expense results from such Indemnified Party’s gross negligence or willful misconduct as determined in a final non-appealable judgment by a court of competent jurisdiction. In no event shall any Indemnified Party have any liability for any special, indirect, consequential or punitive damages in connection with any matter relating hereto.

(c) If any payment of principal of, or Conversion of, any Eurodollar Rate Advance is made by either Borrower to or for the account of a Lender other than on the last day of the Interest Period for such Advance, as a result of a payment or Conversion pursuant to Section 2.07(c), 2.09 or 2.11, prepayment, acceleration of the maturity of the Advances on the Notes pursuant to Section 6.01 or for any other reason, or if such Borrower fails to make a prepayment of any Eurodollar Rate Advance under Section 2.09 in accordance with a notice of prepayment given under such Section, such Borrower shall, upon written demand by such Lender (with a copy of such demand to the Administrative Agent), pay to the Administrative

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Agent for the account of such Lender any amounts required to compensate such Lender for any additional losses, costs or expenses that it may reasonably incur as a result of such payment or Conversion or such failure to prepay, including any loss (excluding loss of anticipated profits), cost or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by any Lender to fund or maintain such Advance.

(d) Without prejudice to the survival of any other agreement of each Borrower hereunder, the agreements and obligations of each Borrower contained in Sections 2.10 and 2.13 and this Section 8.04 shall survive the payment in full of principal and interest payable hereunder and under the Notes.

SECTION 8.05 Right of Set-off. Upon the occurrence and during the continuance of any Default under Section 6.01(f) or any Event of Default and the making of the request or the granting of the consent specified by Section 6.01 to authorize the Administrative Agent to declare the Notes due and payable pursuant to the provisions of Section 6.01, or any actual acceleration of the maturity thereof pursuant to the proviso at the end of Section 6.01, each Lender is hereby authorized at any time and from time to time, to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Lender to or for the credit or the account of either Borrower against any and all of the obligations of such Borrower now or hereafter existing under this Agreement and the Note held by such Lender, whether or not such Lender shall have made any demand under this Agreement or such Note and although such obligations may be unmatured. Each Lender agrees promptly to notify such Borrower after any such set-off and application, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of each Lender under this Section 8.05 are in addition to other rights and remedies (including other rights of setoff under applicable law or otherwise) which such Lender may have.

SECTION 8.06 Binding Effect. This Agreement shall become effective when it shall have been executed by the Borrowers and the Agents and when the Administrative Agent shall have been notified by each Lender that such Lender has executed it and thereafter shall be binding upon and inure to the benefit of the Borrowers, the Agents and each Lender and their respective successors and assigns, except that the Borrowers shall not have the right to assign its rights hereunder or any interest herein without the prior written consent of the Lenders.

SECTION 8.07 Assignments and Participations. (a) Each Lender may, if approved by the Borrowers and the Administrative Agent (which approvals may not be unreasonably withheld or delayed and which approvals of the Borrowers shall not be required if an Event of Default has occurred and is continuing), and, if demanded by the Borrowers in the event that at any time any Lender shall cease to have the Required Lender Rating, upon at least 5 Business Days’ notice to such Lender and the Administrative Agent, will assign to one or more Persons all or a portion of its rights and obligations under this Agreement (including, without limitation, all or a portion of its Commitment, the Advances owing to it and the Note or Notes held by it); provided, however, that (i) each such assignment shall be of a constant, and not a varying, percentage of all rights and obligations under this Agreement, (ii) except in the case of an assignment to a Person that, immediately prior to such assignment, was a Lender or an assignment of all of a Lender’s rights and obligations under this Agreement, the amount of the

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Commitment of the assigning Lender being assigned pursuant to each such assignment (determined as of the date of the Assignment and Acceptance with respect to such assignment) shall in no event be less than $10,000,000 or an integral multiple of $1,000,000 in excess thereof, (iii) each such assignment shall be to an Eligible Assignee and (iv) the parties to each such assignment shall execute and deliver to the Administrative Agent, for its acceptance and recording in the Register, an Assignment and Acceptance, together with any Note subject to such assignment and a processing and recordation fee of $3,500. Upon such execution, delivery, acceptance and recording, from and after the effective date specified in each Assignment and Acceptance, (A) the assignee thereunder shall be a party hereto and, to the extent that rights and obligations hereunder have been assigned to it pursuant to such Assignment and Acceptance, have the rights and obligations of a Lender hereunder and (B) the Lender assignor thereunder shall, to the extent that rights and obligations hereunder have been assigned by it pursuant to such Assignment and Acceptance, relinquish its rights and be released from its obligations under this Agreement (and, in the case of an Assignment and Acceptance covering all or the remaining portion of an assigning Lender’s rights and obligations under this Agreement, such Lender shall cease to be a party hereto). Notwithstanding the foregoing, each Lender will have the right, upon notice to the Administrative Agent and with the approval of the Borrower (which approval may not be unreasonably withheld or delayed and which approval shall not be required if an Event of Default has occurred and is continuing), to assign all or part of its rights and obligations under any Loan Document to any of its Affiliates.

(b) By executing and delivering an Assignment and Acceptance, the Lender assignor thereunder and the assignee thereunder confirm to and agree with each other and the other parties hereto as follows: (i) other than as provided in such Assignment and Acceptance, such assigning Lender makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with this Agreement or the execution, legality, validity, enforceability, genuineness, sufficiency or value of this Agreement or any other instrument or document furnished pursuant hereto; (ii) such assigning Lender makes no representation or warranty and assumes no responsibility with respect to the financial condition of either Borrower or the performance or observance by either Borrower of any of its obligations under this Agreement or any other instrument or document furnished pursuant hereto; (iii) such assignee confirms that it has received a copy of this Agreement, together with copies of the financial statements referred to in Section 4.01 and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into such Assignment and Acceptance; (iv) such assignee will, independently and without reliance upon the Administrative Agent, such assigning Lender or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement; (v) such assignee confirms that it is an Eligible Assignee; (vi) such assignee appoints and authorizes the Administrative Agent to take such action as agent on its behalf and to exercise such powers and discretion under this Agreement as are delegated to the Administrative Agent by the terms hereof, together with such powers and discretion as are reasonably incidental thereto; and (vii) such assignee agrees that it will perform in accordance with their terms all of the obligations that by the terms of this Agreement are required to be performed by it as a Lender.

43

(c) The Administrative Agent shall maintain at its address referred to in Section 8.02 a copy of each Assignment and Acceptance delivered to and accepted by it and a register for the recordation of the names and addresses of the Lenders and the Commitment of, and principal amount of the Advances owing to, each Lender from time to time (the “Register”). The entries in the Register shall be conclusive and binding for all purposes, absent manifest error, and the Borrowers, the Administrative Agent and the Lenders may treat each Person whose name is recorded in the Register as a Lender hereunder for all purposes of this Agreement. The Register shall be available for inspection by the Borrowers or any Lender at any reasonable time and from time to time upon reasonable prior notice.

(d) Upon its receipt of an Assignment and Acceptance executed by an assigning Lender and an assignee representing that it is an Eligible Assignee, together with any Note or Notes subject to such assignment, the Administrative Agent shall, if such Assignment and Acceptance has been completed and is in substantially the form of Exhibit C hereto, (i) accept such Assignment and Acceptance, (ii) record the information contained therein in the Register and (iii) give prompt notice thereof to each Borrower. Within five Business Days after its receipt of such notice, each Borrower, at its own expense, shall execute and deliver to the Administrative Agent in exchange for the surrendered Note a new Note to the order of such Eligible Assignee in an amount equal to the Commitment assumed by it pursuant to such Assignment and Acceptance and, if the assigning Lender has retained a Commitment hereunder, a new Note to the order of the assigning Lender in an amount equal to the Commitment retained by it hereunder. Such new Note or Notes shall be in an aggregate principal amount equal to the aggregate principal amount of such surrendered Note or Notes, shall be dated the effective date of such Assignment and Acceptance and shall otherwise be in substantially the form of Exhibit A hereto.

(e) Each Lender may sell participations to one or more banks or other entities (other than the Borrowers or any of their Affiliates) in or to all or a portion of its rights and obligations under this Agreement (including, without limitation, all or a portion of its Commitment, the Advances owing to it and the Note or Notes held by it); provided, however, that (i) such Lender’s obligations under this Agreement (including, without limitation, its Commitment to the Borrowers hereunder) shall remain unchanged, (ii) such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, (iii) such Lender shall remain the holder of any such Note for all purposes of this Agreement, (iv) the Borrowers, the Administrative Agent and the other Lenders shall continue to deal solely and directly with such Lender in connection with such Lender’s rights and obligations under this Agreement and (v) no participant under any such participation shall have any right to approve any amendment or waiver of any provision of this Agreement or any Note, or any consent to any departure by either Borrower therefrom, except to the extent that such amendment, waiver or consent would reduce the principal of, or interest on, the Notes or any fees or other amounts payable hereunder, in each case to the extent subject to such participation, or postpone any date fixed for any payment of principal of, or interest on, the Notes or any fees or other amounts payable hereunder, in each case to the extent subject to such participation.

(f) Any Lender may, in connection with any assignment or participation or proposed assignment or participation pursuant to this Section 8.07, disclose to the assignee or participant or proposed assignee or participant any information relating to either Borrower

44

furnished to such Lender by or on behalf of such Borrower; provided that, prior to any such disclosure, the assignee or participant or proposed assignee or participant shall agree to preserve the confidentiality of any Confidential Information relating to such Borrower received by it from such Lender.

(g) Notwithstanding any other provision set forth in this Agreement, any Lender may at any time create a security interest in all or any portion of its rights under this Agreement (including, without limitation, the Advances owing to it and any Note held by it) in favor of any Federal Reserve Bank in accordance with Regulation A of the Board of Governors of the Federal Reserve System.

SECTION 8.08 Confidentiality. Neither an Agent nor any Lender shall disclose any Confidential Information to any other Person without the consent of the Borrowers, other than (a) to such Agent’s or such Lender’s Affiliates and their officers, directors, employees, agents and advisors and, as contemplated by Section 8.07(f), to actual or prospective assignees and participants, and then only on a confidential basis, (b) as required by any law, rule or regulation or judicial process and (c) as requested or required by any state, federal or foreign authority or examiner regulating banks or banking.

SECTION 8.09 Governing Law. This Agreement and the Notes shall be governed by, and construed in accordance with, the law of the State of New York.

SECTION 8.10 Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of a signature page to this Agreement by telecopier shall be effective as delivery of a manually executed counterpart of this Agreement.

SECTION 8.11 Waiver of Jury Trial. Each of the Borrowers, the Agents and the Lenders hereby knowingly, voluntarily and irrevocably waives all right to trial by jury in any action, proceeding or counterclaim (whether based on contract, tort or otherwise) arising out of or relating to this Agreement or the Notes or the transactions contemplated hereby.

SECTION 8.12 Jurisdiction, Etc. Each of the parties hereto hereby irrevocably and unconditionally submits, for itself and its property, to the nonexclusive jurisdiction of any New York State court or federal court of the United States of America sitting in New York City, and any appellate court from any thereof, in any action or proceeding arising out of or relating to this Agreement or the Notes, or for recognition or enforcement of any judgment, and each of the parties hereto hereby irrevocably and unconditionally agrees that all claims in respect of any such action or proceeding may be heard and determined in any such New York State court or, to the extent permitted by law, in such federal court. Each of the parties hereto agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. Nothing in this Agreement shall affect any right that any party may otherwise have to bring any action or proceeding relating to this Agreement or the Notes in the courts of any jurisdiction.

45

SECTION 8.13 Nature of Obligations. The obligations of the Borrowers under the Loan Documents are several obligations, and are not joint and several obligations, of the respective Borrowers unless otherwise expressly provided herein.

46

IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written.

