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 September 30, 2007

¨ 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act): (Check one):

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

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

As of November 2, 2007, 101,549,736 shares of Common Stock, par value $0.01 per share, (net of 7,643,360 treasury shares) of the Registrant were outstanding.

Ambac Financial Group, Inc. and Subsidiaries

INDEX

		PAGE
PART I     FINANCIAL INFORMATION
Item 1.	Financial Statements of Ambac Financial Group, Inc. and Subsidiaries
	Consolidated Balance Sheets – September 30, 2007 (unaudited) and December 31, 2006	3
	Consolidated Statements of Operations (unaudited) – three and nine months ended September 30, 2007 and 2006 Ended September 30, 2001 and 2000	4
	Consolidated Statements of Stockholders’ Equity (unaudited) – nine months ended September 30, 2007 and 2006	5
	Consolidated Statements of Cash Flows (unaudited) – nine months ended September 30, 2007 and 2006	6
	Notes to Unaudited Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	55
Item 4.	Controls and Procedures	60
PART II     OTHER INFORMATION
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	61
Item 6.	Exhibits	62
SIGNATURES		63
INDEX TO EXHIBITS		64

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

September 30, 2007 and December 31, 2006

(Dollars in Thousands)

	September 30, 2007			December 31, 2006
	(unaudited)
Assets
Investments:
Fixed income securities, at fair value (amortized cost of $17,899,842 in 2007 and $16,484,257 in 2006)	$	17,984,060		$	16,800,338
Fixed income securities pledged as collateral, at fair value (amortized cost of $346,770 in 2007 and $311,546 in 2006)		360,799			307,101
Short-term investments, at cost (approximates fair value)		686,133			311,759
Other (cost of $13,482 in 2007 and $13,427 in 2006)		14,787			14,391
Total investments		19,045,779			17,433,589
Cash		26,814			31,868
Securities purchased under agreements to resell		—			273,000
Receivable for securities sold		97,816			12,857
Investment income due and accrued		175,215			193,199
Reinsurance recoverable on paid and unpaid losses		10,406			3,921
Prepaid reinsurance		332,373			315,498
Deferred taxes		21,319			—
Deferred acquisition costs		277,619			252,115
Loans		870,637			625,422
Derivative assets		1,000,569			1,019,339
Other assets		122,544			107,005
Total assets	$	21,981,091		$	20,267,813
Liabilities and Stockholders’ Equity
Liabilities:
Unearned premiums	$	3,128,278		$	3,037,544
Loss and loss expense reserve		284,128			220,074
Ceded reinsurance balances payable		24,406			20,084
Obligations under investment and payment agreements		9,135,270			8,202,590
Obligations under investment repurchase agreements		135,524			154,287
Deferred income taxes		—			263,483
Current income taxes		32,312			49,920
Long-term debt		1,669,944			991,804
Accrued interest payable		116,624			105,129
Derivative liabilities		1,451,392			667,066
Other liabilities		322,449			275,670
Payable for securities purchased		30,852			95,973
Total liabilities		16,331,179			14,083,624
Stockholders’ equity:
Preferred stock		—			—
Common stock		1,092			1,092
Additional paid-in capital		836,742			790,168
Accumulated other comprehensive income		71,300			197,576
Retained earnings		5,387,639			5,454,575
Common stock held in treasury at cost		(646,861	)		(259,222	)
Total stockholders’ equity		5,649,912			6,184,189
Total liabilities and stockholders’ equity	$	21,981,091		$	20,267,813

See accompanying Notes to Unaudited Consolidated Financial Statements

3

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

For the Three and Nine Months Ended September 30, 2007 and 2006

(Dollars in Thousands Except Share Data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Revenues:
Financial Guarantee:
Gross premiums written	$	286,585		$	212,335		$	797,636		$	744,893
Ceded premiums written		(35,095	)		(26,351	)		(93,016	)		(75,341	)
Net premiums written	$	251,490		$	185,984		$	704,620		$	669,552
Net premiums earned	$	194,795		$	198,533		$	631,820		$	603,594
Other credit enhancement fees		20,035			16,057			52,920			44,400
Net premiums earned and other credit enhancement fees		214,830			214,590			684,740			647,994
Net investment income		115,825			107,156			341,079			313,345
Net realized investment gains		3,965			1,329			5,286			2,842
Net mark-to-market (losses) gains on credit derivative contracts		(743,379	)		2,572			(805,370	)		9,906
Other (loss) income		(1,291	)		2,952			7,214			35,367
Financial Services:
Investment income		120,603			107,501			334,476			287,484
Derivative products		1,216			2,942			7,286			10,949
Net realized investment gains		198			6,636			6,669			53,867
Net mark-to-market (losses) gains on total return swap contracts		(12,856	)		(501	)		(10,623	)		6,540
Net mark-to-market losses on non-trading derivatives		(1,320	)		(1,175	)		(1,479	)		(1,237	)
Corporate:
Net investment income		1,225			3,545			4,147			9,941
Net realized investment gains		—			—			—			791
Total revenues		(300,984	)		447,547			573,425			1,377,789
Expenses:
Financial Guarantee:
Loss and loss expenses		19,082			(2,543	)		47,600			10,406
Underwriting and operating expenses		34,576			30,186			104,390			99,909
Financial Services:
Interest on investment and payment agreements		112,000			97,126			312,082			262,624
Operating expenses		3,164			3,119			9,569			9,994
Interest		22,232			19,474			63,612			58,424
Corporate		2,857			3,036			9,777			10,679
Total expenses		193,911			150,398			547,030			452,036
(Loss) income before income taxes		(494,895	)		297,149			26,395			925,753
Provision for income taxes		(134,282	)		83,626			628			252,520
Net (loss) income	$	(360,613	)	$	213,523		$	25,767		$	673,233
Net (loss) income per share	$	(3.53	)	$	2.00		$	0.25		$	6.32
Net (loss) income per diluted share	$	(3.53	)	$	1.98		$	0.25		$	6.26
Weighted average number of common shares outstanding:
Basic		102,297,811			106,725,567			103,171,675			106,549,856
Diluted		102,297,811			107,737,122			103,937,780			107,473,723

See accompanying Notes to Unaudited Consolidated Financial Statements

4

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

For The Nine Months Ended September 30, 2007 and 2006

(Dollars in Thousands)

	2007						2006
Retained Earnings:
Balance at January 1	$	5,454,575					$	4,703,256
Net income		25,767		$	25,767			673,233		$	673,233
Dividends declared—common stock		(58,241	)					(50,807	)
Dividends on restricted stock units		(9	)					(633	)
Exercise of stock options		(34,453	)					(49,051	)
Balance at September 30	$	5,387,639					$	5,275,998
Accumulated Other Comprehensive Income:
Balance at January 1	$	197,576					$	202,312
Unrealized losses on securities, ($213,048) and ($15,577), pre-tax in 2007 and 2006, respectively(1)					(123,299	)					(8,369	)
(Loss) gain on derivative hedges, ($10,464) and $1,294, pre-tax in 2007 and 2006, respectively					(6,159	)					723
Foreign currency translation gain					3,182						5,086
Other comprehensive loss		(126,276	)		(126,276	)		(2,560	)		(2,560	)
Comprehensive income				$	(100,509	)				$	670,673
Balance at September 30	$	71,300					$	199,752
Preferred Stock:
Balance at January 1 and September 30	$	—					$	—
Common Stock:
Balance at January 1 and September 30	$	1,092					$	1,092
Additional Paid-in Capital:
Balance at January 1	$	790,168					$	723,680
Share-based compensation		37,357						17,011
Excess tax benefit related to share-based compensation		9,217						15,058
Balance at September 30	$	836,742					$	755,749
Common Stock Held in Treasury at Cost:
Balance at January 1	$	(259,222	)				$	(247,578	)
Cost of shares acquired		(449,386	)					(67,242	)
Shares issued under equity plans		61,747						98,101
Balance at September 30	$	(646,861	)				$	(216,719	)
Total Stockholders’ Equity at September 30	$	5,649,912					$	6,015,872
(1) Disclosure of reclassification amount:
Unrealized holding losses arising during period	$	(120,702	)				$	(7,029	)
Less: reclassification adjustment for net gains included in net income		2,597						1,340
Net unrealized losses on securities	$	(123,299	)				$	(8,369	)

See accompanying Notes to Unaudited Consolidated Financial Statements

5

Ambac Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

For The Nine Months Ended September 30, 2007 and 2006

(Dollars in Thousands)

	Nine Months Ended September 30,
	2007			2006
Cash flows from operating activities:
Net income	$	25,767		$	673,233
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization		2,010			2,127
Amortization of bond premium and discount		1,168			2,644
Share-based compensation		32,320			18,937
Current income taxes		(17,608	)		12,555
Deferred income taxes		(192,464	)		7,927
Deferred acquisition costs		(19,056	)		(15,254	)
Unearned premiums, net		73,859			67,742
Loss and loss expenses		57,569			(26,087	)
Ceded reinsurance balances payable		4,322			(6,782	)
Investment income due and accrued		17,984			(3,740	)
Accrued interest payable		11,495			(446	)
Change in trading account		—			(85,000	)
Net mark-to-market losses (gains)		817,472			(15,209	)
Net realized investment gains		(11,955	)		(57,500	)
Other, net		25,005			96,371
Net cash provided by operating activities		827,888			671,518
Cash flows from investing activities:
Proceeds from sales of bonds		425,394			791,749
Proceeds from matured bonds		1,340,515			1,469,416
Purchases of bonds		(3,361,022	)		(3,936,857	)
Change in short-term investments		(374,374	)		194,271
Securities purchased under agreements to resell		273,000			219,000
Loans, net		(245,215	)		41,016
Recoveries from impaired investments		6,206			50,782
Other, net		(1,956	)		1,013
Net cash used in investing activities		(1,937,452	)		(1,169,610	)
Cash flows from financing activities:
Dividends paid		(58,241	)		(50,807	)
Securities sold under agreements to repurchase		—			57,000
Proceeds from issuance of investment and payment agreements		1,858,172			1,555,439
Payments for investment and payment agreement draws		(1,011,915	)		(1,044,148	)
Proceeds from the issuance of long-term debt		674,030			—
Capital issuance costs		(2,882	)		(2,636	)
Net cash collateral received		58,221			(695	)
Purchases of treasury stock		(449,386	)		(67,242	)
Proceeds from sale of treasury stock		27,294			49,129
Excess tax benefit related to share-based compensation		9,217			15,058
Net cash provided by financing activities		1,104,510			511,098
Net cash flow		(5,054	)		13,006
Cash at January 1		31,868			27,619
Cash at September 30	$	26,814		$	40,625
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Income taxes	$	182,099		$	195,971
Interest on long-term debt	$	57,213		$	55,208
Interest on investment agreements	$	293,191		$	259,016

See accompanying Notes to Unaudited Consolidated Financial Statements

6

Ambac Financial Group, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands, except share amounts)

(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 guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch Inc. Financial guarantee insurance provides an unconditional and irrevocable guarantee that protects the holder of a fixed income obligation against non-payment of principal and interest when due. Essentially, Ambac Assurance makes payment if the obligor responsible for making payments fails to do so. A bond guaranteed by Ambac Assurance receives triple-A ratings, typically resulting in lower financing costs for the issuer and the guarantee generally makes the issue more marketable, both in the primary and secondary markets. Ambac’s financial strength ratings are an essential part of Ambac Assurance’s ability to provide credit enhancement and any reduction in these ratings could have a materially adverse affect on Ambac Assurance’s ability to compete in the financial guarantee business. Ambac Assurance provides financial guarantees for bond issues and other forms of debt financing. As an alternative to financial guarantee insurance, credit protection relating to a particular pool of assets, security or issuer can be provided through a credit derivative. Ambac provides credit protection in the global markets in credit derivative form.

Ambac’s consolidated unaudited interim financial statements have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”) and, in the opinion of management, reflect all 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 nine months ended September 30, 2007 may not be indicative of the results that may be expected for the full year ending December 31, 2007. These consolidated financial statements and notes should be read in conjunction with the financial statements and notes included in (i) Ambac’s Annual Report on Form 10-K for the year ended December 31, 2006, which was filed with the Securities and Exchange Commission on March 1, 2007, (ii) Ambac’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007, which was filed with the SEC on May 10, 2007 and (iii) Ambac’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007, which was filed with the SEC on August 9, 2007.

The consolidated financial statements include the accounts of Ambac and all other entities in which Ambac has a controlling financial interest. All significant intercompany balances have been eliminated. The usual condition for a controlling financial interest is ownership of a majority of the voting interests of an entity. However, a controlling financial interest may also exist in entities, such as variable interest entities (“VIEs”), through arrangements that do not involve controlling voting interests. Certain reclassifications have been made to prior periods’ amounts to conform to the current period’s presentation.

7

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

(2) Net Premiums Earned

Gross premiums are received either upfront (typical of public finance obligations), or in installments (typical of structured finance obligations). Up-front insurance premiums written are received for an entire bond issue, which may contain several maturities; and are recorded as unearned premiums. The premium is allocated to each bond maturity proportionately based on total principal amount guaranteed and is recognized as premiums on a straight-line basis over the term of each maturity. Installment insurance premiums written are recognized as premiums earned over each installment period, typically one year or less, on a straight-line basis. Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. When an issue insured by Ambac Assurance has been refunded or called, the remaining unrecognized premium (net of refunding credits, if any) is recognized at that time.

Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies. For both up-front and installment premiums, ceded premiums written are primarily recognized in earnings in proportion to and at the same time the related gross premium revenue is recognized. Prepaid reinsurance represents the portion of premiums ceded to reinsurers relating to unearned premiums ceded under reinsurance contracts. As discussed in footnote 9, the accounting for premiums earned is subject to change.

(3) Loss and Loss Expenses

The loss reserve policy for financial guarantee insurance discussed in this footnote relates only to Ambac’s non-derivative insurance business. The policy for derivative contracts is discussed in Note (4) “Derivative Contracts”. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. In most instances, claim payments are forecasted in advance of issuer default as a result of active surveillance of the insured book of business and observation of deterioration in the obligor’s credit standing. Based upon Ambac’s experience, claim payments become probable and estimable once the issuer’s credit profile has migrated to certain impaired credit levels. The trustee, on behalf of the insured party, named beneficiary, or custodian has the right to make a claim under Ambac’s financial guarantee insurance policy at the first scheduled debt service date of the defaulted obligation. As discussed in the last paragraph of this Note, the accounting for credit loss reserves is subject to change.

The liability for losses and loss expenses consists of active credit and case basis credit reserves. Active credit reserves are for probable and estimable losses due to credit deterioration on insured credits that have not yet defaulted or been reported and are reflected on an undiscounted basis as of the reporting date. The establishment of reserves for exposures that have not yet defaulted is a common practice in the financial guarantee industry. However, Ambac is aware that there are differences in the specific methodologies applied by other financial guarantors in establishing such reserves. Ambac’s active credit reserve is based on management’s on-going review of the non-derivative financial guarantee credit portfolio.

8

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

Active surveillance of the insured portfolio enables Ambac’s Surveillance Group to track credit migration of insured obligations from period to period and prepare an adversely classified credit listing. The active credit reserve is established only for adversely classified credits. The criteria for an exposure to be included on the adversely classified credit listing includes the deterioration in an issuer’s financial condition, underperformance of the underlying collateral (for collateral dependent transactions such as mortgage-backed securitizations), problems with the servicer of the underlying collateral and other adverse economic events or trends. The servicer of the underlying collateral of an insured securitization transaction is a consideration in assessing credit quality because the servicer’s performance can directly impact the performance of the related issue. For example, a servicer of a mortgage-backed securitization that does not remain current in its collection efforts could cause an increase in the delinquency and potential default of the underlying obligation.

The active credit reserve is established through a process that begins with estimates of probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac’s internal system of credit ratings, which are analogous to the risk ratings of the major rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) the net par outstanding on the adversely classified credit. The loss severities and default information are based on rating agency information and are specific to each bond type and are established and approved by Ambac’s Portfolio Risk Management Committee. The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac. For certain adversely classified credit exposures, Ambac’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities applied to adversely classified credits can include various actions by Ambac. The most common actions include obtaining detailed appraisal information on collateral, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical approach discussed above. Senior management meets at least quarterly with the Surveillance Group to review the status of their work to determine the adequacy of Ambac’s loss reserves and make any necessary adjustments. Active credit reserves were $166,734 and $172,644 at September 30, 2007 and December 31, 2006, respectively. The active credit reserves at September 30, 2007 and December 31, 2006 were comprised of 48 credits with net par of $1,859,994 and 55 credits with net par outstanding of $3,830,759, respectively. Included in the calculation of active credit reserves at September 30, 2007 and December 31, 2006 was the consideration of $13,222 and $6,859, respectively, of reinsurance which would be due to Ambac from reinsurers, upon default of the insured obligation.

Case basis credit reserves are for losses on insured obligations that have defaulted. We believe our definition of case basis credit reserves differs from other financial guarantee industry participants. Upon the occurrence of a payment default, the related active credit reserve is transferred to case basis credit reserve. Additional provisions for losses upon further credit deterioration of a case basis exposure are initially recorded through the active credit reserve and subsequently transferred to case basis credit reserves. Our case reserves represent the present value of anticipated loss and loss expense payments expected over the estimated period of default. Loss and loss expenses consider anticipated defaulted debt service payments, estimated expenses associated with settling the claims and estimated

9

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

recoveries under collateral and subrogation rights. The estimate does not consider future installment premium receipts, as the likelihood of such receipts is remote. Ambac discounts these estimated net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio.

Case basis credit reserves were $117,394 and $47,430 at September 30, 2007 and December 31, 2006, respectively. The discount rate applied to case basis credit reserves was 4.50% at September 30, 2007 and December 31, 2006. The case basis credit reserves at September 30, 2007 and December 31, 2006 were comprised of 10 and 7 credits, respectively, with net par outstanding of $822,054 and $668,440, respectively. Additionally, we have reinsurance recoverables on case basis credit reserves of $10,295 and $4,972 at September 30, 2007 and December 31, 2006, respectively.

Ambac provides information on the classification of its loss reserve between active credit reserve and case basis credit reserve for the purpose of disclosing the components of the total reserve that relate to exposures that have not yet defaulted and those that have defaulted. The total reserve (active credit and case basis) was $284,128 and $220,074 at September 30, 2007 and December 31, 2006, respectively. Due to the relatively small number and large size of certain insured obligations comprising the active and case basis credit reserves, improvements or further deterioration in any one credit may significantly impact our loss provision in a given period. The provision for losses and loss expenses in the accompanying Consolidated Statements of Operations represents the expense recorded to bring the total reserve to a level determined by management to be adequate for losses inherent in the non-derivative financial guarantee insurance portfolio. Ambac’s management believes that the reserves for losses and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.

Our liabilities for credit losses are based in part on the short-duration accounting guidance in SFAS 60, “Accounting and Reporting by Insurance Enterprises.” The trustee (on behalf of the insured party), named beneficiary or custodian has a right to a claim payment under the financial guarantee insurance policy at the date of the first scheduled debt service payment of a defaulted security in the amount equal to the payment shortfall. We believe a loss event occurs for financial guarantee insurance products at the time the issuers’ financial condition deteriorates to an impaired credit status rather than at the time the insured party has a right to a claim payment. Because of this belief and the ambiguities discussed below in the application of SFAS 60 to the financial guarantee industry, Ambac does not believe that SFAS 60 alone provides sufficient guidance. As a result, Ambac supplements the guidance in SFAS 60 with the guidance in SFAS 5, “Accounting for Contingencies,” which calls for a loss to be accrued if it is probable that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. Ambac also relies by analogy on EITF Issue 85-20, “Recognition of Fees for Guaranteeing a Loan,” which states that a guarantor should perform an ongoing assessment of the probability of loss to determine if a liability (and a loss) should be recognized under SFAS 5.

In management’s view, the accounting guidance noted above does not comprehensively address the attributes of financial guarantee insurance contracts, primarily due to the fact that SFAS 60 was developed prior to the maturity of the financial guarantee industry. Financial guarantee contracts have elements of long-duration insurance contracts in that they are generally irrevocable and extend over a period of time that may be 30 years or

10

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

more but are considered and reported for regulatory purposes as property and casualty insurance, normally considered short-duration contracts. The short-duration and long-duration classifications have different methods of accounting for premium revenue, deferred acquisition costs and contract liability recognition.

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

In January and February of 2005, the Securities and Exchange Commission staff discussed with the financial guarantee industry participants differences in loss reserve recognition practices among those participants. In September 2005, the Financial Accounting Standards Board (“FASB”) added a project to its agenda to consider the accounting by financial guarantee insurers for claims liability recognition, premium recognition and deferred acquisition costs. The proposed guidance was issued on April 18, 2007 and the final guidance is expected to be issued in the first quarter of 2008.

(4) Derivative Contracts

SFAS 133 “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS 138, SFAS 149 and SFAS 155, establishes accounting and reporting standards for derivative instruments. All derivatives, whether designated for hedging relationships or not, are required to be recorded on the Consolidated Balance Sheets at fair value. When available, quotes from independent market sources are obtained for market value. However, when quotes are not available, Ambac uses internally developed valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. The valuation results from these models could differ materially from amounts that would actually be realized in the market. In accordance with the Emerging Issues Task Force (EITF) Issue 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (EITF 02-3), recognition of a trading profit or loss at inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating observable market data. Ambac defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. The deferral is recognized in income when the market data becomes observable or over the life of the transaction. The fair value includes an adjustment for counterparty credit risk and other adjustments, as appropriate, to reflect liquidity and ongoing servicing costs.

11

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

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

Derivative Contracts Classified as Held for Trading Purposes:

Financial Guarantee Credit Derivatives:

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

Financial Services Derivative Products:

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

Derivative Contracts used for Non-Trading and Hedging Purposes:

In order to qualify for hedge accounting, a derivative must be considered highly effective at reducing the risk associated with the exposure being hedged. Each derivative must be designated as a hedge, with documentation of the risk management objective and strategy, including identification of the hedging instrument, the hedged item, the risk exposure, and how effectiveness will be assessed prospectively and retrospectively. The extent to which a hedging instrument is effective at achieving offsetting changes in fair values or cash flows must be assessed at least quarterly. Any ineffectiveness must be reported in net income.

Interest rate and currency swaps are utilized to hedge exposure to changes in fair value of assets or liabilities resulting from changes in interest rates and foreign exchange rates, respectively. These interest rate and currency swap hedges are referred to as “fair value” hedges. If the provisions of the derivative contract meet the technical requirements for fair value hedge accounting under SFAS 133, the change in fair value of the derivative contract, excluding accrued interest, is recorded as a component of “Net mark-to-market (losses) on non-trading derivative contracts” in the Consolidated Statements of Operations. The change in fair value of the hedged asset or liability attributable to the hedged risk adjusts the carrying

12

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

amount of the hedged item and is recorded as a component of “Net mark-to-market (losses) on non-trading derivative contracts.” The net amount representing hedge ineffectiveness, recorded in “Net mark-to-market (losses) on non-trading derivative contracts” was ($1,691) and ($1,281) for the three months ended September 30, 2007 and 2006, respectively, and ($1,887) and ($1,113) for the nine months ended September 30, 2007 and 2006, respectively. Changes in the accrued interest component of the derivative contract are recorded as an offset to changes in the accrued interest component of the hedged item.

Interest rate swaps are also utilized by certain of our equity method investees to hedge the exposure to changes in cash flows caused by variable interest rates. These interest rate swap hedges are referred to as “cash flow” hedges. The effective portion of the gains and losses on interest rate swaps that meet the technical requirements for cash flow hedge accounting under SFAS 133 is reported in “Accumulated Other Comprehensive Income” in Stockholders’ Equity. As of September 30, 2007, $1,630 of pre-tax deferred losses on derivative instruments reported in Accumulated Other Comprehensive Income are expected to be reclassified to net income during the next twelve months. Transactions and events expected to occur over the next twelve months that will necessitate reclassifying these derivative losses include the repricing of variable-rate medium-term notes (“MTNs”).

Ambac discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative expires, is sold or terminated. When hedge accounting is discontinued because the derivative no longer qualifies as an effective fair value hedge, Ambac continues to carry the derivative on the balance sheet at its fair value. The adjustment of the carrying amount of the hedged asset or liability is accounted for in the same manner as other components of the carrying amount of that asset or liability. The net derivative gain or loss related to a discontinued cash flow hedge (recognized during the period of hedge effectiveness) will continue to be reported in Accumulated Other Comprehensive Income and amortized into net income as a yield adjustment to the previously designated asset or liability. If the previously designated asset or liability is sold or matures, the net derivative gain or loss related to a discontinued cash flow hedge reported in Accumulated Other Comprehensive Income will be reclassified into net income immediately. All subsequent changes in fair values of derivatives previously designated as cash flow hedges will be recognized in net income.

Ambac enters into non-trading derivative contracts for the purpose of economically hedging exposures to fair value or cash flow changes caused by fluctuations in interest rates and foreign currency rates. The changes to the fair value of the derivative contract are recorded as a component of “Net Mark-to-Market (Losses) on Non-trading Derivative Contracts” in the accompanying Consolidated Statements of Operations. The change in fair value of such derivative contracts was $1,913 and $106 for the three months ended September 30, 2007 and 2006, respectively, and $1,950 and ($124) for the nine months ended September 30, 2007 and 2006, respectively. The change in fair values due to the fluctuations in foreign currency rates for these economically hedged items was ($1,542) as of September 30, 2007, which are recorded as a component of “Net Mark-to-Market (Losses) on Non-trading Derivative Contracts”.

13

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

(5) Income Taxes

On January 1, 2007, Ambac adopted the provisions of FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes”, an interpretation of SFAS 109, which provides a framework to determine the appropriate level of tax reserves for uncertain tax positions. FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition. Ambac’s liability for unrecognized tax benefits was not impacted as a result of the adoption of FIN 48.

Ambac files a consolidated Federal income tax return with its subsidiaries. Ambac and its subsidiaries also file separate or combined income tax returns in various states, local and foreign jurisdictions.

The following are the major jurisdictions in which Ambac and its affiliates operate and the earliest tax years subject to examination:

Jurisdiction	Tax Year
United States	2001
New York State	2005
New York City	2000
United Kingdom	2005

As of September 30, 2007 and December 31, 2006, the liability for unrecognized tax benefits is approximately $61,960 and $59,600, respectively. Included in these balances at September 30, 2007 and December 31, 2006 are $38,160 and $35,800, respectively, of unrecognized tax benefits that, if recognized, would affect the effective tax rate. Over the next 12 months, Ambac estimates it may decrease federal tax reserves related to the unrecognized tax benefits by approximately $11,200 for issues that may no longer warrant a tax reserve after an expected settlement for the years 2001 through 2004.