AMBAC FINANCIAL GROUP, INC.
By
	Name:
	Title:

AMBAC ASSURANCE CORPORATION
By
	Name:
	Title:

CITIBANK, N.A., as Administrative Agent
By
	Name:
	Title:

BARCLAYS BANK PLC, as Syndication Agent
By
	Name:
	Title:

LENDERS
CITIBANK, N.A.
By
	Name:
	Title:

BARCLAYS BANK PLC
By
	Name:
	Title:

THE BANK OF NEW YORK
By
	Name:
	Title:

KEYBANK NATIONAL ASSOCIATION
By
	Name:
	Title:

CAJA MADRID
By
	Name:
	Title:

WESTLB AG, NEW YORK BRANCH
By
	Name:
	Title:

By
	Name:
	Title:

SCHEDULE I

COMMITMENTS

LENDER	COMMITMENT
Citibank, N.A.	$	60,000,000
Barclays Bank PLC	$	60,000,000
The Bank of New York	$	60,000,000
KeyBank National Association	$	42,500,000
Caja Madrid	$	42,500,000
WestLB AG, New York Branch	$	35,000,000
TOTAL COMMITMENTS	$	300,000,000

SCHEDULE II

AMBAC FINANCIAL GROUP, INC./

AMBAC ASSURANCE CORPORATION

REVOLVING CREDIT AGREEMENT

APPLICABLE LENDING OFFICES

Name of Lender	Domestic Lending Office	Eurodollar Lending Office
Citibank, N.A.	2 Penns Way Suite 110 New Castle, DE 19720 Attn: Keith Carter	2 Penns Way Suite 110 New Castle, DE 19720 Attn: Keith Carter
Barclays Bank PLC	200 Park Avenue New York, NY 10166 Attn: Catherine Gil	200 Park Avenue New York, NY 10166 Attn: Catherine Gil
The Bank of New York	One Wall Street, 17th Floor New York, NY 10286 Attn: David Trick, Vice President	One Wall Street, 17th Floor New York, NY 10286 Attn: David Trick, Vice President
KeyBank National Association	127 Public Square Cleveland, OH 44114 Attn: Mary K. Young	127 Public Square Cleveland, OH 44114 Attn: Mary K. Young
Caja Madrid	Paseo de La Castellana 189 Torre Caja Madrid, 4th Floor Madrid 28046 Spain Attn: Beatriz Alvarez	Paseo de La Castellana 189 Torre Caja Madrid, 4th Floor Madrid 28046 Spain Attn: Beatriz Alvarez
WestLB AG, New York Branch	1211 Avenue of the Americas New York, NY 10036 Attn: Lillian Tung Lum Executive Director	1211 Avenue of the Americas New York, NY 10036 Attn: Lillian Tung Lum Executive Director

SCHEDULE 4.01(H)

AMBAC FINANCIAL GROUP, INC./

AMBAC ASSURANCE CORPORATION

REVOLVING CREDIT AGREEMENT

CONTINGENT LIABILITIES

[TO BE UPDATED BY BORROWERS]

SCHEDULE 5.02(A)

AMBAC FINANCIAL GROUP, INC./

AMBAC ASSURANCE CORPORATION

REVOLVING CREDIT AGREEMENT

ONGOING SECURED DEBT

[TO BE UPDATED BY BORROWERS]

EXHIBIT A-1 - FORM OF

REVOLVING CREDIT NOTE

U.S.$                     Dated:                     , 2004

FOR VALUE RECEIVED, the undersigned, [AMBAC FINANCIAL GROUP, INC./AMBAC ASSURANCE CORPORATION] (the “Borrower”), HEREBY PROMISES TO PAY on the Maturity Date (as defined in the Credit Agreement referred to below) to the order of                      (the “Lender”) for the account of its Applicable Lending Office (as defined in the Credit Agreement referred to below) the aggregate principal amount of the Revolving Credit Advances made by the Lender to the Borrower pursuant to the Credit Agreement dated as of July 29, 2004, among the Borrower, the Lender and certain other lenders parties thereto, and Barclays Bank PLC, as Syndication Agent, and Citibank, N.A., as Administrative Agent for the Lender and such other lenders (as amended or modified from time to time, the “Credit Agreement”; the terms defined therein being used herein as therein defined) outstanding on the Commitment Termination Date.

The Borrower promises to pay interest on the unpaid principal amount of each Revolving Credit Advance from the date of such Revolving Credit Advance until such principal amount is paid in full, at such interest rates, and payable at such times, as are specified in the Credit Agreement.

Both principal and interest are payable in lawful money of the United States of America to Citibank, N.A., as Administrative Agent, at the Administrative Agent’s Account, in same day funds. Each Revolving Credit Advance owing to the Lender by the Borrower pursuant to the Credit Agreement, and all payments made on account of principal thereof, shall be recorded by the Lender and, prior to any transfer hereof, endorsed on the grid attached hereto which is part of this Promissory Note.

This Promissory Note is one of the Revolving Credit Notes referred to in, and is entitled to the benefits of, the Credit Agreement. The Credit Agreement, among other things, (i) provides for the making of Revolving Credit Advances by the Lender to the Borrower from time to time in an aggregate amount not to exceed at any time outstanding the Dollar amount first above mentioned, the indebtedness of the Borrower resulting from each such Advance being evidenced by this Promissory Note, and (ii) contains provisions for acceleration of the maturity hereof upon the happening of certain stated events and also for prepayments on account of principal hereof prior to the maturity hereof upon the terms and conditions therein specified.

[AMBAC FINANCIAL GROUP INC./AMBAC ASSURANCE CORPORATION]
	By
		Name:
		Title:

REVOLVING CREDIT NOTE

ADVANCES AND PAYMENTS OF PRINCIPAL

Date Amount of Advance Amount of Principal Paid or Prepaid Unpaid Principal Balance Notation Made By

REVOLVING CREDIT NOTE

EXHIBIT A-2 - FORM OF

TERM NOTE

U.S.$                     Dated: [Term Loan Conversion Date]

FOR VALUE RECEIVED, the undersigned, [AMBAC FINANCIAL GROUP, INC./AMBAC ASSURANCE CORPORATION] (the “Borrower”), HEREBY PROMISES TO PAY on the Maturity Date (as defined in the Credit Agreement referred to below) to the order of                      (the “Lender”) for the account of its Applicable Lending Office (as defined in the Credit Agreement referred to below) the aggregate principal amount of the Term Loan of the Lender pursuant to the Credit Agreement dated as of July 29, 2004, among the Borrower, the Lender and certain other lenders parties thereto, and Barclays Bank PLC, as Syndication Agent, and Citibank, N.A., as Administrative Agent for the Lender and such other lenders (as amended or modified from time to time, the “Credit Agreement”; the terms defined therein being used herein as therein defined).

The Borrower promises to pay interest on the unpaid principal amount of the Term Loan from the date hereof until such principal amount is paid in full, at such interest rates, and payable at such times, as are specified in the Credit Agreement.

Both principal and interest are payable in lawful money of the United States of America to Citibank, N.A., as Administrative Agent, at the Administrative Agent’s Account, in same day funds.

This Promissory Note is one of the Term Notes referred to in, and is entitled to the benefits of, the Credit Agreement. The Credit Agreement, among other things, contains provisions for acceleration of the maturity hereof upon the happening of certain stated events.

[AMBAC FINANCIAL GROUP INC./AMBAC ASSURANCE CORPORATION]
	By
		Name:
		Title:

TERM NOTE

EXHIBIT B - FORM OF

NOTICE OF BORROWING

Citibank, N.A., as Administrative Agent

             for the Lenders parties

             to the Credit Agreement

             referred to below

_______________

_______________ [Date]

Attention:                     

Ladies and Gentlemen:

The undersigned, [Ambac Financial Group, Inc./Ambac Assurance Corporation], refers to the Credit Agreement, dated as of July 29, 2004 (as amended or modified from time to time, the “Credit Agreement”, the terms defined therein being used herein as therein defined), among the undersigned, [Ambac Financial Group, Inc./Ambac Assurance Corporation], certain Lenders parties thereto, Barclays Bank PLC, as Syndication Agent, and Citibank, N.A., as Administrative Agent for said Lenders, and hereby gives you notice, irrevocably, pursuant to Section 2.02 of the Credit Agreement that the undersigned hereby requests a Borrowing under the Credit Agreement, and in that connection sets forth below the information relating to such Borrowing (the “Proposed Borrowing”) as required by Section 2.02(a) of the Credit Agreement:

(i) The Business Day of the Proposed Borrowing is                         , 200  .

(ii) The Type of Advances comprising the Proposed Borrowing is [Base Rate Advances] [Eurodollar Rate Advances].

(iii) The aggregate amount of the Proposed Borrowing is $                    .

[(iv) The initial Interest Period for each Eurodollar Rate Advance made as part of the Proposed Borrowing is                      month[s].]

The undersigned hereby certifies that the following statements are true on the date hereof, and will be true on the date of the Proposed Borrowing:

(A) the representations and warranties contained in Section 4.01 (other than subparagraphs (f) and (g) and the final sentence of subparagraph (e) thereof) of the Credit Agreement are correct, before and after giving effect to the Proposed Borrowing and to the application of the proceeds therefrom, as though made on and as of such date; and

B-1

(B) no event has occurred and is continuing, or would result from such Proposed Borrowing or from the application of the proceeds therefrom, that constitutes a Default.

Very truly yours,
[AMBAC FINANCIAL GROUP, INC./AMBAC ASSURANCE CORPORATION]
By
	Name:
	Title:

B-2

EXHIBIT C - FORM OF

ASSIGNMENT AND ACCEPTANCE

Reference is made to the Credit Agreement dated as of July 29, 2004 (as amended or modified from time to time, the “Credit Agreement”) among Ambac Financial Group, Inc. and Ambac Assurance Corporation (the “Borrowers”), the Lenders (as defined in the Credit Agreement), Barclays Bank PLC, as syndication agent (the “Syndication Agent”), and Citibank, N.A., as administrative agent for the Lenders (the “Administrative Agent”). Terms defined in the Credit Agreement are used herein with the same meaning.

The “Assignor” and the “Assignee” referred to on Schedule I hereto agree as follows:

1. The Assignor hereby sells and assigns to the Assignee, and the Assignee hereby purchases and assumes from the Assignor, an interest in and to the Assignor’s rights and obligations under the Credit Agreement as of the date hereof equal to the percentage interest specified on Schedule 1 hereto of all outstanding rights and obligations under the Credit Agreement. After giving effect to such sale and assignment, the Assignee’s Commitment and the amount of the Advances owing to the Assignee will be as set forth on Schedule 1 hereto.

2. The Assignor (a) represents and warrants that it is the legal and beneficial owner of the interest being assigned by it hereunder and that such interest is free and clear of any adverse claim; (b) makes no representation or warranty and assumes no responsibility with respect to any statements, warranties or representations made in or in connection with the Credit Agreement or the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Credit Agreement or any other instrument or document furnished pursuant thereto; (c) makes no representation or warranty and assumes no responsibility with respect to the financial condition of either Borrower or the performance or observance by either Borrower of any of its obligations under the Credit Agreement or any other instrument or document furnished pursuant thereto; and (d) attaches the Note held by the Assignor and requests that the Administrative Agent exchange such Note for a new Note payable to the order of the Assignee in an amount equal to the Commitment assumed by the Assignee pursuant hereto or new Notes payable to the order of the Assignee in an amount equal to the Commitment assumed by the Assignee pursuant hereto and the Assignor in an amount equal to the Commitment retained by the Assignor under the Credit Agreement, respectively, as specified on Schedule 1 hereto.

3. The Assignee (a) confirms that it has received a copy of the Credit Agreement, together with copies of the financial statements referred to in Section 4.01 thereof and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment and Acceptance; (b) agrees that it will, independently and without reliance upon the Administrative Agent, the Assignor or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Credit Agreement; (c) confirms that it is an Eligible Assignee;

C-1

(d) appoints and authorizes the Administrative Agent to take such action as agent on its behalf and to exercise such powers and discretion under the Credit Agreement as are delegated to the Administrative Agent by the terms thereof, together with such powers and discretion as are reasonably incidental thereto; (e) agrees that it will perform in accordance with their terms all of the obligations that by the terms of the Credit Agreement are required to be performed by it as a Lender; and (f) attaches any U.S. Internal Revenue Service forms required under Section 2.13 of the Credit Agreement.

4. Following the execution of this Assignment and Acceptance, it will be delivered to the Administrative Agent for acceptance and recording by the Administrative Agent. The effective date for this Assignment and Acceptance (the “Effective Date”) shall be the date of acceptance hereof by the Administrative Agent, unless otherwise specified on Schedule 1 hereto.

5. Upon such acceptance and recording by the Administrative Agent, as of the Effective Date, (a) the Assignee shall be a party to the Credit Agreement and, to the extent provided in this Assignment and Acceptance, have the rights and obligations of a Lender thereunder and (b) the Assignor shall, to the extent provided in this Assignment and Acceptance, relinquish its rights and be released from its obligations under the Credit Agreement.

6. Upon such acceptance and recording by the Administrative Agent, from and after the Effective Date, the Administrative Agent shall make all payments under the Credit Agreement and the Notes in respect of the interest assigned hereby (including, without limitation, all payments of principal, interest and facility fees with respect thereto) to the Assignee. The Assignor and Assignee shall make all appropriate adjustments in payments under the Credit Agreement and the Notes for periods prior to the Effective Date directly between themselves.

7. This Assignment and Acceptance shall be governed by, and construed in accordance with, the laws of the State of New York.

8. This Assignment and Acceptance may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original and all of which taken together shall constitute one and the same agreement. Delivery of an executed counterpart of Schedule 1 to this Assignment and Acceptance by telecopier shall be effective as delivery of a manually executed counterpart of this Assignment and Acceptance.

IN WITNESS WHEREOF, the Assignor and the Assignee have caused Schedule 1 to this Assignment and Acceptance to be executed by their officers thereunto duly authorized as of the date specified thereon.

C-2

Schedule 1

to

Assignment and Acceptance

Percentage interest assigned:	%
Assignee’s Commitment:	$
Aggregate outstanding principal amount of Advances assigned:	$
Principal amount of Note payable to Assignee:	$
Principal amount of Note payable to Assignor:	$
Effective Date*	,

[NAME OF ASSIGNOR], as Assignor

By

	Name:
	Title:
Dated:	,
[NAME OF ASSIGNEE], as Assignee

By
	Name:
	Title:
Domestic Lending Office: [Address]
Eurodollar Lending Office: [Address]

* This date should be no earlier than five Business Days after the delivery of this Assignment and Acceptance to the Agent.

C-3

Accepted [and Approved] this

                     day of                    ,            

                                             , as Administrative Agent

By
	Name:
	Title:
Approved this                      day of                              ,

AMBAC FINANCIAL GROUP, INC.
By
	Name:
	Title:

AMBAC ASSURANCE CORPORATION
By
	Name:
	Title:

C-4

EXHIBIT D

FORM OF COMPLIANCE CERTIFICATE

AMBAC FINANCIAL GROUP, INC.

AMBAC ASSURANCE CORPORATION

This certificate is delivered pursuant to clause (vi) of Section 5.01(f) of the Credit Agreement dated as of July 29, 2004 (together with all amendments and other modifications, if any, from time to time made thereto, the “Credit Agreement”), among AMBAC FINANCIAL GROUP, INC (“Ambac Financial”), AMBAC ASSURANCE CORPORATION (“Ambac Assurance”; together with Ambac Financial, the “Borrowers”), the various commercial lending institutions as are or may become parties (hereto collectively, the “Lenders”), BARCLAYS BANK PLC, as syndication agent (the “Syndication Agent”), and CITIBANK, N.A., as administrative agent (the “Administrative Agent”). Unless otherwise defined herein, terms used herein and in the Attachment 1 hereto have the meanings provided therefor in the Credit Agreement.

This Compliance Certificate relates to the              Fiscal Quarter, commencing on                     ,              and ending on                     ,              (such latter date being the “Computation Date”). Ambac Financial hereby further certifies, represents and warrants that as of the Computation Date:

(1) No Default has occurred and is continuing;

(2) The Leverage Ratio on the Computation Date was              to 1.00, as computed on Attachment 1 hereto. The maximum Leverage Ratio permitted pursuant to Section 5.03(a) of the Credit Agreement on the Computation Date is .30 to 1.00, and accordingly, Section 5.03(a) of the Credit Agreement has [not] been complied with; and

(3) The excess of Consolidated total assets over Consolidated total liabilities (in each case excluding the assets and liabilities of Aleutian and Juneau) is $                . The minimum amount by which Consolidated total assets must exceed Consolidated total liabilities pursuant to Section 5.03(b) of the Credit Agreement is $2,000,000,000, and accordingly, Section 5.03(b) of the Credit Agreement has [not] been complied with.

IN WITNESS WHEREOF, the undersigned has caused this Compliance Certificate to be delivered by its Responsible Officer this          day of                     ,             .

AMBAC FINANCIAL GROUP, INC.
By:
	Name:
	Title:

D-1

Attachment 1

(to         /        /        

Compliance Certificate)

LEVERAGE RATIO

As of                    ,            

(the “Computation Date”)

(A)   Total Debt of Ambac Financial and its Subsidiaries (other than Aleutian and Juneau) on a Consolidated basis as of the Computation Date
(1)    Borrowed money and all obligations evidenced by bonds, debentures, notes or other similar instruments.	$
(2)    All obligations, contingent or otherwise, relative to the face amount of all letters of credit, whether or not drawn, and banker’s acceptances issued for the account of Ambac Financial or its Subsidiaries (other than Aleutian and Juneau) on a Consolidated basis.	$
(3)    All obligations as lessees under leases which have been or should be, in accordance with GAAP, recorded as capitalized lease liabilities.	$
(4)    All Contingent Liabilities in respect of any of Items A(1), A(2) and A(3).	$
(5)    The sum of Items A(1), A(2), A(3) and A(4).	$
(B)   Stockholders’ Equity: Stockholders’ equity of Ambac Financial and its Subsidiaries (other than Aleutian and Juneau), on a Consolidated basis (excluding unrealized gains on investments and unrealized losses on investments).	$
(C)   Leverage Ratio:
The ratio of Item A(5) to the sum of Item A(5) and Item B	to 1.00

D-2

EXHIBIT E

FORM OF OPINION OF ANNE GILL KELLY, MANAGING DIRECTOR, ASSISTANT

GENERAL COUNSEL AND SECRETARY OF AMBAC FINANCIAL GROUP, INC.

July 29, 2004

Citibank, N.A., as the Administrative Agent

(as defined below)

Re: Ambac Financial Group, Inc.

$300 Million Credit Agreement

Ladies and Gentlemen:

This opinion is delivered to you pursuant to Section 3.01(c)(vi) of the Credit Agreement dated as of July 29, 2004 (the “Credit Agreement”), among Ambac Financial Group, Inc., a Delaware corporation (“Ambac Financial”), Ambac Assurance Corporation, a Wisconsin stock insurance corporation, the Lenders parties thereto and Barclays Bank PLC, as Syndication Agent, and Citibank, N.A., as Administrative Agent for the Lenders (the “Administrative Agent”). Unless otherwise defined herein, terms defined in the Credit Agreement are used herein as therein defined.

I am Assistant General Counsel of Ambac Financial and have acted as counsel to Ambac Financial in connection with the preparation, execution and delivery of the Credit Agreement. In that connection, I have examined:

1. the Credit Agreement;

2. the Revolving Credit Notes dated the date hereof, executed by Ambac Financial and payable to each of you as Lenders (the “Ambac Financial Notes”);

3. the Amended and Restated Certificate of Incorporation of Ambac Financial and all amendments thereto (the “Charter”); and

4. the By-laws of Ambac Financial and all amendments thereto (the “By-laws”).

I also have examined and am familiar with the originals, or copies certified or otherwise identified to my satisfaction, of such documents and corporate records of Ambac Financial, certificates of public officials and officers of Ambac Financial and agreements, instruments and other documents, as I have deemed necessary as a basis for the opinions expressed below. As to questions of fact material to such opinions, I have, when relevant facts

E-1

were not independently established by me, relied, to the extent I deemed appropriate, upon certificates of Ambac Financial or its officers, or of public officials. In addition, I have also assumed the genuineness of all signatures, the authenticity of all documents submitted to me as originals and the conformity with originals of all documents submitted to me as copies thereof. I have also assumed the due execution and delivery, pursuant to due authorization, of the Credit Agreement by each of the Lenders and the Administrative Agent.

I am qualified to practice law in the State of New York. I do not purport to express any opinion herein as to the laws of any jurisdiction other than the laws of the State of New York, the General Corporation Law of the State of Delaware and the Federal laws of the United States of America.

Based upon the foregoing and upon such investigation, as I have deemed necessary, I am of the following opinion:

(1) Ambac Financial is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware. Ambac Financial is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction where the nature of its business requires such qualification, except where the failure to be so qualified, singly or in the aggregate, would not have a Material Adverse Effect.

(2) The execution, delivery and performance by Ambac Financial of the Credit Agreement and the Ambac Financial Notes are within Ambac Financial’s corporate powers, and have been duly authorized by all necessary corporate action on the part of Ambac Financial.

(3) There is no pending or, to my knowledge, threatened action, suit, investigation, litigation, proceeding or labor controversy affecting Ambac Financial before any court, governmental agency or arbitrator which (A) purports to affect the legality, validity or enforceability of the Credit Agreement or any of the Ambac Financial Notes or the consummation of the transactions contemplated thereby or (B) which could be reasonably likely to have a Material Adverse Effect.

(4) The execution, delivery and performance by Ambac Financial of the Credit Agreement and the Ambac Financial Notes do not (i) violate or contravene its Charter or By-laws, or any contractual restriction or law applicable to Ambac Financial or any rule or regulation applicable to Ambac Financial or (ii) result in, or require the creation or imposition of, any Lien on any of Ambac Financial’s properties.

(5) The execution, delivery and performance by Ambac Financial of the Credit Agreement and the Ambac Financial Notes do not conflict with or result in a breach of any of the terms or provisions of, or constitute a default under (i) any indenture, loan agreement, lease, guarantee, mortgage or other agreement or instrument, or (ii) any order, writ, judgment, award, injunction or decree known to me to which Ambac

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Financial is a party or by which it is bound or to which any of its properties or assets are subject, except for such conflicts, breaches or defaults, which individually or in the aggregate, would not have any Material Adverse Effect, would not have a material adverse effect on the legality, validity, binding effect or enforceability of the Credit Agreement or the Ambac Financial Notes, and would not subject the Administrative Agent or any Lender to any liability.

(6) No authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery and performance by Ambac Financial of the Credit Agreement or any Ambac Financial Note.

(7) The Credit Agreement and the Ambac Financial Notes have been duly executed and delivered on behalf of Ambac Financial.

A copy of this opinion letter may be delivered by each of you to any Eligible Assignee in connection with and at the time of any assignment and delegation by either of you as a Lender to such Eligible Assignee of a portion of your Loans and Commitment in accordance with the provisions of the Credit Agreement, and such Eligible Assignee may rely on the opinions expressed above with respect to the Credit Agreement as if this opinion letter were addressed and delivered to such Eligible Assignee on the date hereof.

This opinion letter speaks only as of the date hereof. I do not assume, and I expressly disclaim, any responsibility to advise any of you or any other Person who is permitted to rely on any opinion expressed herein as specified in the next preceding paragraph of any or change of law or fact that may occur after the date of this opinion letter even though such change may affect the legal analysis, a legal conclusion or any other matter set forth in or relating to this opinion letter.

This opinion is given pursuant to the Credit Agreement and in connection with the Loan Documents and is not to be relied upon for any other purpose.

Very truly yours,

Anne Gill Kelly,

Managing Director, Assistant General

Counsel and Secretary

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EXHIBIT F

FORM OF OPINION OF KEVIN J. DOYLE, MANAGING DIRECTOR AND GENERAL

COUNSEL OF AMBAC ASSURANCE CORPORATION

July 29, 2004

Citibank, N.A., as the Administrative Agent

    (as defined below)

Re: Ambac Assurance Corporation

$300 Million Credit Agreement

Ladies and Gentlemen:

This opinion is delivered to you pursuant to Section 3.01(c)(vii) of the Credit Agreement dated as of July 29, 2004 (the “Credit Agreement”), among Ambac Financial Group, Inc., a Delaware corporation, Ambac Assurance Corporation, a Wisconsin stock insurance corporation (“Ambac Assurance”), the Lenders parties thereto, Barclays Bank PLC, as Syndication Agent, and Citibank, N.A., as Administrative Agent for the Lenders (the “Administrative Agent”). Unless otherwise defined herein, terms defined in the Credit Agreement are used herein as therein defined.