Ambac accrues interest and penalties related to unrecognized tax benefits in the provision for income taxes. During the three and nine months ended September 30, 2007 Ambac recognized interest of approximately $950 and $2,360, respectively, compared to $500 and $900 in the three and nine months ended September 30, 2006, respectively. Ambac had approximately $4,560 and $2,200 for the payment of interest accrued at September 30, 2007 and December 31, 2006, respectively.

(6) Special Purpose Entities and Variable Interest Entities

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

14

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

Financial Guarantees:

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

As of September 30, 2007, Ambac is the primary beneficiary and therefore consolidated a VIE under one transaction as a result of providing a financial guaranty. The VIE is a bankruptcy remote special purpose financing entity created by the issuer of debt securities to facilitate the sale of notes guaranteed by Ambac Assurance. Ambac is not primarily liable for the debt obligations of the VIE. Ambac would only be required to make payments on these debt obligations in the event that the issuer defaults on any principal or interest due. Additionally, Ambac’s creditors do not have rights with regard to the assets of the VIE.

Proceeds from the note issuance of the VIE were used to extend loans to universities in the United Kingdom. The financial reports of this VIE are prepared by an outside trustee and are not available within the time constraints Ambac requires to ensure the financial accuracy of the operating results. As such, the financial results of the VIE are consolidated on a one quarter lag. Total long-term debt outstanding under this note issuance was $280,690 with a maturity date of December 7, 2047 and a fixed rate of interest of 5.32% at September 30, 2007. Ambac is subject to potential consolidation of an additional $743,000 of assets and liabilities in connection with future utilization of the VIE.

The following table provides supplemental information about the combined assets and liabilities associated with the VIE discussed above. The assets and liabilities of the VIE are consolidated into the respective Balance Sheet captions.

	At September 30, 2007		At December 31, 2006
Assets:
Cash	$	1,334	$	—
Investment income due and accrued		1,830		—
Loans		265,741		—
Other assets		12,984		—
Total assets	$	281,889		—
Liabilities:
Accrued interest payable	$	1,199	$	—
Long-term debt		280,690		—
Total liabilities		281,889		—
Stockholders’ equity:		—		—
Total liabilities and stockholders’ equity	$	281,889	$	—

15

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

Qualified Special Purpose Entities:

A subsidiary of Ambac has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with SFAS 140, “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. 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 September 30, 2007, there have been 15 individual transactions processed through the QSPEs of which 10 are outstanding. In each case, a subsidiary of Ambac sold fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPEs and the absence of any agreement or obligation for Ambac to repurchase or redeem assets of the QSPEs. Additionally, Ambac’s creditors do not have any rights with regards to the assets of the QSPEs. The purchase by the QSPEs is financed through the issuance of MTNs, which are collateralized by the purchased assets. Derivative contracts (interest rate and currency swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchases, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued and/or the related derivative contracts. As of September 30, 2007, Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the QSPEs.

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 nine months ended September 30, 2007 and the year ended December 31, 2006 were $0 and $450,000, respectively. No gains or losses were recognized on the sales in either period. As of September 30, 2007, the estimated fair value of financial assets, MTN liabilities and derivative hedge liabilities of the QSPEs was $1,985,274, $1,995,897 and $21,097, respectively. When market quotes are not available, fair values are based on internal valuation models, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $4,665 and $3,774 for the nine months ended September 30, 2007 and 2006, respectively. Ambac also received fees for providing other services amounting to $179 and $200 for the nine months ended September 30, 2007 and 2006, respectively.

16

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

VIE Beneficial Interest:

Ambac owns a beneficial interest in a special purpose entity that meets the definition of a VIE. This entity has issued floating rate beneficial interests to investors and invested the proceeds in fixed rate municipal debt securities. These beneficial interests are directly secured by the related municipal debt securities. Ambac is the primary beneficiary of this entity as a result of its beneficial interest. The fixed rate municipal debt securities, which are reported as “Investments in fixed income securities, at fair value” on the Consolidated Balance Sheets, were $255,952 and $258,976 as of September 30, 2007 and December 31, 2006, respectively. The beneficial interests issued to third parties, reported as “Obligations under investment and payment agreements” on the Consolidated Balance Sheets, were $248,180 and $248,415 as of September 30, 2007 and December 31, 2006, respectively. Under the terms of these beneficial interests, the investors have the contractual right to redeem their investment at any time, with five business days notice. As of September 30, 2007 and December 31, 2006, the interest rates on these beneficial interests ranged from 3.54% to 4.06% and from 2.95% to 4.01%, respectively.

(7) Stockholders’ Equity

Ambac is authorized to issue 350,000,000 shares of Common Stock, par value $0.01 per share, of which 109,193,096 were issued and 101,549,070 were outstanding as of September 30, 2007. 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 September 30, 2007.

In 2007, Ambac’s shares held in treasury increased due to an accelerated share repurchase program, whereby Ambac repurchased 4,459,223 shares of common stock, and other share repurchases of 599,211 shares.

(8) Segment Information

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

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

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

17

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

The following tables are a summary of financial information by reportable segment as of and for the three and nine month periods ended September 30, 2007 and 2006:

(Dollars in thousands) Three months ended September 30,	Financial Guarantee			Financial Services			Corporate and Other			Intersegment Eliminations			Consolidated
2007:
Revenues:
Unaffiliated customers	$	(410,050	)	$	107,841		$	1,225		$	—		$	(300,984	)
Intersegment		2,225			(2,109	)		47,550			(47,666	)		—
Total revenues	$	(407,825	)	$	105,732		$	48,775		$	(47,666	)	$	(300,984	)
Income before income taxes:
Unaffiliated customers	$	(463,708	)	$	(7,323	)	$	(23,864	)	$	—		$	(494,895	)
Intersegment		4,954			(3,948	)		46,544			(47,550	)		—
Total income before income taxes	$	(458,754	)	$	(11,271	)	$	22,680		$	(47,550	)	$	(494,895	)
Total assets	$	11,557,979		$	10,319,077		$	104,035		$	—		$	21,981,091
2006:
Revenues:
Unaffiliated customers	$	328,599		$	115,403		$	3,545		$	—		$	447,547
Intersegment		13,697			(3,431	)		39,371			(49,637	)		—
Total revenues	$	342,296		$	111,972		$	42,916		$	(49,637	)	$	447,547
Income before income taxes:
Unaffiliated customers	$	300,956		$	15,158		$	(18,965	)	$	—		$	297,149
Intersegment		16,360			(4,143	)		38,376			(50,593	)		—
Total income before income taxes	$	317,316		$	11,015		$	19,411		$	(50,593	)	$	297,149
Total assets	$	10,363,811		$	9,271,167		$	337,113		$	—		$	19,972,091
(Dollars in thousands) Nine months ended September 30,	Financial Guarantee			Financial Services			Corporate And Other			Intersegment Eliminations			Consolidated
2007:
Revenues:
Unaffiliated customers	$	232,949		$	336,329		$	4,147		$	—		$	573,425
Intersegment		10,201			(9,488	)		149,311			(150,024	)		—
Total revenues	$	243,150		$	326,841		$	153,458		$	(150,024	)	$	573,425
Income before income taxes:
Unaffiliated customers	$	80,959		$	14,678		$	(69,242	)	$	—		$	26,395
Intersegment		18,388			(14,917	)		145,806			(149,277	)		—
Total income before income taxes	$	99,347		$	(239	)	$	76,564		$	(149,277	)	$	26,395
Total assets	$	11,557,979		$	10,319,077		$	104,035		$	—		$	21,981,091
2006:
Revenues:
Unaffiliated customers	$	1,009,454		$	357,603		$	10,732		$	—		$	1,377,789
Intersegment		26,925			(5,546	)		131,896			(153,275	)		—
Total revenues	$	1,036,379		$	352,057		$	142,628		$	(153,275	)	$	1,377,789
Income before income taxes:
Unaffiliated customers	$	899,139		$	84,985		$	(58,371	)	$	—		$	925,753
Intersegment		34,917			(8,031	)		128,911			(155,797	)		—
Total income before income taxes	$	934,056		$	76,954		$	70,540		$	(155,797	)	$	925,753
Total assets	$	10,363,811		$	9,271,167		$	337,113		$	—		$	19,972,091

18

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

The following table summarizes gross premiums written and net premiums earned and other credit enhancement fees included in the Financial Guarantee segment by location of risk for the three and nine months ended September 30, 2007 and 2006:

(Dollars in thousands)	Three Months				Nine Months
	Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees		Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees
2007:
United States	$	209,786	$	161,974	$	606,678	$	517,525
United Kingdom		46,751		18,669		91,794		55,686
Other International		30,048		34,187		99,164		111,529
Total	$	286,585	$	214,830	$	797,636	$	684,740
2006:
United States	$	149,866	$	150,034	$	534,068	$	476,516
United Kingdom		32,541		27,928		106,128		60,033
Other International		29,928		36,628		104,697		111,445
Total	$	212,335	$	214,590	$	744,893	$	647,994

(9) Future Application of Accounting Standards

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In addition, SFAS 157 supersedes certain accounting guidance, which prohibited the recognition of day one gains on certain derivative transactions. With the adoption of SFAS 157, any remaining reserves for day one gains will be reflected as a cumulative effect adjustment to the opening balance of retained earnings. Ambac is currently evaluating the implications of SFAS 157 on its financial statements.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS 159 permits reporting entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments and not to portions of instruments. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years that begin after November 15, 2007. Ambac is currently evaluating the implications of SFAS 159 on its financial statements.

On April 18, 2007, the FASB issued an Exposure Draft (“ED”) for a proposed SFAS “Accounting for Financial Guarantee Insurance Contracts”, an interpretation of SFAS 60, “Accounting and Reporting by Insurance Enterprises”. The ED clarifies how SFAS 60 applies to financial guarantee insurance contracts issued by insurance enterprises, including the methodology to account for premium revenue and claim liabilities. The comment period for the ED ended on June 18, 2007 and the final Statement is expected to be issued in the first quarter of 2008. The final Statement shall be applied to existing and future financial guarantee

19

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands, except share amounts)

insurance contracts. The cumulative effect of initially applying this final Statement will be recorded as an adjustment to the opening balance of retained earnings for that fiscal year. For additional disclosure regarding the ED, see “Financial Guarantee Exposure Draft” located in Management’s Discussion and Analysis.

In April 2007, the FASB issued FASB Staff Position (“FSP”) FIN 39-1, an amendment of FASB Interpretation No. 39. FSP FIN 39-1 permits fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a liability) to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under the same master netting arrangement. The decision to offset fair value amounts constitutes an accounting policy election by the entity. A reporting entity shall not offset fair value amounts recognized for derivative instruments without offsetting fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007, with earlier application permitted. An entity must recognize the effect of applying FSP FIN 39-1 retrospectively as a change in accounting principle for all financial statement periods presented, unless it is impracticable to do so. Ambac is currently evaluating the implications of FSP FIN 39-1 on its financial statements.

20

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

Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995

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

Any or all of management’s forward-looking statements here or in other publications may turn out to be wrong and are based on current expectations and the current economic environment. Ambac’s actual results may vary materially, and there are no guarantees about the performance of Ambac’s securities. Among factors that could cause actual results to differ materially are: (1) changes in the economic, credit, foreign currency or interest rate environment in the United States and abroad; (2) the level of activity within the national and worldwide credit markets; (3) competitive conditions and pricing levels; (4) legislative and regulatory developments; (5) changes in tax laws; (6) the policies and actions of the United States and other governments; (7) changes in capital requirements whether resulting from large numbers of downgrades in our insured portfolio or changes in rating agencies’ rating criteria with respect to financial guaranty insurers; (8) changes in Ambac’s and/or Ambac Assurance’s credit or financial strength ratings; (9) changes in accounting principles or practices that may impact Ambac’s reported financial results; (10) inadequacy of reserves established for losses and loss expenses; (11) default of one or more of Ambac Assurance’s reinsurers; (12) market spreads and pricing on insured pooled debt obligations and other derivative products insured or issued by Ambac; (13) prepayment speeds on insured asset-backed securities; and (14) other risks and uncertainties that have not been identified at this time. Ambac is not obligated to publicly correct or update any forward-looking statement if we later become aware that it is not likely to be achieved, except as required by law. You are advised, however, to consult any further disclosures we make on related subjects in Ambac’s reports to the SEC.

Introduction

Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose subsidiaries provide financial guarantee products and other financial services to clients in both the public and private sectors around the world.

Ambac’s principal operating subsidiary, Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch Inc. Please refer to Capital and Capital Support within the Liquidity and Capital Resources section of this Management’s Discussion and Analysis for further discussion on these triple-A ratings’ importance to our business. Financial guarantee

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

insurance is a promise to pay scheduled interest and principal if the issuer fails to meet its obligations. A bond guaranteed by Ambac Assurance 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. As an alternative to financial guarantee insurance, credit protection relating to a particular pool of assets, security or issuer can be provided through a credit derivative.

Ambac’s activities are divided into two business segments: (i) Financial Guarantee and (ii) Financial Services.

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

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

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

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

Overview

Ambac’s diluted (loss) earnings per share were ($3.53) and $0.25 for the three and nine months ended September 30, 2007, a large decrease from $1.98 per diluted share in the third quarter of 2006 and a (96%) decrease from $6.26 per diluted share in the nine months ended September 30, 2006. These negative variances were primarily driven by (i) a pre-tax unrealized mark-to-market loss on credit derivative exposures of ($743.4) million or ($5.31) per diluted share and ($805.4) million or ($5.63) per diluted share for the three and nine months ended September 30, 2007, respectively, resulting from unfavorable market pricing of collateralized debt obligations with significant amounts of sub-prime residential mortgage collateral, and (ii) higher loss and loss expenses in 2007. In addition, the nine months ended September 30, 2007 earnings variance was impacted by a large gain in 2006 from the sale of three aircraft related to a previously reported defaulted enhanced equipment trust certificate (reported as “Other Income” in the accompanying Consolidated Statements of Operations). Return on average shareholders’ equity was (24.7%) and 0.6% for the three and nine months ended September 30, 2007, respectively, compared to 14.7% and 15.8% for the three and nine months ended September 30, 2006, respectively.

During the first half of 2007, Ambac completed the buyback of $400 million of its common stock under its accelerated share buyback program. The total number of shares purchased under the agreement amounted to 4.46 million common shares.

Critical Accounting Estimates

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

Critical accounting estimates are defined as those that require management to make significant judgments and could potentially result in materially different results under different assumptions and conditions. Management has identified the accounting for loss and loss expenses and the valuation of financial instruments as critical accounting estimates. This discussion should be read in conjunction with the consolidated financial statements and notes thereon included elsewhere in this report, and in the 2006 Form 10-K filed with the SEC on March 1, 2007.

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

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

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

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

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

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

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

For the active credit reserve component of our total reserves, as the probability of default for an individual credit increases and/or the severity of loss given a default increases, our loss reserve for that insured obligation will also increase. Political, economic or other unforeseen events could have an adverse impact on default probabilities and loss severities. Downgrades to the underlying rating of a classified credit, particularly those individual credits with a large net par balance, could have a significant impact on our reserves. Case basis credit reserves are only sensitive to severity assumptions because the underlying financial obligation has already defaulted (that is, a 100% probability of default).

Adjustments to our loss reserves may create volatility in our financial results in any given quarter or year. Loss reserve volatility will be a direct result of the credit performance of our insured portfolio including the number, size, asset classes and quality of credits included on our classified list. The number and severity of adversely classified credits depend to a large extent on transaction specific attributes, but will generally increase during periods of economic stress and decline during periods of economic stability. Due to the small number of credits and size of certain individual adversely classified credits, modest changes in underlying ratings or classifications can have a large impact on any quarter’s provision for losses and loss expenses. Furthermore, external influences on our transactions beyond our control may result in favorable or unfavorable development on our reserves. Historically Ambac has not ceded large percentages of outstanding exposures to our reinsurers, therefore, reinsurance recoveries have not had a significant effect on loss reserve volatility. The table below indicates the number of credits and net par outstanding for case reserves and active credit reserves on non-investment grade credits at September 30, 2007:

$ in millions	Number of credits	Net par outstanding		Net Loss Reserves(1)
Active credit reserves	48	$	1,860	$	166.7
Case reserves	10		822		107.1
Totals	58	$	2,682	$	273.8

(1) Net of reinsurance recoverable on unpaid losses of $10.3 million.

Ambac has exposure to various bond types issued in the debt capital markets. Our experience has shown that for the majority of bond types, we have not experienced claims and therefore the estimate of loss severity has remained constant. However, for certain bond types, Ambac has loss experience that indicates that factors or events could have a material impact on the original estimate of loss severity. We have observed that, with respect to four bond types in particular, it is reasonably possible that a material change in actual loss severities could occur over time. These four bond types are healthcare institutions, aircraft lease securitizations known as Enhanced Equipment Trust Certificates (“EETC”), collateralized debt obligations (“CDOs”) and mortgage-backed and home equity securitizations. These four bond kinds represent 52% of our ever-to-date claim payments. Typically, bonds insured by Ambac in the healthcare sector are secured by revenues generated by a hospital enterprise. The value of a hospital and its ability to generate revenues are primarily impacted by the essentiality of that hospital enterprise to a particular community. For example, hospitals that do not have significant competition in a community generally have more stable collateral values than facilities in communities with significant competition. Intense competition in the global airline industry and high energy costs could adversely impact our EETC transactions. We currently do not have any exposure to EETC in our classified credit portfolio. Continued increases in residential mortgage defaults as a result of fraud, foreclosures, increases in

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

interest rates, unemployment and/or personal bankruptcies could adversely impact residential real estate values and the probability of default and severity of loss for our transactions. As a result of our experience to date, we note that the mortgage-backed and home equity ultimate severities have usually been less than or equal to our current severity assumption. However, our past experience had been observed during a period of rising real estate values for much of the United States and past results are no indication of future performance. When calculating modeled loss estimates for an insured CDO obligation, Ambac considers the unique attributes of the underlying collateral and transaction. It is reasonably possible that loss estimates for CDOs may increase as a result of increased probability of default and severity of loss of the underlying collateral; however Ambac’s exposure to CDOs in its classified credit portfolio is currently limited.

Currently, the credits that comprise our case basis credit reserves primarily include mortgage-backed and home equities from the four bond kinds discussed above as well as transportation credits. The case basis credit reserve, net of reinsurance for mortgage-backed and home equity transactions, was approximately $60.8 million at September 30, 2007.

Generally, severity assumptions are established within our ACR for entire asset classes and therefore represent an average severity of loss given a default. However, it is our experience that ultimate severity outcomes often vary from averages. Therefore, we have not provided reasonably possible negative scenarios for the severity assumption. The table below outlines the estimated impact on the September 30, 2007 consolidated loss reserve from reasonably possible increases in the probability of default estimate arising via an assumption of one full letter downgrade for each credit (including both investment grade and non-investment grade) of the appropriate bond type that presently resides within the adversely classified credit listing.

(Dollars in millions) Category	Net Par Outstanding		Increase in Reserve Estimate
Transportation	$	1,074	$	77
Mortgage-backed and home equity	$	1,274	$	74
Health care	$	446	$	39

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

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

Investments in fixed income securities are accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) 115, “Accounting for Certain Investments in Debt and Equity Securities”. SFAS 115 requires that all debt instruments and certain equity instruments be classified in Ambac’s balance sheet according to their purpose and, depending

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

on that classification, be carried at either cost or fair market value. The fair values of fixed income investments are based primarily on quoted market prices received from a nationally recognized pricing service or dealer quotes. For those fixed income investments where quotes were not available, fair values are based on internal valuation models. Key inputs to the internal valuation models include maturity date, coupon and generic yield curves for industry and credit rating characteristics that closely match those characteristics of the specific investment securities being valued. Valuation results, particularly those derived from valuation models, could differ materially from amounts that would actually be realized in the market. Approximately 2% of the investment portfolio was valued using internal valuation models at September 30, 2007 and December 31, 2006.

Ambac’s exposure to derivative instruments is created through interest rate, currency, total return and credit default swaps. These contracts are accounted for at fair value under SFAS 133 “Accounting for Derivative Instruments and Certain Hedging Activities,” as amended (“SFAS 133”). Fair value is determined based upon market quotes from independent sources, when available. When independent quotes are not available, fair value is determined using valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. Due to the size of both the portfolio and individual credits and correlation in our credit derivative portfolio, modest changes in factors that impact their fair value can have a large impact on any quarter’s mark-to-market gains or losses. Fair value of credit derivative contracts are primarily driven by the fair value of their underlying reference obligations which are in turn driven primarily by market perceptions of credit and liquidity risk of such reference obligation. As the credit protection provider, Ambac assumes only credit risk; we do not assume liquidity risk or other risks and costs inherent in direct ownership of the underlying reference securities. Therefore we typically receive only a portion of the return demanded by securities holders as fees to provide credit protection on such securities. Because of this relationship and in the absence of severe credit deterioration, changes in the fair value of our credit default swaps will generally be less than changes in the fair value of the underlying reference obligations. So far in the fourth quarter of 2007, we have observed a continued lack of liquidity and credit deterioration in the collateralized debt obligation market and as a result may experience future mark-to-market losses. Please refer to Item 3. “Quantitative and Qualitative Disclosures About Market Risk” for fair value sensitivities for our credit derivative portfolio as a result of changes in credit spreads.

The net fair value of all derivative contracts at September 30, 2007 and December 31, 2006 was ($451) million and $352 million, respectively. This decrease in net asset value relates primarily to the unrealized mark-to-market loss on credit derivatives during the first nine months of 2007.

Ambac uses both vendor-developed and proprietary models, based on the complexity of transactions. The selection of a model to value a derivative depends on the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. For derivatives that are less complex and trade in liquid markets, such as interest rate and currency swaps, we utilize vendor-developed models. For derivatives that trade in less liquid markets, such as credit derivatives on collateralized debt obligations and total return swaps, a proprietary model is used because such instruments tend to be more complex and pricing information is not readily available in the market. These models and the related assumptions are continuously re-evaluated by management and enhanced, as

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

appropriate, based on improvements in modeling techniques. Key variables used in our valuation of credit derivatives on collateralized debt obligations include the balance of unpaid notional, tenor, fair values of the underlying reference obligations and assumptions about the portion of fair value changes attributable to credit versus liquidity risk and other factors. The fair values of the underlying reference obligations are obtained from broker quotes when available, or are derived from other market indications such as new issuance spreads for similar transactions.In accordance with the Emerging Issues Task Force (“EITF”) Issue 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (“EITF 02-3”), recognition of a trading profit or loss at inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating observable market data. Ambac defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. Management’s judgment is applied in recording adjustments to fair value that take into account various factors, including but not limited to, credit risk, future administration costs, the bid offer spread and illiquidity due to lack of market depth. The FASB issued SFAS 157, “Fair Value Measurements” in September 2006 which is effective for financial statements issued for fiscal years beginning after November 15, 2007 and will supersede the guidance in EITF 02-3. Please refer to Note 9 of the Consolidated Financial Statements for further discussion on how SFAS 157 will impact derivative transaction gains and losses.

Results of Operations

The following paragraphs describe the consolidated results of operations of Ambac and its subsidiaries for the three and nine months ended September 30, 2007 and 2006, and its financial condition as of September 30, 2007 and December 31, 2006.

Consolidated Net Income

Ambac’s net (loss) income for the three months ended September 30, 2007 was ($360.6) million or ($3.53) per diluted share, a decrease of $574.1 million or ($5.51) per diluted share, compared to $213.5 million, or $1.98 per diluted share in the three months ended September 30, 2006. Ambac’s (loss) before income taxes was ($494.9) million for the three months ended September 30, 2007, a decrease from income before income taxes of $297.1 million in the three months ended September 30, 2006. Of the ($494.9) million of loss before income taxes in the third quarter of 2007, ($463.7) million was from Financial Guarantee, ($7.3) million from Financial Services and $(23.9) million from Corporate, compared to $301.0 million, $15.1 million and $(19.0) million for Financial Guarantee, Financial Services and Corporate, respectively, in the third quarter of 2006. Corporate consists primarily of Ambac’s interest expense on its long-term debentures outstanding, partially offset by interest income on investments held at the parent company.

Financial Guarantee net income for the three months ended September 30, 2007 decreased primarily as a result of unrealized mark-to-market losses on credit derivative exposures driven primarily by the impact of market pricing of pooled debt obligations with significant amounts of sub-prime residential mortgage collateral, a higher provision for loss and

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

loss expenses, lower other income and higher underwriting and operating expenses, partially offset by higher net investment income. The Financial Services segment decrease in the third quarter of 2007 is primarily attributable to net mark-to-market losses on total return swaps, lower net realized gains compared to the third quarter of 2006 (which included recoveries received from National Century Financial Enterprises, Inc. (“NCFE”)), as well as lower revenue from the derivative product and the investment agreement businesses.

Ambac’s net income for the nine months ended September 30, 2007 was $25.8 million or $0.25 per diluted share, a decrease of ($647.4) million compared to $673.2 million, or $6.26 per diluted share in the nine months ended September 30, 2006. Ambac’s income before income taxes was $26.4 million for the nine months ended September 30, 2007, a decrease of 97% from income before income taxes of $925.8 million in the nine months ended September 30, 2006. Of the $26.4 million of income before income taxes in the nine months ended September 30, 2007, $80.9 million was from Financial Guarantee, $14.7 million from Financial Services and $(69.2) million from Corporate, compared to $899.1 million, $85.0 million and $(58.3) million for Financial Guarantee, Financial Services and Corporate, respectively, in the nine months ended September 30, 2006.

Financial Guarantee net income for the nine months ended September 30, 2007 decreased primarily as a result of the unrealized mark-to-market losses on credit derivative exposures mentioned above, lower other income compared to the comparable period in 2006 (which included recoveries from the sale of three aircraft from a defaulted enhanced equipment trust certificate transaction), and a higher provision for loss and loss expenses, partially offset by higher net premiums earned and higher net investment income. The Financial Services segment decrease in the nine months of 2007 is primarily attributable to lower net realized gains as mentioned above, net mark-to-market losses on total return swaps and lower revenues from the derivative product and investment agreement businesses.

Included in the nine months ended September 30, 2006 income before income taxes in the Financial Guarantee segment, is the impact from cancellations of the remaining reinsurance contracts with AXA Re Finance S.A. (“AXA Re”) and American Re-Insurance Company (“American Re”). The insured par that was recaptured as a result of the cancellation totaled approximately $3.9 billion. Included in ceded premiums written in Ambac’s Consolidated Statement of Operations is $37.0 million in returned premiums from the cancellation, of which $29.3 million was deferred. The difference, $7.7 million, included in net earned premiums, results from the difference between the negotiated amount of returned premiums and the associated unearned premium remaining on the previously ceded portion of the underlying guarantees. The net impact of this cancellation to the Consolidated Statement of Operations amounted to approximately $3.1 million, $2.0 million after-tax.