I am a Managing Director and the General Counsel of Ambac Assurance and have acted as counsel to Ambac Assurance in connection with the preparation, execution and delivery of the Credit Agreement. In that connection, I have examined:

1. the Credit Agreement;

2. the Notes dated the date hereof, executed by Ambac Assurance and payable to each of you as Lenders (the “Ambac Assurance Notes”);

3. the Restated Articles of Incorporation of Ambac Assurance and all amendments thereto (the “Charter”); and

4. the restated by-laws of Ambac Assurance and all amendments thereto (the “By-laws”).

I have also examined and am familiar with originals or copies, certified or otherwise identified to my satisfaction, of such documents and corporate records of Ambac Assurance, certificates of public officials and officers of Ambac Assurance and agreements, instruments and other documents, as I have deemed necessary as a basis for the opinions expressed below. As to questions of fact material to such opinions, I have, when relevant facts were not independently established by me, relied, to the extent I deemed appropriate, upon certificates of Ambac

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Assurance or its officers, or of public officials. In addition, I have also assumed the genuineness of all signatures, the authenticity of all documents submitted to me as originals and the conformity with originals of all documents submitted to me as copies thereof I have also assumed the due execution and delivery, pursuant to due authorization, of the Credit Agreement by each of the Lenders and the Administrative Agent.

I am qualified to practice law in the State of New York. I do not purport to express any opinion herein as to the laws of any jurisdiction other than the laws of the State of New York and the Federal laws of the United States of America.

Based upon the foregoing and upon such investigation as I have deemed necessary, I am of the following opinion:

(1) Ambac Assurance is duly qualified to do business and is in good standing as a foreign corporation in each jurisdiction where the nature of its business requires such qualification, except where the failure to be so qualified, singly or in the aggregate, would not have a Material Adverse Effect.

(2) There is no pending or, to my knowledge, threatened action, suit, investigation, litigation, proceeding or labor controversy affecting Ambac Assurance before any court, governmental agency or arbitrator which (A) purports to affect the legality, validity or enforceability of the Credit Agreement or any of the Ambac Assurance Notes or the consummation of the transactions contemplated thereby or (B) which could be reasonably likely to have a Material Adverse Effect.

(3) All the outstanding shares of capital stock of Ambac Assurance are fully paid and non-assessable and issued to, and held of record by, Ambac Financial.

(4) The execution, delivery and performance by Ambac Assurance of the Credit Agreement and the Ambac Assurance Notes do not (i) violate or contravene its Charter or By-laws or any contractual restriction or law applicable to Ambac Assurance or any rule or regulation applicable to Ambac Assurance or (ii) result in, or require the creation or imposition of, any Lien on any of Ambac Assurance’s properties.

(5) The execution, delivery and performance by Ambac Assurance of the Credit Agreement and the Ambac Assurance Notes do not conflict with or result in a breach of any of the terms or provisions of, or constitute a default under (i) any indenture, loan agreement, lease, guarantee, mortgage or other agreement or instrument, or (ii) any order, writ, judgment, award, injunction or decree known to me to which Ambac Assurance is a party or by which it is bound or to which any of its properties or assets are subject, except for such conflicts, breaches or defaults, which individually or in the aggregate, would not have any Material Adverse Effect, would not have a material adverse effect on the legality, validity, binding effect or enforceability of the Credit Agreement or the Ambac Assurance Notes, and would not subject the Administrative Agent or any Lender to any liability.

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(6) No authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body is required for the due execution, delivery and performance by Ambac Assurance of the Credit Agreement or any Ambac Assurance Note.

(7) The Credit Agreement and the Ambac Assurance Notes have been duly executed and delivered on behalf of Ambac Assurance.

A copy of this opinion letter may be delivered by each of you to any Eligible Assignee in connection with and at the time of any assignment and delegation by either of you as a Lender to such Eligible Assignee of a portion of your Loans and Commitment in accordance with the provisions of the Credit Agreement and such Eligible Assignee may rely on the opinions expressed above with respect to the Credit Agreement, as if this opinion letter were addressed and delivered to such Eligible Assignee on the date hereof

This opinion letter speaks only as of the date hereof. I do not assume, and I expressly disclaim, any responsibility to advise any of you or any other person who is permitted to rely on any opinion expressed herein as specified in the next preceding paragraph of any change of law or fact that may occur after the date of this opinion letter even though such change may affect the legal analysis, a legal conclusion or any other matter set forth in or relating to this opinion letter.

This opinion is given pursuant to the Credit Agreement and in connection with the Loan Documents and is not to be relied upon for any other purpose.

Very truly yours,

Kevin J. Doyle,

Managing Director and General Counsel

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EXHIBIT G

FORM OF OPINION OF DEWITT ROSS & STEVENS, S.C.

July 29, 2004

Citibank, N.A., as the Administrative Agent

    (as defined below)

RE: Ambac Assurance Corporation

Ladies and Gentlemen:

This opinion is delivered to you pursuant to Section 3.01(c)(viii) of the Credit Agreement dated as of July 29, 2004, (the “Credit Agreement”) among Ambac Financial Group, Inc., a Delaware corporation (“Ambac Financial”), Ambac Assurance Corporation, a Wisconsin stock insurance corporation (“Ambac Assurance”; together with Ambac Financial, the “Borrowers”), the various commercial lending institutions as are or may become parties thereto (collectively, the “Lenders”), Barclays Bank PLC, as Syndication Agent, and Citibank, N.A., as Administrative Agent for the Lenders (the “Administrative Agent”). Unless otherwise defined herein, terms to which meanings are ascribed in the Credit Agreement are used herein with such meanings.

We have acted as special counsel for Ambac Assurance in connection with the preparation, execution and delivery of the Credit Agreement.

In that connection, we have examined:

1. the Credit Agreement;

2. the Revolving Credit Notes dated the date hereof, executed by Ambac Assurance and payable to each of you as Lenders (the “Ambac Assurance Notes”);

3. the Restated Articles of Incorporation of Ambac Assurance and all amendments thereto (the “Charter”);

4. the Restated Bylaws of Ambac Assurance and all amendments thereto (the “Bylaws”); and

5. the Certificate of Authority issued to Ambac Assurance by the Office of the Commissioner of Insurance for the State of Wisconsin.

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We have examined the originals, or copies certified to our satisfaction, of such other corporate records of Ambac Assurance, certificates of public officials and of officers of Ambac Assurance and Ambac Financial and agreements, instruments and other documents, as we have deemed necessary as a basis for the opinions expressed below. As to questions of fact material to such opinions, we have, when relevant facts were not independently established by us, relied, to the extent we deemed appropriate, upon certificates of Ambac Assurance and Ambac Financial or their respective officers, or of public officials. We have assumed the due execution and delivery, pursuant to due authorization, of the Credit Agreement by the Lenders and the Administrative Agent. We have assumed the due execution and delivery of the Credit Agreement and the Ambac Assurance Notes, the genuineness of all signatures, the authenticity of all documents submitted to us as originals and the conformity to originals of all documents submitted to us as copies thereof.

QUALIFICATIONS AND ASSUMPTIONS

(1) We are qualified to practice law in the State of Wisconsin and the opinions expressed herein relate solely to the laws of the State of Wisconsin and are limited to the presently existing statutes of the State of Wisconsin and the published decisions of the State of Wisconsin and federal courts.

(2) We assume that Ambac Financial is a Delaware corporation and wholly owns the outstanding capital stock of Ambac Assurance, which fact has been certified to us by Ambac Financial.

(3) The insurance laws of the State of Wisconsin govern the activities of Ambac Assurance and the agreements, transactions and other activities between Ambac Assurance and its affiliates, including Ambac Financial. The opinions set forth below are limited to the agreements and other documents specified herein and no opinion is rendered herein regarding any agreements or transactions between Ambac Assurance and its affiliates, including Ambac Financial.

OPINION

Based solely upon the foregoing and subject to the qualifications and assumptions stated above, in our opinion:

(1) Ambac Assurance is a corporation duly organized, validly existing and in good standing under the laws of the State of Wisconsin. Ambac Assurance is licensed as an insurance company by the Office of the Commissioner of Insurance of the State of Wisconsin.

(2) The execution, delivery and performance by Ambac Assurance of the Credit Agreement and the Ambac Assurance Notes: (a) are within Ambac Assurance’s corporate powers and have been duly authorized by all necessary corporate

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action on the part of Ambac Assurance; and (b) do not violate or contravene the Charter or Bylaws of Ambac Assurance or any laws or regulations of the State of Wisconsin.

(3) No authorization, approval or other action by and no notice to or filing with the Office of the Commissioner of Insurance of the State of Wisconsin or any other Wisconsin governmental authority or regulatory body is required for the due execution, delivery and performance by either Borrower of the Credit Agreement or any Ambac Assurance Note.

(4) a. The New York governing law clauses of the Credit Agreement and the Ambac Assurance Notes to which Ambac Assurance is a party are valid under the law of the State of Wisconsin.

b. Under the law of the State of Wisconsin, the law of the State of New York will be applied to the Loan Documents to which Ambac Assurance is a party, except to the extent that any term of such documents or any provision of the law of the State of New York applicable to such document violates an important public policy of the State of Wisconsin. We have no reason to believe that any such term violates an important public policy of the State of Wisconsin.

(5) Assuming that the Credit Agreement and the Ambac Assurance Notes are legal, valid, binding and enforceable under the law of the State of New York, the Credit Agreement and the Ambac Assurance Notes constitute the legal, valid and binding obligations of Ambac Assurance, and are enforceable against Ambac Assurance in accordance with their respective terms.

The opinions set forth above are subject to the following qualifications:

a. Our opinion in Paragraph 5 is subject to the effect of any applicable bankruptcy, insolvency (including, without limitation, all laws relating to fraudulent transfers), reorganization, moratorium or similar law affecting creditors’ rights generally.

b. Our opinion in Paragraph 5 above is also subject to the effect of general principles of equity, including (without limitation) concepts of materiality, reasonableness, good faith and fair dealing (regardless of whether considered in proceeding in equity or at law).

                    , [                                             ] of Ambac Assurance may rely on the opinions above for the purpose of rendering his opinion letter pursuant to Section 3.0l(c)(vii) of the Credit Agreement on the date hereof. In addition, a copy of this opinion letter may be delivered by each of you to any Eligible Assignee in connection with and at the time of any assignment and delegation by either of you as a Lender to such Eligible Assignee of a portion of your Loans and Commitment in accordance with the provisions of the Credit Agreement, and such Eligible Assignee may rely on the opinions expressed above with respect to the Credit Agreement as if this opinion letter were addressed and delivered to such Eligible Assignee on the date hereof.

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This opinion letter speaks only as of the date hereof. We do not assume, and we expressly disclaim, any responsibility to advise any of you or any other person who is permitted to rely on any opinion expressed herein as specified in the next preceding paragraph of any change of law or fact that may occur after the date of this opinion letter even though such change may affect the legal analysis, a legal conclusion or any other matter set forth in or relating to this opinion letter.

This opinion is given pursuant to the Credit Agreement and in connection with the Loan Documents and is not to be relied upon for any other purpose.

Very truly yours,

DEWITT ROSS & STEVENS S.C.

[                                                 ]

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EXHIBIT H

FORM OF OPINION OF

SHEARMAN & STERLING LLP

July 29, 2004

To each of the Lenders listed on

      Schedule I hereto and

      Citibank, N.A.,

      as Administrative Agent

Ambac Financial Group, Inc. and Ambac Assurance Corporation

Ladies and Gentlemen:

This opinion is furnished to you pursuant to Section 3.01(c)(ix) of the Credit Agreement dated as of July 29, 2004 (the “Credit Agreement”), among Ambac Financial Group, Inc. and Ambac Assurance Corporation (the “Borrowers”), the Lenders parties thereto, Barclays Bank PLC, as Syndication Agent, and Citibank, N.A., as Administrative Agent for said Lenders. Terms defined in the Credit Agreement are used herein as therein defined.