Financial Guarantee Segment

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

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

Ambac Assurance guaranteed $33.4 billion of gross par value bonds during the three months ended September 30, 2007, an increase of 25% from $26.7 billion during the comparable prior year period. During the nine months ended September 30, 2007, Ambac Assurance guaranteed $103.9 billion in par value debt obligations, an 8% increase from $96.5 billion in par value debt obligations guaranteed in the nine months ended September 30, 2006.

The following table provides a breakdown of guaranteed net par outstanding by market sector at September 30, 2007 and December 31, 2006:

(Dollars in billions)	September 30, 2007		December 31, 2006
Public Finance	$	300.0	$	282.2
Structured Finance		176.7		162.6
International Finance		79.5		74.2
Total net par outstanding	$	556.2	$	519.0

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

The following tables provide a rating distribution of guaranteed net par outstanding based upon internal Ambac Assurance credit ratings at September 30, 2007 and December 31, 2006 and a distribution by bond type of Ambac Assurance’s below investment grade exposures at September 30, 2007 and December 31, 2006. Below investment grade is defined as those exposures with a credit rating below BBB-:

	Percentage of Guaranteed Portfolio(1)
	September 30, 2007		December 31, 2006
AAA	18	%	16	%
AA	21		20
A	41		43
BBB	20		20
Below investment grade	<1		1
Total	100	%	100	%

Summary of Below Investment Grade Exposure ⁽¹⁾

Bond Type	September 30,		December 31,
(Dollars in millions)	2007		2006
Public Finance:
Transportation	$	1,013	$	1,264
Health care		410		404
General obligation		184		292
Tax-backed		132		134
University		30		69
Other		121		120
Total Public Finance		1,890		2,283
Structured Finance:
Mortgage-backed and home equity		1,470		848
Enhanced equipment trust certificates		621		950
Investor-owned utilities		588		509
Pooled debt obligations		68		90
Total Structured Finance		2,747		2,397
International Finance:
Transportation revenue		30		397
Public finance infrastructure		—		149
Other		38		40
Total International Finance		68		586
Grand Total	$	4,705	$	5,266

(1) Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. In cases where Ambac has insured multiple tranches of an issue with varying internal ratings, or more than one obligation of an issuer with varying internal ratings, a weighted average rating is used. Ambac credit ratings are subject to revision at any time and do not constitute investment advice. Ambac Assurance, or one of its affiliates, has insured the obligations listed and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.

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

The total number of credits with Ambac Assurance ratings below investment grade were 58 and 65 at September 30, 2007 and December 31, 2006, respectively. The decrease in Public Finance transportation is primarily due to an upgrade of a transportation credit to investment grade. The increase in Structured Finance’s mortgage-backed and home equity category is due to the downgrade of six transactions. The decrease in International Finance’s transportation revenue category is due to the refinancing of the Eurotunnel credit.

Structured Finance includes exposure to sub-prime and mid-prime first and second lien residential mortgage-backed securities. Ambac has exposure to the U.S. sub-prime market through direct guarantees in our MBS portfolio, guarantees of pooled debt obligations and, to a lesser extent, guarantees of bank sponsored multi-seller conduits that contain residential mortgage-backed securities (“RMBS”) in their collateral pool. Furthermore, Ambac has issued a $3 billion commitment to provide a financial guarantee on a pool of CDO of asset-backed securities, mostly RMBS. Currently, this pool is primarily comprised of CDOs that were originated prior to 2006 (71%) and 83% of the pool is rated AA or better (48% rated AAA). Ambac is afforded first loss protection consistent with other collateralized debt obligations noted below.

MBS Portfolio exposure:

Ambac classifies first-lien mortgage loan borrowers into three broad credit risk classes: prime, mid-prime and sub-prime. The most common statistical metric that is used to determine the credit risk of a borrower is the FICO score (Fair Isaac Credit Organization). FICO credit scores are calculated by using models and mathematical tables that assign points for different pieces of information, which in their view, best predict future credit performance. Score-model developers find predictive factors in the data that have proven to indicate future credit performance. Credit scores analyze a borrower’s credit history considering numerous factors such as: late payments, the amount of time credit has been established, the amount of credit used versus the amount of credit available, length of time at present residence and negative credit information such as bankruptcies, charge-offs, collections, etc. FICO scores range from 300 to 850. Generally, FICO scores of these three classifications are as follows: prime (FICO score over 710), mid-prime (FICO score between 640 and 710) and sub-prime (FICO score below 640). We have classified our insured exposures among these three classifications based on the predominant characteristics of the securitized loan collateral as noted within the offering circular of the RMBS transaction.

Additionally, Ambac will insure RMBS transactions that contain predominately underlying second-lien mortgage loans, such as home equity loans. A second lien mortgage loan is a type of loan in which the borrower uses the equity in their home as collateral and is subordinate to the first lien on the home. The borrower is obligated to make monthly payments on both their first and second lien loans. If the borrower defaults on their payments due on these loans and the property is subsequently liquidated, the liquidation proceeds are first allocated to pay off the first lien loan and any remaining funds are applied to pay off the second lien.

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

Ambac insures tranches issued in RMBS, including transactions that contain risks to the above types of mortgages and risk classifications. We insure the RMBS from a given loss attachment point to the top of the capital structure. Recent downgrades by the major independent rating agencies have been concentrated in transactions which are comprised principally of first and second lien mortgage loans originated during the 2005 – 2007 period. The following tables provide details with respect to US transactions issued in specified years and underlying credit rating of Ambac’s affected RMBS book of business:

	Total Net Par Outstanding At September 30, 2007
Year of Issue * ($ in billions)	Second Lien			Sub-prime			Mid-prime
1998-2001	$	0.3		$	1.2		<$	0.1
2002		0.4			1.2			0.1
2003		0.1			2.4			0.3
2004		2.7			0.8			0.7
2005		2.3			1.6			2.3
2006		6.8			1.0			0.6
2007		5.5			0.6			2.9
Total	$	18.1		$	8.8		$	7.0
% of Total MBS Portfolio		32.0	%		15.5	%		12.3	%
	Percent of Related RMBS Transactions’ Net Par
Internal Ambac Credit Rating*	Second Lien			Sub-prime			Mid-prime
AAA		1	%		6	%		77	%
AA		<1	%		4	%		19	%
A		28	%		37	%		1	%
BBB		66	%		48	%		3	%
Below investment grade		5	%		5	%		0	%

* Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac Assurance. Ambac’s credit ratings are subject to revision at any time and do not constitute investment advice. The insured RMBS in the BBB portion of the table are all relatively large senior tranches that reside at the top of the capital structure. Because of their size and position in the capital structure, these tranches generally produce lower levels of loss severity, upon collateral default, than BBB-rated mezzanine tranches with similar collateral.

RMBS exposure in Collateralized Debt Obligations:

Ambac’s RMBS exposure embedded in CDOs relates primarily to the asset class commonly referred to as CDO of asset backed securities or CDO of ABS. Since Ambac has established a minimum requirement for participation in these transactions to be a triple A rating from one or more of the major rating agencies, the existing transactions were executed at subordination levels that were well in excess of an initial rating agency triple A attachment point (i.e. the level of subordination that was initially required to achieve such rating). Ambac’s participation in CDO of ABS transactions is at the senior class in the capital structure. Our exposure to sub-prime RMBS embedded in CDO of ABS relates primarily to CDO of high-grade ABS transactions, but also includes CDO of mezzanine ABS transactions. At September 30, 2007, Ambac’s exposures to CDO of ABS, where the RMBS collateral represents greater than 25% of the collateral, were $29.2 billion, of which $26.2 billion related to CDO of high-grade ABS. In October 2007, the independent rating agencies downgraded a number of MBS and CDO transactions. In addition, the junior tranches of some of our CDO of ABS transactions have been downgraded or placed on the watch-list for negative rating action.

33

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

Our CDO of ABS transactions contain exposures to some of these downgraded transactions, which may impact pricing of such securities. If prices of these securities are reduced, such reductions would cause mark-to-market losses in the fourth quarter of 2007.

High-grade CDO of ABS transactions are typically comprised of underlying RMBS collateral generally originally rated single A through triple A by one or more of the major rating agencies at the inception of the CDO. High-grade transactions contain a mix of sub-prime, mid-prime and prime mortgages. High-grade deals may contain components of other high-grade and mezzanine CDO exposure. These CDO components would also generally have single A through triple A ratings. The higher investment grade ratings of the underlying collateral give rise to the term “high-grade.” Ambac’s CDO of high-grade ABS exposures have underlying collateral that consists of 39% sub-prime, 36% other RMBS and 13% mezzanine CDO exposures. The current ratings of the sub-prime RMBS collateral is 8% Aaa, 41% Aa, 39% A, 8% Baa and 4% below investment grade.

CDO of mezzanine ABS transactions are structured similar to high-grade transactions. The primary difference is that the underlying collateral exposure in a mezzanine transaction is comprised primarily of triple B originally rated tranches of sub-prime and mid-prime mortgages (at the inception of the CDO). Typically, mezzanine transactions require a more significant level of subordination to achieve triple A credit ratings because of the lower credit quality of the underlying collateral pool.

Ambac typically provides credit protection in connection with CDOs through credit default swaps that replicate the protection provided by financial guarantees. Credit default swaps are derivative contracts that are subject to mark to market accounting under generally accepted accounting principles. Ambac has tailored its credit derivative contracts to contain certain provisions that are similar to our standard insurance contracts in order to mitigate certain liquidity risk that is inherent in standard credit derivative contracts. While derivative contracts generally provide for mark-to-market termination payments in the event a derivative transaction is terminated early, Ambac has typically limited these events to its own payment default or bankruptcy.

The two key liquidity risk mitigation terms are as follows:

• “Pay as you go” in the event of a loss - The significant majority of our credit derivatives (post 2004) are written as “pay-as-you-go”. Similar to an insurance policy execution, pay-as-you-go provides that we pay interest shortfalls on the referenced transaction as they are incurred on each scheduled payment date, but only pay principal shortfalls upon the earlier of (i) the date on which all of the assets designated to fund the referenced obligation have been disposed of and all proceeds of those assets have been fully distributed to note holders and (ii) the legal final maturity date of the referenced obligation. Unlike the dealer credit derivative contract, our contracts do not give the buyer of protection the option to physically settle upon the occurrence of a credit event; i.e. the protection buyer cannot deliver the reference obligation and for a payment equal to the par amount of the reference obligation.

• No collateral posting - None of our outstanding credit derivative transactions includes ratings based collateral triggers or otherwise require Ambac to post collateral regardless of its ratings or the size of the mark to market exposure to Ambac.

34

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

Public Finance:

Public Finance bond obligations par value written was $14.2 billion for the three months ended September 30, 2007, which was 53% higher than $9.3 billion of par value written in the three months ended September 30, 2006. During the nine months ended September 30, 2007 par value written was $42.7 billion, which was 35% higher than $31.7 billion of par value written in the nine months ended September 30, 2006. The increases were primarily due to higher overall market issuance, which were up 13% and 24% for the three and nine months ended September 30, 2007, respectively, partially offset by a lower percentage of bonds issued with financial guarantee insurance. The overall market issuance for the nine months of 2007 was driven by both the new money (up 19%) and refundings (up 30%) components of the market. Ambac’s market share was 28.0% and 24.0% for the three and nine months ended September 30, 2007, compared to 22.5% and 23.6% for the three and nine months ended September 30, 2006.

The table below shows the percentage, by bond type, of new Public Finance business gross par guaranteed by Ambac Assurance during the nine months of 2007 and the full year 2006.

New Business Guaranteed by Bond Type

Bond Type	Year-to-Date 2007		Full Year 2006
Public Finance:
Lease and tax-backed revenue	27	%	34	%
General obligation	27	%	24	%
Utility revenue	14	%	11	%
Health care revenue	9	%	10	%
Higher education	8	%	9	%
Transportation revenue	8	%	6	%
Housing revenue	6	%	4	%
Other	1	%	2	%
Total Public Finance	100	%	100	%

Structured Finance:

Structured Finance obligations par value written was $11.0 billion for the three months ended September 30, 2007, which was 14% lower than $12.8 billion of par value written in the three months ended September 30, 2006. During the nine months ended September 30, 2007, par value written was $45.5 billion, 12% lower compared to $51.6 billion in the nine months ended September 30, 2006. The decreases in Structured Finance obligations guaranteed for the three months ended September 30, 2007 were primarily due to lower pooled debt obligations and lower mortgage-backed and home equity loan securitizations, partially offset by higher student loan par guaranteed. In addition to the above, the decrease for the nine months ended September 30, 2007 also include lower asset-backed and conduits par guaranteed.

35

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

The table below shows the percentage, by bond type, of new Structured Finance business gross par guaranteed by Ambac Assurance during the nine months of 2007 and the full year 2006.

New Business Guaranteed by Bond Type

Bond Type	Year-to-Date 2007		Full Year 2006
Structured Finance:
Pooled debt obligations	35	%	33	%
Mortgage-backed and home equity	30	%	30	%
Asset-backed and conduits	20	%	25	%
Student loan	11	%	5	%
Investor-owned utilities	4	%	4	%
Other	<1	%	3	%
Total U.S. Structured Finance	100	%	100	%

International Finance:

International Finance bond obligations par value written was $8.2 billion for the three months ended September 30, 2007, which was 78% higher than $4.6 billion of par value written for the three months ended September 30, 2006. During the nine months ended September 30, 2007, par value written was $15.7 billion, which was 19% higher than $13.2 billion of par value written for the nine months ended September 30, 2006. The increase in International Finance obligations guaranteed during the three months ended September 30, 2007 were primarily due to higher asset-backed and conduit obligations, sovereign/sub-sovereign obligations, transportation obligations and investor-owned and public utility obligations, partially offset by lower pooled debt obligations. The increase in the nine months ended September 30, 2007 is primarily due to higher asset-backed and conduit obligations and transportation obligations, partially offset by lower pooled debt and sovereign/sub-sovereign obligations.

The table below shows the percentage, by bond type, of new International Finance business gross par guaranteed by Ambac Assurance during the nine months of 2007 and the full year 2006.

New Business Guaranteed by Bond Type

Bond Type	Year-to-Date 2007		Full Year 2006
International Finance:
Asset-backed and conduits	37	%	25	%
Pooled debt obligations	21	%	36	%
Sovereign/sub-sovereign	13	%	15	%
Investor-owned and public utilities	11	%	12	%
Transportation	10	%	6	%
Mortgage-backed and home equity	5	%	3	%
Other	3	%	3	%
Total International Finance	100	%	100	%

36

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

Gross Premiums Written. Gross premiums written for the three and nine months ended September 30, 2007 were $286.6 million and $797.6 million, respectively, an increase of $74.3 million or 35% from $212.3 million in the three months ended September 30, 2006 and an increase of $52.7 million or 7% from $744.9 million in the nine months ended September 30, 2006.

Up-front premiums written during the three and nine months ended September 30, 2007 were $149.0 million and $387.1 million, respectively, an increase of 121% from $67.5 million in the three months ended September 30, 2006 and an increase of 15% from $337.7 million in the nine months ended September 30, 2006. Up-front premiums written in the third quarter of 2007 saw increases in both Public and International Finance sector, partially offset by a slight decrease in the Structured Finance sector. The first nine months of 2007 saw an increase in Public Finance, partially offset by decreases in Structured and International Finance.

Installment premiums written for the three and nine months ended September 30, 2007 were $137.6 million and $410.5 million, respectively, a decrease of 5% from $144.8 million in the three months ended September 30, 2006, and an increase of 1% from $407.2 million in the nine months ended September 30, 2006. Installment premiums written in the third quarter of 2007 saw decreases in Public Finance and International Finance, partially offset by an increase in Structured Finance, while the first nine months of 2007 saw increases in both Structured and International Finance, partially offset by a decrease in Public Finance installment premiums written.

The following table sets forth the amounts of gross premiums written by type for the three and nine months ended September 30, 2007 and 2006:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2007		2006		2007		2006
Public Finance:
Up-front	$	123.0	$	61.6	$	334.1	$	262.6
Installment		5.1		9.4		20.1		23.7
Total Public Finance		128.1		71.0		354.2		286.3
Structured Finance:
Up-front		5.8		5.9		22.1		22.7
Installment		75.9		72.9		230.4		225.1
Total Structured Finance		81.7		78.8		252.5		247.8
International Finance:
Up-front		20.2		—		30.9		52.4
Installment		56.6		62.5		160.0		158.4
Total International Finance		76.8		62.5		190.9		210.8
Total	$	286.6	$	212.3	$	797.6	$	744.9
Total up-front	$	149.0	$	67.5	$	387.1	$	337.7
Total installment		137.6		144.8		410.5		407.2
Total	$	286.6	$	212.3	$	797.6	$	744.9

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Reinsurance. Ambac Assurance’s reinsurance program is principally comprised of a surplus share treaty and facultative reinsurance. The surplus share treaty requires Ambac Assurance to cede covered transactions while affording Ambac Assurance the flexibility to cede par amounts of such transactions within a predefined range. Management uses facultative reinsurance to cede risks in amounts greater than the maximums that can be ceded under the surplus share treaty and risks which are excluded from the surplus share treaty. Ceded premiums written for the three and nine months ended September 30, 2007 were $35.1 million and $93.0 million, respectively, an increase of $8.8 million or 33% from $26.3 million in the three months ended September 30, 2006 and an increase of $17.7 million or 24% from $75.3 million in the nine months ended September 30, 2006.

Included in ceded premiums written in the nine months ended September 30, 2006 is $37.0 million in return premiums from reinsurance contracts that were cancelled. Excluding the return premiums from the nine months ended September 30, 2006, ceded premiums written were $112.3 million. For the nine months ended September 30, 2007, ceded premiums written decreased 17% compared with the nine months ended September 30, 2006 after excluding the return premiums. Ceded premiums as a percentage of gross premiums written were 12.2% and 12.4% for the third quarter of 2007 and 2006. Ceded premiums (exclusive of the return premiums) as a percentage of gross premiums written were 11.7% and 15.1% for the nine months ended September 30, 2007 and 2006, respectively. The decline in ceded written premiums as a percentage of gross written premiums written for the nine months ended September 30, 2007 (exclusive of the return premiums) was attributable to the underwriting of larger public finance transactions during the nine months ended September 30, 2006.

Net Premiums Earned and Other Credit Enhancement Fees. Net premiums earned and other credit enhancement fees for the three and nine months ended September 30, 2007 were $214.8 million and $684.7 million, basically flat compared to $214.6 million for the three months ended September 30, 2006 and an increase of 6% from $648.0 million for the nine months ended September 30, 2006. The increase for the three months ended September 30, 2007 was primarily the result of higher normal premiums earned (which is defined as net premiums earned less refundings and calls of previously insured obligations and other accelerations, such as reinsurance cancellations, (collectively referred to as “accelerated earnings”) and reconciled to total net premiums earned in the table below) and higher other credit enhancement fees, partially offset by lower accelerated earnings. The increase for the nine months ended September 30, 2007 compared to the prior year period is a result of higher normal premiums earned, higher accelerated earnings and higher other credit enhancement fees earned.

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

	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in Millions)	2007		2006		2007		2006
Public Finance	$	59.0	$	58.8	$	176.4	$	172.7
Structured Finance		73.0		70.9		218.8		210.9
International Finance		46.4		45.1		137.4		133.9
Total normal premiums earned		178.4		174.8		532.6		517.5
Accelerated earnings		16.4		23.7		99.2		86.1
Total net premiums earned		194.8		198.5		631.8		603.6
Other credit enhancement fees		20.0		16.1		52.9		44.4
Total net premiums earned and other credit enhancement fees	$	214.8	$	214.6	$	684.7	$	648.0

38

Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. However, given the same underlying attributes of an insured obligation such as tenor, gross premium amount, and amortization schedule, the timing of revenue recognition may differ for premiums collected upfront versus premiums collected in installments. When an issue insured by Ambac Assurance has been refunded or called, any remaining unearned premium (net of refunding credits, if any) is earned at that time. The level of refundings or calls vary, depending upon a number of conditions, primarily the relationship between current interest rates and interest rates on outstanding debt. Earnings on refundings typically relate to transactions where the premium was paid up-front at the inception of the policy. Net premiums earned during the three and nine months ended September 30, 2007 included $16.4 million and $99.2 million, respectively, from accelerated earnings as compared to $23.7 million and $86.1 million for the three and nine months ended September 30, 2006, respectively. The following table provides a breakdown of accelerated earnings:

	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in Millions)	2007		2006		2007		2006
Public Finance	$	14.4	$	9.1	$	79.6	$	48.8
Structured Finance		1.7		1.8		6.8		13.2
International Finance		0.3		12.8		12.8		16.3
Reinsurance Cancellations		—		—		—		7.7
Total accelerated earnings	$	16.4	$	23.7	$	99.2	$	86.1

Normal net premiums earned increased 2% from $174.8 million in the third quarter of 2006 to $178.4 million in the third quarter of 2007. Normal net premiums earned for the nine months ended September 30, 2007 was $532.6 million, an increase of 3% from $517.5 million in the nine months ended September 30, 2006. Normal net premiums earned for the three months ended September 30, 2007 increased 0% for Public, 3% for Structured, and 3% for International Finance, respectively, from the three months ended September 30, 2006. Normal net premiums earned for the nine months ended September 30, 2007 increased 2% for Public Finance, 4% for Structured Finance and 3% for International Finance, from the nine months ended September 30, 2006. Public Finance normal earned premium growth has been negatively impacted by the high level of refunding activity over the past two years, competitive pricing and the mix of business underwritten in recent periods. The growth in normal earned premiums in Structured Finance was driven by strong business production in asset classes such as pooled debt obligations and commercial asset-backed securities over the past several quarters. The increase in the level of growth in International Finance normal earned premium has resulted from improving deal flow.

Other credit enhancement fees, which is primarily comprised of fees received from the credit derivatives product were $20.0 million and $52.9 million for the three and nine months ended September 30, 2007, respectively, an increase of 24% from $16.1 million in the three

39

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

months ended September 30, 2006 and an increase of 19% from $44.4 million in the nine months ended September 30, 2006. The increases are primarily due to higher domestic credit derivative writings.

Net Investment Income. Net investment income for the three and nine months ended September 30, 2007 was $115.8 million and $341.1 million, an increase of 8% from $107.2 million in the three months ended September 30, 2006 and an increase of 9% from $313.3 million in the nine months ended September 30, 2006. The increases were primarily attributable to the growth of the investment portfolio resulting from the positive operating cash flows of the Financial Guarantee book of business (primarily premiums written and coupon receipts on invested assets). Investments in tax-exempt securities amounted to 78% and 77% of the total fair value of the Financial Guarantee portfolio as of September 30, 2007 and September 30, 2006, respectively. The average pre-tax yield-to-maturity on the investment portfolio was 4.63% at September 30, 2007 compared with 4.65% at September 30, 2006.

Net Mark-to-Market (Losses) Gains on Credit Derivative Contracts. Net mark-to-market (losses) on credit derivative contracts for the three and nine months ended September 30, 2007 were ($743.4) million and ($805.4) million, respectively, compared to net mark-to-market gains of $2.6 million and $9.9 million in the three and nine months ended September 30, 2006, respectively. During the third quarter of 2007, a net mark-to-market loss was recorded across the entire credit derivative portfolio, with the largest declines related to collateralized debt obligations of asset-backed securitizations (“CDO of ABS”) containing sub-prime mortgage-backed securities as collateral, including CDOs containing other CDO of ABS securities as collateral (“CDO of CDO”). Unrealized losses of CDO of ABS comprised approximately 71% of the total unrealized losses for the three months ended September 30, 2007. The remainder of the mark is attributed primarily to CDOs of corporate assets, both loans and bonds. The negative mark-to-market is driven by current market concerns over the credit quality of the most recent vintages of sub-prime residential mortgage-backed securities and the recent lack of liquidity in collateralized debt obligations of the asset–backed security market resulting in a reduction in market-quoted prices on the underlying reference obligations of our credit derivatives. There were no realized net losses paid on credit derivatives for the three and nine months ended September 30, 2007 and 2006. So far in the fourth quarter of 2007, we have observed rating agency downgrades of mortgage-backed securities and CDOs, a continued lack of liquidity in the collateralized debt obligation market and continued credit deterioration and as a result Ambac may experience future mark-to-market losses.

Other (Loss) Income. Other (loss) income for the three and nine months ended September 30, 2007 was ($1.3) million and $7.2 million, respectively, compared to other income of $3.0 million and $35.4 million for the three and nine months ended September 30, 2006, respectively. Included within other (loss) income are deal structuring fees, commitment fees, aircraft revenues and equity earnings from Ambac’s Qualifying Special Purpose Entities (“QSPEs”). Included in the three and nine months ended September 30, 2007 were ($2.6) million and $0.7 million, respectively, related to these QSPEs, compared to $2.0 million and $2.9 million for the three and nine months ended September 30, 2006, respectively. During the first quarter of 2006, Ambac Assurance sold three aircraft from a previously reported defaulted enhanced equipment trust certificate. The gain on the sale amounted to $25.0 million. Also included within other income are structuring fee revenues for the three and nine months ended September 30, 2007 of approximately $0.4 million and $1.5 million, respectively, compared to $0.4 million and $1.5 million in the three and nine months ended September 30, 2006,

40

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

respectively. Structuring fees are negotiated for certain domestic and international structured finance transactions, typically collected at inception of the transactions, and are earned ratably over the life of the transactions. Ambac has approximately $14.4 million and $14.8 million of deferred structuring fees included in “Other liabilities” on the Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006, respectively.

Loss and Loss Expenses. Loss and loss expenses are based upon estimates of the aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. Loss and loss expenses for the three and nine months ended September 30, 2007 were $19.1 million and $47.6 million, respectively, compared to ($2.5) million and $10.4 million for the three and nine months ended September 30, 2006. The increased loss provisions in 2007 are primarily the result of increases for domestic transportation and residential mortgage-backed security sectors, partially offset by a reduction in the remaining Public Finance portfolio due to improved financial conditions.