We have acted as special New York counsel for the Borrowers in connection with the preparation, execution and delivery of the Credit Agreement.

In that connection, we have examined:

(1) The Credit Agreement.

(2) The documents furnished by each Borrower pursuant to Article III of the Credit Agreement, including the Revolving Credit Notes furnished by each Borrower thereunder on the date hereof (for purposes of this opinion letter, the “Notes”).

We have also examined the originals, or copies certified to our satisfaction, of such certificates of officers of each Borrower and agreements, instruments and other documents, as we have deemed necessary as a basis for the opinions expressed below. As to questions of fact material to such opinions, we have, when relevant facts were not independently established by us, relied upon certificates of each Borrower.

In our examination of the documents, certificates and instruments referred to above, we have assumed the authenticity of all such documents, certificates and instruments submitted to us as originals, the genuineness of all signatures, the due authority of the parties executing such documents, certificates and instruments, and the conformity to authentic originals of all such documents, certificates or instruments submitted to us as copies. We have also assumed, without independent investigation, that (a) each Borrower (i) is a corporation duly organized and validly existing under the laws of the state of its organization and (ii) has full

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power and authority to enter into and perform its obligations under the Credit Agreement and the Notes, (b) the execution, delivery and performance by each Borrower of the Credit Agreement and the Notes have been duly authorized by all necessary board, company, member, manager or officer action and do not violate or contravene any law, rule or regulation applicable to either Borrower or any agreement, instrument or other document binding on or affecting either Borrower or any constituent document of either Borrower, (c) no authorization, approval or other action by, and no notice to or filing with, any governmental authority or regulatory body or any other Person is required for the due execution, delivery or performance by either Borrower of the Credit Agreement or the Notes, or if any such authorization, approval, action, notice or filing is required therefor, it has been duly obtained or made and is in full force and effect, (d) the Credit Agreement has been duly executed and delivered, with all necessary power and authority (corporate and otherwise), by each party thereto, other than the Borrowers, and is the legal, valid and binding obligation of such party, enforceable against such party in accordance with its terms and (e) the Credit Agreement and the Notes have been duly executed and delivered on behalf of each Borrower.

Based upon the foregoing and upon such investigation as we have deemed necessary and subject to the qualifications set forth below, we are of the opinion that the Credit Agreement is, and if an Advance were made, each of the Notes evidencing such Advance would be, the legal, valid and binding obligations of each Borrower, enforceable against each Borrower in accordance with their respective terms.

Our opinion above is subject to the following qualifications:

(a) Our opinion is subject to the effect of any applicable bankruptcy, insolvency, reorganization, moratorium or similar law affecting creditors’ rights generally (including, without limitation, all laws relating to fraudulent transfers).

(b) Our opinion is also subject to the effect of general principles of equity, including, without limitation, concepts of materiality, reasonableness, good faith and fair dealing (regardless of whether considered in a proceeding in equity or at law).

(c) We express no opinion as to the enforceability of the indemnification provisions, or of release or exculpation provisions, set forth in Section 8.04(b) of the Credit Agreement to the extent enforcement thereof is contrary to public policy regarding the indemnification against or release or exculpation of criminal violations, intentional harm or acts of gross negligence or recklessness.

(d) Our opinion is limited to Generally Applicable Law and we do not express any opinion herein concerning any other law. “Generally Applicable Law” means the federal law of the United States of America, and the law of the State of New York (including the rules and regulations promulgated thereunder or pursuant thereto), that a New York lawyer exercising customary professional diligence would reasonably be expected to recognize as being applicable to the

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Credit Agreement and the Notes. Without limiting the generality of the foregoing definition of Generally Applicable Law, the term “Generally Applicable Law” does not include any law, rule or regulation (including, without limitation, any insurance law, rule or regulation) that is applicable to either of the Borrowers or to the Credit Agreement or the Notes solely because of the specific assets or business of any party to the Credit Agreement or the Notes or any of its affiliates.

A copy of this opinion letter may be delivered by each of you to any Eligible Assignee in connection with and at the time of any assignment and delegation by any of you as a Lender to such Eligible Assignee of a portion of your Advances and Commitment in accordance with the provisions of the Credit Agreement, and such Eligible Assignee may rely on the opinion expressed above with respect to the Credit Agreement as if this opinion letter were addressed and delivered to such Eligible Assignee on the date hereof.

This opinion letter is rendered to you in connection with the transactions contemplated by the Credit Agreement. This opinion letter may not be relied upon by you or any other Person who is permitted to rely on the opinion expressed herein as specified in the next preceding paragraph for any other purpose without any prior written consent.

This opinion letter speaks only as of the date hereof. We expressly disclaim any responsibility to advise any of you or any other Person who is permitted to rely on the opinion expressed herein as specified in the second preceding paragraph of any development or circumstance of any kind, including any change of law or fact that may occur after the date of this opinion letter even though such development, circumstance or change may affect the legal analysis, a legal conclusion or any other matter set forth in or relating to this opinion letter.

Very truly yours,

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EXHIBIT I

FORM OF OPINION OF

MILBANK, TWEED, HADLEY & McCLOY LLP

July 29, 2004

Each of the Lenders party to

  the Credit Agreement

  referred to below

Citibank, N.A.,

  as Administrative Agent

  (the “Administrative Agent”)

2 Penns Way

Suite 110

New Castle, DE 19720

Ladies and Gentlemen:

We have acted as special New York counsel to Citibank, N.A., as Administrative Agent in connection with the Revolving Credit Agreement dated as of July 29, 2004 (the “Credit Agreement”) among Ambac Financial Group, Inc., and Ambac Assurance Corporation (collectively, the “Borrowers”), the banks, financial institutions and other institutional lenders party thereto and the Administrative Agent, providing for loans to be made by said lenders to the Borrowers in an initial aggregate principal amount at any one time outstanding not exceeding $300,000,000. Capitalized terms used but not defined herein have the respective meanings given to such terms in the Credit Agreement. This opinion is being delivered pursuant to Section 3.01(c)(xi) of the Credit Agreement.

In rendering the opinions expressed below, we have examined the following agreements, instruments and other documents:

(i) the Credit Agreement; and

(ii) such other documents as we have deemed necessary as a basis for the opinions expressed below.

In our examination, we have assumed the genuineness of all signatures, the authenticity of all documents submitted to us as originals and the conformity with authentic original documents of all documents submitted to us as copies, and we have assumed that all authorizations, approvals or consents of, and all filings and registrations with, any governmental or regulatory authority or agency required for the making and performance by each Borrower of the Credit Agreement have been obtained or made and are in effect. When relevant facts were

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not independently established, we have relied upon representations made in or pursuant to the Credit Agreement.

In rendering the opinions expressed below, we have assumed, with respect to all of the documents referred to in this opinion letter, that:

(i) such documents have been duly authorized by, have been duly executed and delivered by, and (except to the extent set forth below as to the Borrowers) constitute legal, valid, binding and enforceable obligations of, all of the parties to such documents;

(ii) all signatories to such documents have been duly authorized; and

(iii) all of the parties to such documents are duly organized and validly existing and have the power and authority (corporate or other) to execute, deliver and perform such documents.

Based upon and subject to the foregoing and subject also to the comments and qualifications set forth below, and having considered such questions of law as we have deemed necessary as a basis for the opinions expressed below, we are of the opinion that the Credit Agreement constitutes, and each of the Notes, when duly executed and delivered in accordance with the Credit Agreement will constitute, the legal, valid and binding obligation of each Borrower party thereto, enforceable against each such Borrower in accordance with its terms, except as may be limited by bankruptcy, fraudulent conveyance or transfer, insolvency, receivership, conservatorship, reorganization, moratorium or other similar laws relating to or affecting the rights of creditors generally, and except as enforceability is subject to the application of general principles of equity (regardless of whether considered in a proceeding in equity or at law), including, without limitation, (a) the possible unavailability of specific performance, injunctive relief or any other equitable remedy and (b) concepts of materiality, reasonableness, good faith and fair dealing.

The foregoing opinions are subject to the following comments and qualifications:

(A) The enforceability of provisions in the Credit Agreement to the effect that terms may not be waived or modified except in writing may be limited under certain circumstances.

(B) The enforceability of Section 8.04(b) of the Credit Agreement may be limited by (i) laws rendering unenforceable indemnification contrary to Federal or state securities laws and the public policy underlying such laws and (ii) laws limiting the enforceability of provisions exculpating or exempting a party from, or requiring indemnification of a party for, liability for its own action or inaction, to the extent the action or inaction involves gross negligence, recklessness, willful misconduct or unlawful conduct.

(C) We express no opinion as to (i) the effect of the laws of any jurisdiction in which any Lender is located (other than the State of New York) that limit the interest, fees or other charges such Lender may impose, (ii) Section 8.05 of the Credit Agreement or (iii) the first

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sentence of Section 8.12 of the Credit Agreement, insofar as such sentence relates to the subject matter jurisdiction of the United States District Court for the Southern District of New York to adjudicate any controversy related to any of the Loan Documents.

The foregoing opinions are limited to matters involving the Federal laws of the United States and the law of the State of New York, and we do not express any opinion as to the laws of any other jurisdiction.

This opinion letter is provided to you by us in our capacity as special New York counsel to the Administrative Agent pursuant to Section 3.01(c)(xi) of the Credit Agreement and may not be relied upon by any Person for any purpose other than in connection with the transactions contemplated by the Credit Agreement without, in each instance, our prior written consent.

Very truly yours,

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EX-10.34

EXHIBIT 10.34

EMPLOYMENT AGREEMENT

EMPLOYMENT AGREEMENT dated as of July     , 2004 by and between AMBAC FINANCIAL GROUP, INC., a Delaware corporation (the “Company”), and WILLIAM T. McKINNON ( the “Executive”).

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

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

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

1. Employment and Duties.

(a) Term of the Agreement. This Agreement will apply for a non-renewable term beginning on the date this Agreement is signed by both the Executive and the Company and ending on July 30, 2006 (the “Term”). The Executive’s employment may continue beyond the end of the Term, but nothing herein shall require the Executive to continue his employment with the Company after the end of the Term. In addition, nothing in this Agreement shall alter the Executive’s status as an “at will” employee of the Company, subject to the Executive’s rights and obligations under this Agreement.

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

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

2. Relation of this Agreement to Retention Agreement.

The Company and the Executive are parties to an Amended and Restated Management Retention Agreement, dated as of January 27, 2004 (the “Retention Agreement”), that sets forth certain provisions applicable to the Executive’s employment in the event of a “Change in Control” as defined therein. Notwithstanding anything to the contrary in this

Agreement, following a Change in Control, the term of the Executive’s employment, as well as his compensation and benefits, rights upon termination of employment and other matters provided for in the Retention Agreement, shall be governed by the Retention Agreement rather than the present Agreement; provided, however, that promptly following the occurrence of a Change in Control, the Company shall make the payment provided for in Section 3(f) below. Without limiting the generality of the preceding sentence, following a Change in Control: (i) the equity grant provided for in Section 3(c) below shall automatically vest pursuant to the terms of the Retention Agreement; and (ii) the definition of “Cause” set forth in the Retention Agreement shall apply, rather than the definition set forth in this Agreement.

3. Compensation and Other Benefits.

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

(a) Salary. Effective as of the date of this Agreement, the Executive’s annual salary (the “Salary”) shall be $300,000. The Salary is payable in accordance with the Company’s payroll practices as established by the Company from time to time. The Compensation Committee of the Board of Directors (or any successor thereto) (the “Committee”) shall periodically review and may increase, but not decrease, the Executive’s Salary.

(b) Sign-on Bonus. Within ten business days of the execution of this Agreement, the Company will pay the Executive a special cash bonus of $350,000, less applicable withholding taxes.