The following table summarizes the changes in the total net loss reserves for the nine months ended September 30, 2007 and the year-ended December 31, 2006:

(Dollars in millions)	Nine Months Ended September 30, 2007			Year Ended December 31, 2006
Beginning balance of net loss reserves	$	215.0		$	300.6
Provision for losses and loss expenses		47.6			20.0
Losses paid		(17.7	)		(126.2	)
Recoveries of losses paid from reinsurers		1.9			3.9
Other recoveries, net of reinsurance		27.0			16.7
Ending balance of net loss reserves	$	273.8		$	215.0

The following tables provide details of net losses paid, net of recoveries received for the nine months ended September 30, 2007 and 2006 and gross case basis credit reserves and total gross loss reserves at September 30, 2007 and December 31, 2006:

(Dollars in millions)	Nine Months Ended September 30, 2007			Nine Months Ended September 30, 2006
Net losses (recovered)/ paid:
Public Finance	$	(7.4	)	$	5.9
Structured Finance		(0.6	)		23.0
International Finance		(3.2	)		(1.1	)
Total	$	(11.2	)	$	27.8

	September 30, 2007				December 31, 2006
(Dollars in millions)	Gross Case Basis Reserves(1)(2)		Total Loss Reserves(3)		Gross Case Basis Reserves(1)(2)			Total Loss Reserves(3)
Public Finance	$	51.1	$	179.7	$	45.7		$	195.0
Structured Finance		66.3		103.6		(0.2	)		21.6
International Finance		0		0.8		2.0			3.5
Total	$	117.4	$	284.1	$	47.5		$	220.1

⁽¹⁾ Ambac discounts estimated net payments using discount rates that approximate the average taxable equivalent yield on our investment portfolio. Discount rates applied to case basis credit reserves were 4.5% at September 30, 2007 and at December 31, 2006.

41

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

⁽²⁾ Reinsurance recoverables on case basis credit reserves were $10.3 million and $5.0 million at September 30, 2007 and December 31, 2006, respectively.

⁽³⁾ Included in the calculation of active credit reserves at September 30, 2007 and December 31, 2006 was the consideration of $13.2 million and $5.0 million, respectively, of reinsurance which would be due to Ambac Assurance from the reinsurers, upon default of the insured obligations.

Active credit reserves were $166.7 million and $172.6 million at September 30, 2007 and December 31, 2006, respectively. The active credit reserve at September 30, 2007 and December 31, 2006 was comprised of 48 and 55 credits with net par outstanding of $1,860 million and $3,831 million, respectively. The decrease in net par outstanding of credits within the active credit reserve was driven primarily by upgrades in Hurricane Katrina-related credits, exposure paydowns, and transfers to case basis credit reserves, offset by downgrades in the residential mortgage-backed security sector. During 2007, five residential mortgage-backed transactions defaulted. Net par outstanding for these transactions was $369.1 million at September 30, 2007.

Case basis credit reserves at September 30, 2007 and December 31, 2006 were comprised of 10 credits and 7 credits with net par outstanding of $822.1 million and $668.4 million, respectively. The increase in case basis credit reserves net par is primarily due to the default of several mortgage-backed transactions.

At September 30, 2007, the expected future claim payments on credits that have already defaulted, totaled $199.3 million. Related future payments are $8.3 million, $29.4 million, $22.0 million, $16.7 million and $13.7 million for the remainder of 2007, 2008, 2009, 2010 and 2011, respectively.

Please refer to the “Critical Accounting Policies and Estimates” section of this Management’s Discussion and Analysis and to Note 3 of the Consolidated Financial Statements for further background information on loss reserves, our policy and for further explanation of potential changes.

Underwriting and Operating Expenses. Underwriting and operating expenses for the three and nine months ended September 30, 2007 were $34.6 million and $104.4 million, respectively, an increase of 15% from $30.2 million in the three months ended September 30, 2006 and an increase of 5% compared to $99.9 million in the nine months ended September 30, 2006, respectively. Underwriting and operating expenses consist of gross underwriting and operating expenses, less the deferral to future periods of expenses and reinsurance commissions related to the acquisition of new insurance contracts, plus the amortization of previously deferred expenses and net reinsurance commissions. The following table provides details of underwriting and operating expenses for the three and nine months ended September 30, 2007 and 2006:

42

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

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in Millions)	2007			2006			2007			2006
Gross underwriting and operating expenses	$	50.6		$	45.7		$	148.7		$	144.1
Net reinsurance commissions received (1)		(9.7	)		(6.9	)		(25.3	)		(17.9	)
Operating expenses and reinsurance commissions deferred (1)		(17.4	)		(19.4	)		(53.0	)		(53.7	)
Amortization of previously deferred expenses (1)		11.1			10.8			34.0			27.4
Underwriting and operating expenses	$	34.6		$	30.2		$	104.4		$	99.9

(1) The 2006 cancellations of reinsurance contracts disclosed above impacted the nine months net reinsurance commissions received by ($10.3) million and the amortization of previously deferred expenses by $8.1 million.

The increases in gross underwriting expenses for the three and nine months ended September 30, 2007 was primarily due to higher premium tax expenses driven by higher writings, particularly in jurisdictions with higher than average premium tax rates.

Financial Guarantee Exposure Draft (“ED”). On April 18, 2007, the FASB issued an ED for public comment entitled “Accounting for Financial Guarantee Insurance Contracts”, an interpretation of SFAS 60 “Accounting and Reporting by Insurance Enterprises”. The proposals contained within the ED are not considered final accounting guidance until the FASB completes its public due process procedures, which is expected to conclude in the first quarter 2008. The FASB’s due process procedures include obtaining the comments from its constituency, including preparers of financial statements, users of financial statements such as investors and rating agencies, and other interested parties such as auditors and regulators. The comment period ended on June 18, 2007 and a roundtable with interested parties was held on September 4, 2007.

Under the ED, Ambac would be required to recognize premium revenue, for both upfront and installment paying policies, in proportion to the insured contractual principal and interest payments made by the issuer of the insured financial obligation, rather than being recognized over the term of each maturity for upfront paying policies, or over the installment period for such policies. This change would generally result in a volatile revenue recognition pattern over the life of the insured obligation as premium would only be recognized as the insured obligation’s principal or interest is paid. Furthermore, for certain bonds such as investor-owned utilities, CDOs and many other types of asset-backed securities that do not have periodic payments, this change would result in significantly slower revenue recognition. The volatility would be most evident for insured securities whereby the principal payments are made at maturity but would also impact insured securities with customized amortization schedules. Furthermore, the majority of our insured public finance book of business has semi-annual principal and interest payments, which would cause uneven revenue recognition throughout each calendar year. For installment paying policies, the ED requires that the discount, equating to the difference between gross installment premiums and the present value of installment premiums, be recognized as investment income rather than premiums.

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

43

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

Financial Services Segment

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

Revenues. Revenues for the three and nine months ended September 30, 2007 were $107.8 million and $336.3 million, a decrease of 7% from $115.4 million in the three months ended September 30, 2006 and a decrease of 6% from $357.6 million in the nine months ended September 30, 2006.

The following table provides a breakdown of Financial Services revenues for the three and nine months ended September 30, 2007 and 2006:

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in Millions)	2007			2006			2007			2006
Investment income	$	120.6		$	107.5		$	334.5		$	287.5
Derivative products		1.2			3.0			7.3			10.9
Net realized investment gains		0.2			6.6			6.6			53.9
Net mark-to-market (losses) gains on total return swaps		(12.9	)		(0.5	)		(10.6	)		6.5
Net mark-to-market losses on non-trading derivative contracts		(1.3	)		(1.2	)		(1.5	)		(1.2	)
Total Financial Services revenue	$	107.8		$	115.4		$	336.3		$	357.6

The increase in investment income for the three and nine months ended September 30, 2007 was driven by higher rates on a larger portfolio of floating rate investments in the investment agreement business. The total return swap portfolio has experienced net mark-to-market losses for the three and nine months ended September 30, 2007 as a result of credit spread widening.

Prior to 2004, realized losses included an impairment write-down of $150.2 million related to asset-backed notes issued by National Century Financial Enterprises, Inc (“NCFE”). These notes, which were backed by health care receivables and rated triple-A until October 25, 2002, defaulted and NCFE filed for protection under Chapter 11 of the U.S. Bankruptcy Code in November 2002. The loss was specific to the NCFE notes and had no impact on other investments held. Ambac has received cash recoveries of $90.3 million through September 30, 2007 resulting from distributions under the NCFE Bankruptcy Plan, payments made by a trust created under the Plan and litigation settlements. Included in those

44

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

recoveries are $0 and $6.2 million received during the three and nine months ended September 30, 2007, respectively, compared to $6.6 million and $50.8 million received during the three and nine months ended September 30, 2006, respectively.

Expenses. Expenses for the three and nine months ended September 30, 2007 were $115.2 million and $321.7 million, respectively, up 15% from $100.2 million in the three months ended September 30, 2006 and up 18% from $272.6 million in the nine months ended September 30, 2006. Included in the above are interest expenses related to investment and payment agreements of $112.0 million and $312.1 million for the three and nine months ended September 30, 2007, respectively, and $97.1 million and $262.6 million for the three and nine months ended September 30, 2006, respectively. The increase was primarily related to higher rates on a larger portfolio of floating rate investment agreements, partially offset by runoff of fixed rate investment agreements.

Corporate Items

Interest Expense. Interest expense for the three and nine months ended September 30, 2007 was $22.2 million and $63.6 million, respectively, up 14% from $19.5 million in the three months ended September 30, 2006 and up 9% from $58.4 million in the nine months ended September 30, 2006. The increase is primarily attributable to the completed public offering of $400 million aggregate principal amount of Directly Issued Subordinated Capital Securities (the “DISCs”) on February 12, 2007, partially offset by the October 2006 redemption of Ambac’s $200 million 7% debentures.

Provision for Income Taxes. Income taxes for the three and nine months ended September 30, 2007 were at an effective rate of 27.1% and 2.4%, respectively, compared to 28.1% and 27.3% for the three and nine months ended September 30, 2006, respectively. The decreases in the 2007 effective tax rate is primarily due to the large unrealized mark-to-market losses recognized in the third quarter of 2007. The quarterly tax provision reflects Ambac’s estimated annual effective tax rate. As a result, in the third quarter of 2007, Ambac recognized only nine months of the income tax benefit related to the unrealized mark-to-market loss. The remainder of the tax benefit is expected to be recognized in the fourth quarter of 2007. The actual income tax benefit to be recognized will depend on the results of the fourth quarter mark-to-market adjustments.

Liquidity and Capital Resources

Ambac Financial Group, Inc. Liquidity. Ambac’s liquidity, both on a short-term basis (for the next twelve months) and a long-term basis (beyond the next twelve months), is largely dependent upon: (i) Ambac Assurance’s ability to pay dividends or make other payments to Ambac; and (ii) external financings. Pursuant to Wisconsin insurance laws, Ambac Assurance may pay dividends, provided that, after giving effect to the distribution, it would not violate certain statutory surplus, solvency and asset tests. Based upon these tests, the maximum amount that will be available during 2007 for payment of dividends without regulatory approval by Ambac Assurance is $370.0 million. Additionally, no quarterly dividend may exceed the dividend paid in the corresponding quarter of the preceding year by more than 15% without notifying the Wisconsin Insurance Commissioner 30 days in advance of payment. Ambac Assurance paid dividends of $142.7 million and $102.0 million during the nine months ended

45

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

September 30, 2007 and 2006. Ambac sought and obtained regulatory approval with respect to the dividends paid in each of the first, second and third quarters of 2007, which exceeded by more than 15% the dividends paid in the first, second and third quarters of 2006, respectively. The increase was primarily necessitated by the issuance of the DISCs in February 2007.

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 during 2007, management believes that Ambac will have sufficient liquidity to satisfy its needs over the next twelve months, including the ability to pay dividends on its common stock in accordance with its dividend policy. Beyond the next twelve months, Ambac Assurance’s ability to declare and pay dividends to Ambac may be influenced by a variety of factors including adverse market changes, insurance regulatory changes and changes in general economic conditions. Consequently, although management believes that Ambac will continue to have sufficient liquidity to meet its debt service and other obligations over the long term, no guarantee can be given that Ambac Assurance will be able to dividend amounts sufficient to pay all of Ambac’s operating expenses, debt service obligations and dividends on its common stock.

A subsidiary of Ambac Financial Group provides a $360 million liquidity facility to a reinsurance company which acts as reinsurer with respect to a portfolio of life insurance policies. The liquidity facility, which is guaranteed by Ambac Assurance, provides temporary funding in the event that the reinsurance company’s capital is insufficient to make payments under the reinsurance agreement. The reinsurance company is required to repay all amounts drawn under the liquidity facility. No amounts have been drawn under this facility at September 30, 2007.

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

Financial Services Liquidity. The principal uses of liquidity by Financial Services subsidiaries are payment of investment and payment agreement obligations pursuant to defined terms, net obligations under interest rate, total return and currency swaps, operating expenses and income taxes. Management believes that its Financial Services liquidity needs can be funded from its operating cash flow, the maturity of its invested assets and from time to time, by short-term inter-company loans and repurchase agreement transactions. The principal sources of this segment’s liquidity are proceeds from issuance of investment agreements, net investment income, maturities of securities from its investment portfolio and net receipts from interest rate, currency and total return swaps. The investment objectives with respect to the investment agreement business are preservation of capital by maintaining a minimum average quality rating of AA on invested assets, maximize the net interest rate spread as compared to investment agreements issued and to maintain a liquid floating rate investment portfolio, which

46

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

includes short-term investments, to minimize interest rate and liquidity risk. As of September 30, 2007, the investment agreement business floating rate investment portfolio approximates $7.0 billion or 87% of the investment portfolio related to the investment agreement business.