(c) Special Equity Grant. Management will recommend to the Committee that, in connection with the meetings of the Board of Directors to be held on July 19-20, 2004, the Committee approve a special grant to the Executive of restricted stock units (“RSUs”) under the Company’s 1997 Equity Plan, as amended (the “Equity Plan”). The number of RSUs included in such award will be determined by dividing (i) $250,000 by (ii) the Fair Market Value of a share of the Company’s common stock (the “Common Stock”) on the date the Committee approves such award. All RSUs included in such award will vest on the first anniversary of the end of the Term (that is, on June 30, 2007); provided, however, that if the Executive has remained in continuous employment with the Company through the last day of the Term and subsequently retires from his employment with the Company before the first anniversary of the end of the Term (or if the Company terminates the Executive’s employment without Cause at any time), all such RSUs shall vest as of the effective date of the Executive’s termination of employment. Regardless of when they vest, the RSUs included in the Executive’s award shall be settled by delivery of the corresponding shares of Common Stock to the Executive on the first anniversary of the end of the Term (that is, on June 30, 2007) or as promptly thereafter as practicable, and such settlement shall be subject to the provisions of Section 5(b) below. If the Committee fails to approve the special grant of RSUs provided for in this Section 3(b), then the

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Company shall make a cash grant to the Executive of $250,000, subject to vesting and payment as provided in the preceding two sentences.

(d) Annual Bonus. The Executive shall participate in a bonus arrangement pursuant to which he shall be eligible to earn an annual bonus, based on the Company’s achieving certain performance goals that the Committee shall establish. The Executive’s guaranteed minimum bonus for the 2004 performance year shall be $600,000 and for the 2005 performance year shall be $700,000, which amounts shall be paid regardless of the Company’s performance or results. The amounts specified in the preceding sentence are minimum guaranteed amounts and shall not preclude the Committee from paying the Executive a higher annual bonus for 2004 and/or 2005. The Executive shall have the opportunity, on the same terms and conditions available to the Company’s other senior executives, to defer all or a portion of his annual bonus in the form of restricted stock units. To the extent not so deferred, the Executive’s bonus for each year will be paid at the same time that the Company pays the cash portion of annual bonuses to its other senior executives.

(e) Long-Term Incentive Compensation. The Executive will receive long-term incentive compensation awards under the Equity Plan (or any successor or similar equity plan or program of the Company) as follows: in January 2005, the Company will make awards to the Executive consisting of $200,000 in stock options and $200,000 in RSUs, and in January 2006, the Company will make awards to the Executive consisting of $225,000 in stock options and $225,000 in RSUs. The number of stock options and RSUs corresponding to such amounts and included in such awards will be determined on the same basis that the Committee uses to determine the size of equity awards to the Company’s other senior executives. The Executive’s awards shall be subject to the vesting requirements and other terms and conditions applicable to equity awards made at the same time to the Company’s other senior executives.

(f) End-of-Term Bonus. Within 10 business days of the end of the Term, the Company will pay the Executive an additional special cash bonus of $300,000, less applicable withholding taxes, but only if the Executive has remained in continuous employment with the Company through the last day of the Term (or if the Company has terminated the Executive’s employment without Cause prior to the end of the Term).

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

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

(i) Termination Due to Death or Disability. In the event of the Executive’s Disability, the Company shall be entitled to terminate his employment. Notwithstanding anything contained in this Agreement to the contrary, if the Executive’s employment terminates before the end of the Term due to death or Disability, any Salary earned by the Executive up to the date of such termination, plus a pro rata portion (based on the number of days elapsed prior to such termination or resignation) of his guaranteed bonus and long-term incentive

Page 3 of 10

compensation (which, at the Company’s discretion can be paid in cash or RSUs/options) for the year in which such termination occurs, shall be paid to the Executive or his estate, as the case may be, within 30 days of his termination date. All stock options, restricted stock, restricted stock units or other awards awarded to the Executive under the Equity Plan or any other equity compensation plan of the Company (including without limitation the awards provided for in Sections 3(c) and 3(e) above) shall be fully vested as of the date of the Executive’s death or termination of employment due to Disability.

(j) Continuation at the End of the Term. If the Executive’s employment with the Company continues “at will” following the expiration of the Term, then, during the twelve month period following the expiration of the Term, the Executive’s annual rate of Salary will not be less than the annual rate of Salary in effect for him immediately prior to the expiration of the Term, and his annual bonus target (subject to the achievement of applicable performance objectives and continued employment through the end of the performance period) will be no less favorable to him then the annual performance bonus paid to the Executive in January 2006. In addition, during the period noted in this paragraph 3(c), the Executive will also continue to be eligible to participate in the long-term incentive programs of the Company, as in effect from time to time, in a manner commensurate with the participation of other similarly situated employees of the Company and the Company’s then current practices and valuation methodologies regarding long-term incentives. For the period noted in this paragraph 3(c), the long-term incentive award to be granted in January 2007 will have a value of at least $650,000.

4. Protection of the Company’s Interests.

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

(b) Other Covenants. In consideration of the Company’s undertakings and agreements herein and subject to the election provisions in Section 4(c), the Executive agrees that for the period beginning on the date of this Agreement and continuing through the first anniversary of the last day of the Term (that is, through July 30, 2007), he will not engage in Competition and will not make any Wrongful Solicitation. For the avoidance of doubt, the prohibitions referred to herein end on July 30, 2007.

(c) Company’s Election to End the Competition Covenant. If the Company terminates the Executive’s employment on the last day of the Term or at any time thereafter but prior to July 30, 2007, as a result of the Company’s decision not to continue his employment (other than for Cause) or the Executive terminates his employment for any reason as of the last day of the Term or at any time thereafter but prior to July 30, 2007, then the Executive’s covenant not to engage in Competition shall apply only if (i) the Company continues to pay the Executive for and on regular payroll period during the Election Period (as hereinafter defined) his Salary (at the annual rate in effect immediately prior to the date of such termination of employment) and (ii) an additional monthly amount for each month in the Election Period an

Page 4 of 10

amount equal to 1/12^th of the average annual bonus paid to the executive for the two annual performance periods ended prior to the date of such termination of employment (collectively, the “Continuation Payments”). “Election Period” shall mean the period beginning on the day following the date of the Executive’s termination of employment under circumstances described in the previous sentence and ending on the earlier of (i) July 30, 2007 and (ii) the last day of the month in which the Company delivers to the Executive written notice of its decision to terminate the Election Period. If the Company delivers the notice described in clause (ii) of the previous sentence, the Executive will have no further obligation not to engage in Competition, and the Company will have no further obligation to make the Continuation Payments, following the expiration of the Election Period. For the avoidance of doubt, this Section 4(c) does not apply to the Executive’s obligation not to engage in Wrongful Solicitation.

5. Remedies.

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

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

(x) the Executive voluntarily terminates his employment with the Company and its Subsidiaries before the end of the Term;

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

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

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

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

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

Page 5 of 10

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

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

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

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

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

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

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

“Cause” means any of the following:

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

Page 6 of 10

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

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

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

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

“Competitor” means the following entities:

• Financial Guaranty Insurance Company (“FGIC”);

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

• MBIA Insurance Corporation (“MBIA”);

• XL Capital Assurance, Inc. (“XL”); and

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

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

“Disability” shall be defined in the same manner as such term or a similar term is defined in any long-term disability policy maintained by the Company which covers the Executive and is in effect on the date of the Executive’s termination of employment with

Page 7 of 10

the Company. Any dispute as to whether or not the Executive is disabled within the meaning of the preceding sentence shall be resolved by the Company’s long-term disability carrier.

“Fair Market Value” means, with respect to the Company’s Common Stock, the average of the highest and the lowest quoted selling price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange for the relevant date of determination (or if such prices are not provided for the relevant date of determination, then the average of such prices for the most recent day for which such prices are reported).

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

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

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

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

7. General Provisions.

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

To the Company:	Ambac Financial Group, Inc.
	One State Street Plaza
	New York, NY 10004
	Attention: General Counsel

Page 8 of 10

To the Executive: at the address indicated on the signature page hereof or to such other person or other address as either party may specify to the other in writing.

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

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

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

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

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

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

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

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

[Signature Page Follows]

Page 9 of 10

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

AMBAC FINANCIAL GROUP, INC.
By:
	Name: Robert J. Genader
	Title: President and Chief Executive Officer

EXECUTIVE

William T. McKinnon

Address:

Page 10 of 10

EX-31.1

EXHIBIT 31.1

Ambac Financial Group, Inc.

Certifications

I, Robert J. Genader, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Ambac Financial Group, Inc;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - -15(e) and 15d – 15(e)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

	By:	/s/ Robert J. Genader
		Robert J. Genader
		Chief Executive Officer and President
Date: August 9, 2004

EX-31.2

EXHIBIT 31.2

Ambac Financial Group, Inc.

Certifications

I, Thomas J. Gandolfo, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Ambac Financial Group, Inc;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15(e) and 15d – 15(e)) for the registrant and have:

a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

	By:	/s/ Thomas J. Gandolfo
		Thomas J. Gandolfo
		Senior Vice President and Chief Financial Officer
Date: August 9, 2004

EX-32.1

EXHIBIT 32.1

Certification of CEO Pursuant to

18 U.S.C. Section 1350,

as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Ambac Financial Group, Inc. (the “Company”) for the period ended June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Robert J. Genader, as Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Robert J. Genader

Name: Robert J. Genader

Title:   Chief Executive Officer and President

Date:   August 9, 2004

EX-32.2

EXHIBIT 32.2

Certification of CFO Pursuant to

18 U.S.C. Section 1350,

as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Ambac Financial Group, Inc. (the “Company”) for the period ended June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Thomas J. Gandolfo, as Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Thomas J. Gandolfo

Name: Thomas J. Gandolfo

Title:   Senior Vice President and Chief Financial Officer

Date:   August 9, 2004

EX-99.05

EXHIBIT 99.05

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

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

Consolidated Unaudited Financial Statements

As of June 30, 2004 and December 31, 2003

and for the Three and Six Months Ended June 30, 2004 and 2003

Ambac Assurance Corporation and Subsidiaries

Consolidated Balance Sheets

June 30, 2004 and December 31, 2003

(Dollars in Thousands Except Share Data)

	June 30, 2004		December 31, 2003
	(unaudited)
ASSETS
Investments:
Fixed income securities, at fair value (amortized cost of $7,753,794 in 2004 and $7,008,810 in 2003)	$	7,897,157	$	7,378,291
Short-term investments, at cost (approximates fair value)		180,603		213,716
Other (cost of $3,529 in 2004 and $3,508 in 2003)		3,468		3,311
Total investments		8,081,228		7,595,318
Cash		26,996		18,260
Securities purchased under agreements to resell		144,750		138,795
Receivable for securities sold		143,792		81
Investment income due and accrued		97,192		98,589
Reinsurance recoverable on paid and unpaid losses		2,183		3,030
Prepaid reinsurance		290,234		325,461
Deferred acquisition costs		190,299		175,296
Derivative product assets		978,679		1,146,408
Variable interest entity		150,779		189,482
Other assets		59,655		42,516
Total assets	$	10,165,787	$	9,733,236
LIABILITIES AND STOCKHOLDER’S EQUITY
Liabilities:
Unearned premiums	$	2,733,305	$	2,553,214
Loss and loss expense reserves		238,091		189,414
Ceded reinsurance balances payable		23,134		15,383
Obligations under payment agreements		249,810		249,810
Deferred income taxes		159,364		232,790
Current income taxes		61,500		38,972
Notes payable to affiliate		90,250		84,280
Payable for securities purchased		262,155		2,830
Derivative product liabilities		900,984		1,088,126
Variable interest entity		150,779		189,482
Other liabilities		206,499		189,750
Total liabilities		5,075,871		4,834,051
Stockholder’s equity:
Preferred stock, par value $1,000 per share; authorized shares - 285,000; issued and outstanding shares - none		—		—
Common stock, par value $2.50 per share; authorized shares - 40,000,000; issued and outstanding shares - 32,800,000 at June 30, 2004 and December 31, 2003		82,000		82,000
Additional paid-in capital		1,157,252		1,144,096
Accumulated other comprehensive income		97,128		243,053
Retained earnings		3,753,536		3,430,036
Total stockholder’s equity		5,089,916		4,899,185
Total liabilities and stockholder’s equity	$	10,165,787	$	9,733,236

See accompanying Notes to Consolidated Unaudited Financial Statements.

1

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

For The Three and Six Months Ended June 30, 2004 and 2003

(Dollars in Thousands)

	Three Months Ended June 30,					Six Months Ended June 30,
	2004		2003			2004			2003
Revenues:
Financial Guarantee:
Gross premiums written	$	363,254	$	386,227		$	591,003		$	587,636
Ceded premiums written		15,949		(42,313	)		(17,937	)		(73,481	)
Net premiums written	$	379,203	$	343,914		$	573,066		$	514,155
Net premiums earned	$	190,906	$	153,367		$	358,136		$	289,959
Other credit enhancement fees		11,809		12,294			23,245			22,658
Net premiums earned and other credit enhancement fees		202,715		165,661			381,381			312,617
Net investment income		88,081		79,892			174,785			156,487
Net realized investment gains		3,294		12,777			15,165			26,720
Net mark-to-market gains (losses) on credit derivative contracts		3,256		10,002			10,218			(2,174	)
Variable interest entity		839		—			1,900			—
Other income		500		1,853			1,829			2,679
Financial Services:
Interest from payment agreements		3,016		3,026			6,032			6,027
Other revenue		7,715		(9,470	)		15,098			(3,907	)
Total revenues		309,416		263,741			606,408			498,449
Expenses:
Financial Guarantee:
Loss and loss expenses		17,500		10,900			35,000			20,700
Underwriting and operating expenses		29,246		19,935			54,900			42,532
Variable interest entity		701		—			1,605			—
Interest expense		28		127			59			305
Financial Services:
Interest from payment agreements		834		899			1,604			1,924
Other expenses		1,783		931			3,455			2,509
Total expenses		50,092		32,792			96,623			67,970
Income before income taxes		259,324		230,949			509,785			430,479
Provision for income taxes		69,021		61,847			134,785			113,118
Net income	$	190,303	$	169,102		$	375,000		$	317,361

See accompanying Notes to Consolidated Unaudited Financial Statements.

2

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Stockholder’s Equity

(Unaudited)

For The Six Months Ended June 30, 2004 and 2003

(Dollars in Thousands)

	2004						2003
Retained Earnings:
Balance at January 1	$	3,430,036					$	2,848,481
Net income		375,000		$	375,000			317,361		$	317,361
Dividends declared - common stock		(51,500	)					(44,800	)
Balance at June 30	$	3,753,536					$	3,121,042
Accumulated Other Comprehensive Income:
Balance at January 1	$	243,053					$	231,436
Unrealized (losses) gains on securities, ($225,760) and $118,908, pre-tax, in 2004 and 2003, respectively (1)					(146,740	)					77,290
Foreign currency translation gain					815						534
Other comprehensive (loss) income		(145,925	)		(145,925	)		77,824			77,824
Comprehensive income				$	229,075					$	395,185
Balance at June 30	$	97,128					$	309,260
Preferred Stock:
Balance at January 1 and June 30	$	—					$	—
Common Stock:
Balance at January 1 and June 30	$	82,000					$	82,000
Additional Paid-in Capital:
Balance at January 1	$	1,144,096					$	920,146
Capital contribution		—						75,000
Capital issuance costs		(2,158	)					(2,471	)
Employee benefit plans		15,314						10,191
Balance at June 30	$	1,157,252					$	1,002,866
Total Stockholder’s Equity at June 30	$	5,089,916					$	4,515,168
(1) Disclosure of reclassification amount:
Unrealized holding (losses) gains arising during period	$	(137,095	)				$	103,961
Less: reclassification adjustment for net securities gains included in net income		9,645						26,671
Net unrealized (losses) gains on securities	$	(146,740	)				$	77,290

See accompanying Notes to Consolidated Unaudited Financial Statements

3

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

For The Six Months Ended June 30, 2004 and 2003

(Dollars in Thousands)

	Six Months Ended June 30,
	2004			2003
Cash flows from operating activities:
Net income	$	375,000		$	317,361
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,443			1,395
Amortization of bond premium and discount		3,916			179
Current income taxes		22,528			(18,031	)
Deferred income taxes		5,591			1,048
Deferred acquisition costs		(15,003	)		(591	)
Unearned premiums, net		215,318			224,860
Loss and loss expenses		49,524			10,533
Ceded reinsurance balances payable		7,751			(1,896	)
Net realized investment gains		(15,165	)		(26,720	)
Mark-to-market (gains) losses on credit derivative contracts		(10,218	)		2,174
Other, net		(39,395	)		47,932
Net cash provided by operating activities		601,290			558,244
Cash flows from investing activities:
Proceeds from sales of bonds		724,886			586,760
Proceeds from maturities of bonds		212,230			284,471
Purchases of bonds		(1,554,409	)		(1,408,112	)
Change in short-term investments		33,113			20,061
Securities purchased under agreements to resell		(5,955	)		(10,605	)
Other, net		8,593			(3,691	)
Net cash used in investing activities		(581,542	)		(531,116	)
Cash flows from financing activities:
Dividends paid		(51,500	)		(44,800	)
Capital contribution		—			75,000
Capital issuance costs		(2,158	)		(2,471	)
Payment agreements		—			(724	)
Net cash collateral received		36,676			—
Long-term financing from affilates, net		—			(31,600	)
Short-term financing from affilates, net		5,970			(23,190	)
Net cash used in financing activities		(11,012	)		(27,785	)
Net cash flow		8,736			(657	)
Cash at January 1		18,260			15,876
Cash at June 30	$	26,996		$	15,219
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes	$	82,170		$	112,000
Interest expense on affiliate financings	$	60		$	305
Interest expense on payment agreements	$	904		$	1,116

See accompanying Notes to Consolidated Unaudited Financial Statements.

4

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements

(Dollars in thousands)

(1) Background and Basis of Presentation

Ambac Assurance Corporation is a leading provider of financial guarantees to clients in both the public and private sectors around the world. Ambac Assurance provides financial guarantees on public finance and structured finance obligations. Ambac Assurance has earned triple-A ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, Fitch, Inc., and Rating and Investment Information, Inc. Insurance policies insured by Ambac Assurance guarantee payment when due of the principal of and interest on the obligation guaranteed. Ambac Assurance is a wholly owned subsidiary of Ambac Financial Group, Inc, a holding company whose subsidiaries provide financial guarantees and financial services to clients in both the public and private sectors around the world. As of June 30, 2004, Ambac Assurance’s net guarantees in force (principal and interest) were $652,024,839.

Ambac Assurance UK Limited, which is authorized to conduct certain classes of general financial guarantee business in the United Kingdom, has been Ambac Assurance’s primary vehicle for directly issuing financial guarantee policies in Europe. Ambac UK has entered into net worth maintenance and reinsurance agreements with Ambac Assurance, which support its triple-A ratings. Ambac UK is subject to regulation by the Financial Services Authority (“FSA”) in the conduct of its insurance business.

Ambac Credit Products LLC, a wholly owned subsidiary of Ambac Assurance, provides credit protection in the global markets in the form of structured credit derivatives. These structured credit derivatives, which are privately negotiated contracts, provide the counterparty with credit protection against the occurrence of a specific event such as a payment default or bankruptcy relating to an underlying obligation (generally a fixed income obligation). Upon a credit event, Ambac is required to either (i) purchase the underlying obligation at its par value and realize a loss for the difference between the par and market value of the underlying obligation or (ii), make a payment equivalent to the difference between the par value and market value of the underlying obligation. Substantially all of Ambac’s structured credit derivative contracts are partially hedged with various financial institutions or structured with first loss protection. Structured credit derivatives issued by Ambac Credit Products are insured by Ambac Assurance.

Ambac Assurance, through its affiliate Ambac Financial Services, is a provider of interest rate swaps to states, municipalities and their authorities, and other entities in connection with their financings. The interest rate swaps provided by Ambac Financial Services are guaranteed by Ambac Assurance through policies that guarantee the obligations of Ambac Financial Services and its counterparties. Ambac Assurance, through its subsidiary Ambac Capital Services, enters into total return swaps with professional counterparties. Total return swaps are only used for fixed income obligations, which meet Ambac Assurance’s credit underwriting criteria.

The accompanying consolidated unaudited interim financial statements have been prepared on the basis of accounting principles generally accepted in the United States of America

5

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

(Dollars in thousands)

(“GAAP”) and, in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of Ambac Assurance’s financial condition, results of operations and cash flows for the periods presented. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported revenues and expenses during the reporting period. Actual results could differ from those estimates. The results of operations for the three and six months ended June 30, 2004 may not be indicative of the results that may be expected for the full year ending December 31, 2004. These consolidated financial statements and notes should be read in conjunction with the financial statements and notes included in (i) the audited consolidated financial statements of Ambac Assurance and subsidiaries as of December 31, 2003 and 2002, and for each of the years in the three-year period ended December 31, 2003 which was filed with the Securities and Exchange Commission on March 15, 2004 as Exhibit 99.01 to Ambac Financial Group Inc.’s Form 10-K and (ii) the unaudited consolidated financial statements of Ambac Assurance and subsidiaries as of March 31, 2004, which was filed with the SEC on May 10, 2004 as Exhibit 99.03 to Ambac Financial Group’s 10-Q for the quarterly period ended March 31, 2004.

The consolidated financial statements include the accounts of Ambac Assurance, its subsidiaries and a variable interest entity for which Ambac Assurance is the primary beneficiary. All significant intercompany balances have been eliminated.

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

(2) Special Purpose and Variable Interest Entities

In January 2003, the Financial Accounting Standards Board (“FASB”) released FASB Interpretation No. 46 “Consolidation of Variable Interest Entities” (“FIN 46”). In December 2003, the FASB released a revision of FIN 46 (“FIN 46-R”), which includes substantial changes from the original FIN 46. Ambac adopted FIN 46-R as of December 31, 2003. FIN 46 and FIN 46-R provides accounting and disclosure rules for determining whether certain entities should be consolidated in Ambac Assurance’s consolidated financial statements. An entity is subject to FIN 46 and FIN 46-R, and is called a Variable Interest Entity (“VIE”), if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support or (ii) equity investors that cannot make significant decisions about the entity’s operations or that do not absorb the expected losses or receive the expected returns of the entity. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE or both. FIN 46 requires disclosures for companies that have either a primary or significant variable interest in a VIE. All other entities not considered VIEs are evaluated for consolidation under SFAS No. 94, “Consolidation of all Majority-Owned Subsidiaries”.

6

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

(Dollars in thousands)

Ambac Financial Group has involvement with special purpose entities, including VIEs in two ways. First, Ambac Assurance is a provider of financial guarantee insurance for various securitized asset-backed debt obligations, including mortgage-backed security obligations, collateralized debt obligations (“CDO”) and other asset-backed securitization obligations. Second, Ambac Financial Group has sponsored two special purpose entities that issue medium-term notes (“MTNs”) to fund the purchase of certain financial assets. As discussed in detail below, these Ambac Financial Group sponsored special purpose entities are considered Qualifying Special Purpose Entities (“QSPEs”).

Financial Guarantees:

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

Ambac Assurance is the primary beneficiary of one VIE with assets and liabilities of $150,779 at June 30, 2004 and $189,482 at December 31, 2003. Ambac Assurance consolidated this entity since the structural financial protections are outside the VIE. This VIE is a bankruptcy remote special purpose financing entity created to facilitate the sale of floating rate notes. This VIE was capitalized in 2002 through the issuance of $299,600 of floating rate notes, guaranteed by Ambac Assurance. The proceeds of the VIE note issuance were used to purchase senior mortgage-backed floating rate notes of a Korean mortgage-backed security Issuer. Ambac Assurance’s creditors do not have rights with regards to the assets of the VIE. Protections afforded Ambac Assurance in this transaction were in the form of a reserve fund and first loss protection through subordinated debt issued of approximately $40,000. Ambac Assurance will pay claims under its financial guarantee only in the event that losses on the mortgage assets of the Korean issuer reduce the reserve fund to zero and exceed the principal amount of the subordinated notes.

7

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

(Dollars in thousands)

The following table provides supplemental information about assets and liabilities associated with this entity under the balance sheet caption “Variable interest entity”:

	At June 30, 2004		At December 31, 2003
Assets:
Cash	$	199	$	90
Investment in mortgage-backed security		150,357		189,151
Investment income due and accrued		223		241
Total	$	150,779	$	189,482
Liabilities:
Floating rate notes payable	$	150,357	$	189,151
Accrued interest payable		183		294
Other		239		37
Total	$	150,779	$	189,482

Qualified Special Purpose Entities:

Ambac Financial Group has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with Statement of Financial Accounting Standards 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”). QSPEs are not subject to the requirements of FIN 46-R and accordingly are not consolidated in Ambac Financial Group’s or Ambac Assurance’s financial statements. However, see the discussion below on the Exposure Draft issued by the FASB that could change the accounting rules for QSPEs in the future. The QSPEs are legal entities that are demonstrably distinct from Ambac Financial Group. Ambac Financial Group, its affiliates or its agents cannot unilaterally dissolve the QSPEs. The QSPEs permitted activities are limited to those outlined below.

As of June 30, 2004, there have been 14 individual transactions (1 in 2004) processed through the QSPEs of which 10 are outstanding. In each case, Ambac Financial Group sells fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPE and the absence of any agreement or obligation for Ambac Financial Group to repurchase or redeem assets of the QSPE. The purchase by the QSPE is financed through the issuance of MTNs, which are collateralized by the purchased assets. The cash flows of the MTNs approximately match the cash flows of the assets purchased. Derivative contracts (interest rate and currency swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are contractually limited to purchasing assets from Ambac Financial Group, issuing MTNs to fund such purchase, executing derivative hedges and related administrative services. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued or both. As of June 30, 2004, Ambac Assurance had financial guarantee insurance policies issued for all assets and MTNs owned and outstanding by the QSPEs.

Ambac Assurance’s exposures under these financial guarantee insurance policies as of December 31, 2003 is included in the disclosure in Note 10 “Guarantees in Force” of Ambac

8

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

(Dollars in thousands)

Assurance’s 2003 Annual Report. Pursuant to the terms of Ambac Assurance’s insurance policy, insurance premiums are paid to Ambac Assurance by the QSPEs and are earned in a manner consistent with other insurance policies, over the risk period. Any losses incurred would be included in Ambac Assurance’s Consolidated Statements of Operations. Under the terms of an Administrative Agency Agreement, Ambac Financial Group provides certain administrative duties, primarily collecting amounts due on the obligations and making interest payments on the MTNs.

Assets sold to the QSPEs during the six months ended June 30, 2004 and the year ended December 31, 2003 were $195,000 and $250,000, respectively. No gains or losses were recognized on these sales. As of June 30, 2004, the estimated fair value of financial assets, MTN liabilities and derivative hedge liabilities were $1,868,368, $1,759,178 and $88,509, respectively. When market quotes are not available, estimated fair value is determined utilizing valuation models. These models include estimates, made by Ambac Financial Group management, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $2,838 and $5,278 for the six months ended June 30, 2004 and the year ended December 31, 2003, respectively. Ambac Financial Group also received fees for providing other services amounting to $197 and $461 for the six months ended June 30, 2004 and the year ended December 31, 2003, respectively.

In June 2003, the FASB issued an Exposure Draft for proposed Statement of Financial Accounting Standards entitled “Qualifying Special-Purposes Entities and Isolation of Transferred Assets”, an amendment of FASB Statement No. 140 (“The Exposure Draft”). The Exposure Draft is a proposal that is subject to change and as such, is not yet authoritative. If the proposal is enacted in its current form, it will amend and clarify SFAS 140. The Exposure Draft would prohibit an entity from being a QSPE if it enters into an agreement that obligates a transferor of financial assets, its affiliates, or its agents to deliver additional cash or other assets to fulfill the SPE’s obligations to beneficial interest holders. If this Exposure Draft becomes enacted as currently proposed and if the QSPEs issue new beneficial interests after the effective date and receive assets other than those they are committed to receive under commitments to beneficial interest holders made before the effective date of the final Statement, management believes Ambac Assurance would be required to consolidate. This conclusion is based upon the fact that Ambac Assurance and Ambac Financial Group provide financial support to these entities such as financial guarantees and liquidity commitments. Should Ambac Assurance be required to consolidate under this Exposure Draft if enacted as proposed, the financial statement impact would be to gross up Ambac Assurance’s consolidated balance sheet for the assets and liabilities held by the QSPEs that approximate $1,800,000 at June 30, 2004. Additionally, fees received by both Ambac Assurance and Ambac Financial Group from the QSPEs (primarily insurance premiums) would be eliminated in consolidation and essentially reclassified to net interest income. The risk characteristics of these transactions are not impacted by consolidation.

9

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

(Dollars in thousands)

(3) Segment Information

Ambac Assurance has two reportable segments, as follows: (1) financial guarantee, which provides financial guarantee products (including structured credit derivatives) for public finance and structured finance obligations; and (2) financial services, which provides payment agreements, interest rate and total return swaps.

Ambac Assurance’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different marketing strategies, personnel skill sets and technology.

Pursuant to insurance and indemnity agreements between Ambac Financial Services and Ambac Assurance, Ambac Financial Services’ payment obligations under its swap agreements are guaranteed by Ambac Assurance. Additionally, the payment obligations of Ambac Financial Services’ counterparties, under their swap agreements with Ambac Financial Services, are guaranteed by Ambac Assurance pursuant to insurance and indemnity agreements. Intersegment revenues include the premiums earned under those agreements. Such premiums are accounted for as if they were premiums to third parties, that is, at current market prices. In the three and six months ended June 30, 2004, Financial Guarantee revenues include dividends of $4,500 and $8,558, respectively, from the Financial Services segment.

10

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

(Dollars in thousands)

The following tables summarizes the financial information by reportable segment as of and for the three and six months ended June 30, 2004 and 2003:

(Dollars in thousands) Three months ended June 30,	Financial Guarantee		Financial Services			Intersegment Eliminations			Consolidated
2004:
Revenues:
External customers	$	298,685	$	10,731		$	—		$	309,416
Intersegment		5,040		—			(5,040	)		—
Total revenues	$	303,725	$	10,731		$	(5,040	)	$	309,416
Income before income taxes:
External customers	$	251,210	$	8,114		$	—		$	259,324
Intersegment		5,486		(986	)		(4,500	)		—
Total income before income taxes	$	256,696	$	7,128		$	(4,500	)	$	259,324
Identifiable assets	$	8,791,545	$	1,374,242		$	—		$	10,165,787
2003:
Revenues:
External customers	$	270,185	$	(6,444	)	$	—		$	263,741
Intersegment		534		—			(534	)		—
Total revenues	$	270,719	$	(6,444	)	$	(534	)	$	263,741
Income before income taxes:
External customers	$	239,223	$	(8,274	)	$	—		$	230,949
Intersegment		534		(534	)		—			—
Total income before income taxes	$	239,757	$	(8,808	)	$	—		$	230,949
Identifiable assets	$	7,764,124	$	1,421,301		$	—		$	9,185,425

(Dollars in thousands) Six months ended June 30,	Financial Guarantee		Financial Services			Intersegment Eliminations			Consolidated
2004:
Revenues:
External customers	$	585,278	$	21,130		$	—		$	606,408
Intersegment		9,715		—			(9,715	)		—
Total revenues	$	594,993	$	21,130		$	(9,715	)	$	606,408
Income before income taxes:
External customers	$	493,714	$	16,071		$	—		$	509,785
Intersegment		10,608		(2,050	)		(8,558	)		—
Total income before income taxes	$	504,322	$	14,021		$	(8,558	)	$	509,785
Identifiable assets	$	8,791,545	$	1,374,242		$	—		$	10,165,787
2003:
Revenues:
External customers	$	496,329	$	2,120		$	—		$	498,449
Intersegment		1,153		—			(1,153	)		—
Total revenues	$	497,482	$	2,120		$	(1,153	)	$	498,449
Income before income taxes:
External customers	$	432,792	$	(2,313	)	$	—		$	430,479
Intersegment		1,153		(1,153	)		—			—
Total income before income taxes	$	433,945	$	(3,466	)	$	—		$	430,479
Identifiable assets	$	7,764,124	$	1,421,301		$	—		$	9,185,425

11

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

(Dollars in thousands)

The following table summarizes unaffiliated gross premiums written and net premiums earned and other credit enhancement fees included in the financial guarantee segment by location of risk for the three and six months ended June 30, 2004 and 2003:

(Dollars in thousands)	Three Months				Six Months
	Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees		Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees
2004:
United States	$	306,072	$	147,332	$	481,216	$	274,934
United Kingdom		25,525		16,552		53,830		30,805
Japan		6,581		7,731		13,515		15,211
Italy		6,207		1,929		7,619		3,876
Mexico		3,774		1,732		7,731		3,548
Australia		687		2,115		924		3,534
Germany		519		1,510		1,100		3,182
Internationally diversified (1)		7,581		15,228		13,835		28,534
Other international		6,308		8,586		11,233		17,757
Total	$	363,254	$	202,715	$	591,003	$	381,381
2003:
United States	$	286,752	$	123,841	$	444,382	$	232,149
United Kingdom		66,590		7,354		79,031		14,664
Japan		6,576		6,683		13,168		12,301
Italy		5,860		1,403		9,035		2,803
Mexico		3,614		1,754		7,969		3,761
Australia		194		1,378		4,347		2,712
Germany		390		1,493		822		2,879
Internationally diversified (1)		9,519		15,417		16,012		29,275
Other international		6,732		6,338		12,870		12,073
Total	$	386,227	$	165,661	$	587,636	$	312,617

1) Internationally diversified includes guarantees with multiple locations of risk and includes components of United States exposure.

(4) Stock Options

Ambac Financial Group sponsors the “1997 Equity Plan”, where awards are granted to eligible employees in the form of non-qualified stock options or other stock-based awards. Prior to 2003, Ambac Financial Group accounted for such awards under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees”. Effective January 1, 2003, Ambac Financial Group adopted the fair value recognition provisions of FAS Statement No. 123, “Accounting for Stock-Based Compensation”, prospectively to all employee awards granted after January 1, 2003. The impact of the adoption of the fair value method of accounting for stock-based compensation expense to Ambac Assurance was approximately $1,573 and $3,185 for the three and six months ended June 30, 2004, compared to $1,170 and $2,221 for the three and six months ended June 30, 2003, respectively.

12

Ambac Assurance Corporation and Subsidiaries

Notes to Consolidated Unaudited Financial Statements (Continued)

(Dollars in thousands)

(5) Pension and Postretirement Benefits

Pensions:

Ambac Financial Group has a defined benefit pension plan covering substantially all employees of Ambac. The benefits are based on years of service and the employee’s highest salary during five consecutive years of employment within the last ten years of employment. Ambac Financial Group’s funding policy is to contribute annually the maximum amount that can be deducted for Federal income tax purposes. Contributions for 2004 are estimated to be approximately $2,300. Contributions are intended to provide not only for benefits attributed to service-to-date, but also for those expected to be earned in the future.

Ambac Financial Group’s net periodic pension costs for the six months ended June 30 include the following components:

	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Service cost	$	409		$	414		$	817		$	827
Interest cost		332			287			663			575
Expected return on plan assets		(488	)		(416	)		(975	)		(832	)
Amortization of prior service cost		(36	)		(33	)		(72	)		(66	)
Recognized net loss		51			10			102			19
Net periodic pension cost		268			262			535			523
Other		—			—			136			—
Total pension expense	$	268		$	262		$	671		$	523

Pension expense is allocated to each of Ambac Financial Group’s subsidiaries based on percentage of payroll. Pension expense recorded by Ambac Assurance amounted to $257 and $565 for the three and six months ended June 30, 2004, respectively, compared to $204 million and $420 million for the three and six months ended June 30, 2003.

Postretirement and Other Benefits:

Ambac Financial Group provides certain medical and life insurance benefits for retired employees and eligible dependents. All plans are contributory. None of the plans are currently funded. Ambac Assurance’s post retirement benefit expense was $75 and $122 for the three and six months ended June 30, 2004, respectively, compared to $34 million and $70 million for the three and six months ended June 30, 2003, respectively.

13