Investment agreements subject Ambac to liquidity risk associated with unscheduled withdrawals of principal allowed by the terms of the investment agreements. Ambac manages liquidity risk by characterizing our investment agreements into two broad categories, contingent and fixed. Contingent draw transactions include contractual provisions that allow the investor to withdraw principal and require minimal notice to Ambac. The vast majority of these investment agreements can only be drawn in the event that well-defined, observable events have occurred, primarily credit events. As of September 30, 2007, approximately $5.1 billion relates to contingent draw investment agreements. In addition, many of these contracts contain lock-out periods where unscheduled withdrawals are restricted and provisions which compensate Ambac for break-costs resulting from early withdrawal. As of September 30, 2007, approximately $0.7 billion of contingent draw investment agreements include provisions where our counterparty has the option to withdraw funds prior to maturity during 2007. Fixed draw investment agreements have few provisions for unscheduled withdrawals, however, if permitted, the events triggering the withdrawal are deemed to be remote, require advance notification to Ambac and most often include provisions that compensate Ambac for break costs. As of September 30, 2007, approximately $3.4 billion relates to fixed draw investment agreements, of which $1.8 billion include provisions where under remote circumstances our counterparty has the ability to withdraw funds during 2007.

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

The ratings assigned by Moody’s, S&P, and Fitch are subject to periodic review and may be downgraded by one or more rating agencies as a result of: changes in the views of the rating agencies, adverse developments in our financial condition or results of operations due to underwriting or investment losses. All triple-A ratings were reaffirmed in 2007. At September 30, 2007, Ambac Assurance had stockholder’s equity of $6.9 billion and soft-capital facilities of $0.8 billion. Any downgrade in our financial strength rating, or the placement of our financial strength rating on negative credit watch, would have a material adverse effect on our competitive position and our prospects for future business opportunities. Our results of operations and financial condition would be materially adversely affected by any reduction in its ratings.

Ambac Assurance has a series of perpetual put options on its own preferred stock. The counterparty to these put options are trusts established by a major investment bank. The trusts were created as a vehicle for providing capital support to Ambac Assurance by allowing it to obtain immediate access to new capital at its sole discretion at any time through the exercise of the put option. If the put option were exercised, Ambac Assurance would receive up to $800 million in return for the issuance of its own perpetual preferred stock, the proceeds of which may be used for any purpose, including the payment of claims. The preferred stock would give

47

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

investors the rights of an equity investor in Ambac Assurance. Such rights are subordinate to insurance claims, as well as to the general unsecured creditors of Ambac Assurance. Dividend payments on the preferred stock are cumulative, subject to certain limited exceptions, only if Ambac Assurance pays dividends on its common stock. Each trust is restricted to holding high-quality short-term commercial paper investments to ensure that it can meet its obligations under the put option. To fund these investments, each trust has issued its own auction market perpetual securities. The auction for these securities occurs every 28-days. Beginning in August 2007, a disruption in the auction market caused the auction for these securities to fail. As a result, existing investors were required to maintain their position in the securities and the distribution rate on such securities increased to the maximum rate (100 basis points over one month LIBOR). The impact of this failed auction on Ambac Assurance was an increase in the cost of the put option premium paid to the trusts. Due to the timing of each of the auctions the full impact of the higher put option premium will not be realized until the fourth quarter of 2007. Each trust is rated AA/Aa2 by Standard & Poor’s and Moody’s, respectively. During the nine months ended September 30, 2007 and 2006, Ambac Assurance incurred fees related to these perpetual put options of $2.9 million and $2.6 million, respectively. These fees are included as Corporate expenses on the Consolidated Statements of Operations. 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 February 2006, Ambac filed a Form S-3 with the SEC utilizing a “shelf” registration process for well known seasoned issuers. Under this process, Ambac may issue through February 2009 an unlimited amount of the securities described in the prospectus filed as part of the registration, namely, common stock, preferred stock, debt securities, and warrants of Ambac.

On February 12, 2007, Ambac Financial Group completed the public offering of $400 million aggregate principal amount of DISCs due 2087. The proceeds from the sale of the DISCs was used to repurchase $400 million of Ambac’s common stock pursuant to an accelerated share repurchase program. The total number of common stock purchased under the agreement amounted to 4,459,223 shares.

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

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

Credit Ratings and Collateral. In the event that Ambac Assurance is downgraded, Ambac may be required to post incremental collateral to its investment agreement and derivative counterparties, introducing liquidity risk. In addition, most investment agreements provide certain remedies, including a termination of the investment agreement contract in the event of a downgrade of Ambac Assurance’s credit rating, typically to A1 by Moody’s or A+ by S&P. In most cases Ambac is permitted to post collateral or otherwise enhance its credit, prior to an actual draw on the investment agreement.

48

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

The financial services business executes a range of interest rate and cross-currency swaps to reduce the market risk on investment agreements with Ambac’s derivatives subsidiary, Ambac Financial Services, LLC. In addition, Ambac Financial Services provides interest rate and currency swap transactions for states, municipalities, asset-backed issuers and other entities in connection with their financings. Ambac Financial Services offsets most of the interest rate and currency risks in these instruments and incorporates these transactions under standardized derivative documents including collateral support agreements. Under these agreements, Ambac could be required to post collateral to a swap dealer in the event unrealized losses exceed a predetermined threshold amount. Ambac has posted collateral of $0.0 million under these contracts at September 30, 2007. Conversely, Ambac could receive collateral from the counterparty in the event unrealized gains exceed a predetermined threshold. Ambac has received collateral of $190.6 million under these contracts at September 30, 2007. The thresholds afforded Ambac by the swap dealer would be reduced in the event of a downgrade of Ambac’s credit rating. The reduction in the threshold could result in Ambac posting additional amounts of collateral to the counterparty.

Ambac Capital Services enters into total return swaps. All of our total return swaps have collateral support agreements and would require us to pledge collateral as a result of a downgrade or in the event exposure limit losses exceed a predetermined threshold amount. In addition, a downgrade of our financial strength rating below specified levels would allow total return swaps counterparties to terminate certain agreements, resulting in a possible payment of a settlement amount. At September 30, 2007, Ambac has not pledged collateral under any of its total return swap contracts.

Ambac Credit Products enters into credit derivative contracts. Ambac Credit Products is not required to post collateral under any of its contracts.

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

Credit Facilities. On July 30, 2007, Ambac and Ambac Assurance, as borrowers, extended its $400 million five year unsecured, committed revolving credit facility (the “Credit Facility”) with a group of highly rated banks (the “Banks”) from July 28, 2011 to July 30, 2012. The Credit Facility provides for borrowings by Ambac and Ambac Assurance on a revolving basis up to an aggregate of $400 million at any one time outstanding, which maximum amount may, at Ambac’s and Ambac Assurance’s request and subject to the terms and conditions of the facility, be increased up to $500 million.

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

49

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

The Credit Facility contains customary representations, warranties and covenants for this type of financing, including two financial covenants requiring Ambac to: (i) maintain as of the end of each fiscal quarter a debt-to-capital ratio, excluding debt consolidated under FIN 46, the DISCs and credit link notes, of not more than 30%, and (ii) maintain at all times total stockholders’ equity equal to or greater than $2.9 billion. The stockholders’ equity financial covenant will increase annually, in an amount equal to 15% of the prior fiscal year’s net income and 15% of the net proceeds of any future equity issuances. The Credit Facility also provides for certain events of default with corresponding grace periods, including failure to pay any principal or interest when due, failure to comply with covenants, any material representation or warranty made by Ambac or Ambac Assurance proving to be false in any material respect, certain bankruptcy, insolvency or receivership events affecting Ambac or Ambac Assurance, defaults relating to other indebtedness, imposition of certain judgments and a change in ownership of Ambac and/or Ambac Assurance. Ambac and Ambac Assurance are in full compliance with the terms and conditions of the Credit Facility.

Balance Sheet. Total assets as of September 30, 2007 were $21.98 billion, up 8% compared to total assets of $20.27 billion at December 31, 2006. The increase was driven by cash generated from operations during the period, partially offset by a decrease in unrealized gains in the investment portfolio due primarily to a decline in the fair values of mortgage-backed securities. As of September 30, 2007, stockholders’ equity was $5.65 billion, a 9% decrease from year-end 2006 stockholders’ equity of $6.18 billion. The decrease was primarily the result of the $400 million share buyback mentioned above and lower Accumulated Other Comprehensive Income driven by a decline in the fair values of mortgage-backed securities.

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

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

50

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 September 30, 2007 and December 31, 2006 were as follows:

	September 30, 2007				December 31, 2006
(Dollars in millions)	Amortized Cost		Estimated Fair Value		Amortized Cost		Estimated Fair Value
Fixed income securities:
Municipal obligations	$	8,426.5	$	8,592.8	$	7,891.4	$	8,126.8
Corporate obligations		769.8		785.3		692.0		719.6
Foreign obligations		303.9		321.1		269.8		276.8
U.S. government obligations		48.3		48.6		177.2		174.0
U.S. agency obligations		488.1		510.1		757.9		789.4
Mortgage-backed securities		4,654.6		4,536.8		3,653.0		3,646.2
Asset-backed securities		3,208.6		3,189.4		3,043.0		3,067.5
Short-term		686.1		686.1		311.8		311.8
Other		13.5		14.8		13.4		14.4
		18,599.4		18,685.0		16,809.5		17,126.5
Fixed income securities pledged as collateral:
U.S. government obligations		106.4		104.5		—		—
U.S. agency obligations		130.3		147.5		—		—
Mortgage-backed securities		110.1		108.8		311.5		307.1
		346.8		360.8		311.5		307.1
Total	$	18,946.2	$	19,045.8	$	17,121.0	$	17,433.6

51

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

The following table represents the fair value of mortgage-backed securities at September 30, 2007 and December 31, 2006 by classification:

(Dollars in millions)	Financial Guarantee		Financial Services		Corporate		Total
September 30, 2007:
RMBS First Lien – Mid Prime	$	—	$	3,185.3	$	—	$	3,185.3
U.S. Government Sponsored Enterprise Mortgages		787.5		250.4		—		1,037.9
RMBS Second Lien		—		181.2		—		181.2
Other		7.0		234.2		—		241.2
Total	$	794.5	$	3,851.1	$	—	$	4,645.6
December 31, 2006:
RMBS First Lien – Mid Prime	$	—	$	2,467.3	$	—	$	2,467.3
U.S. Government Sponsored Enterprise Mortgages		892.6		419.0		—		1,311.6
RMBS Second Lien		—		91.2		—		91.2
Other		8.1		75.1		—		83.2
Total	$	900.7	$	3,052.6	$	—	$	3,953.3

52

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

The following table summarizes, for all securities in an unrealized loss position as of September 30, 2007 and December 31, 2006, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position:

	September 30, 2007				December 31, 2006
(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	$	805.3	$	6.7	$	658.5	$	3.4
7–12 months		628.5		13.9		69.9		0.6
Greater than 12 months		1,187.5		11.5		1,129.3		16.7
		2,621.3		32.1		1,857.7		20.7
Corporate obligations in continuous unrealized loss for:
0 – 6 months		113.2		2.1		34.6		0.1
7 – 12 months		58.1		1.6		33.2		0.2
Greater than 12 months		57.2		2.7		50.9		0.8
		228.5		6.4		118.7		1.1
Foreign obligations in continuous unrealized loss for:
0 – 6 months		32.5		0.4		78.8		0.9
7 – 12 months		42.3		0.2		26.5		0.3
Greater than 12 months		41.4		0.3		13.1		0.2
		116.2		0.9		118.4		1.4
U.S. government obligations in continuous unrealized loss for:
0 – 6 months		59.4		1.4		23.1		0.1
7 – 12 months		—		—		—		—
Greater than 12 months		32.2		0.5		128.4		3.1
		91.6		1.9		151.5		3.2
U.S. agency obligations in continuous unrealized loss for:
0 – 6 months		4.1		0.1		239.1		1.2
7 – 12 months		39.9		0.2		—		—
Greater than 12 months		54.3		0.8		234.1		5.2
		98.3		1.1		473.2		6.4
Mortgage-backed securities in continuous unrealized loss for:
0 – 6 months		3,220.1		93.8		368.7		1.4
7 – 12 months		512.3		18.3		52.1		0.3
Greater than 12 months		717.7		17.3		1,067.0		24.1
		4,450.1		129.4		1,487.8		25.8
Asset-backed securities in continuous unrealized loss for:
0 – 6 months		1,586.1		23.9		58.2		0.5
7–12 months		125.9		6.2		23.4		0.3
Greater than 12 months		108.9		4.1		110.4		0.4
		1,820.9		34.2		192.0		1.2
Other in continuous unrealized loss for:
0 – 6 months		0.1		—		0.3		—
7–12 months		0.1		—		0.2		—
Greater than 12 months		—		—		—		—
		0.2		—		0.5		—
Total	$	9,427.1	$	206.0	$	4,399.8	$	59.8

53

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

Management has determined that the unrealized losses in fixed income securities at September 30, 2007 are primarily attributable to the current interest rate environment and the recent lack of liquidity in the mortgage-backed security market. These mortgage-backed securities are predominately rated AAA. Ambac has concluded that unrealized losses are temporary in nature based upon (i) no principal and interest payment defaults on these securities; (ii) analysis of the creditworthiness of the issuers; and (iii) Ambac’s ability and current intent to hold these securities until a recovery in fair value or maturity. Of the $9,427.1 million that were in a gross unrealized loss position at September 30, 2007, below investment grade securities and non-rated securities had a fair value of $0.1 million and an unrealized loss of $0.01 million. Of the $4,399.8 million that were in a gross unrealized loss position at December 31, 2006, below investment grade securities and non-rated securities had a fair value of $0.5 million and an unrealized loss of less than $0.1 million.

There were no impairment write-downs during the three and nine months ended September 30, 2007 and $0.0 and $0.1 million during the three and nine months ended September 30, 2006, respectively. The net realized investment gains were primarily the result of the NCFE impairment recoveries received in the nine months ended September 30, 2007 and 2006. Other net realized investment gains and losses in the nine months ended September 30, 2007 and 2006 were the result of security sales made in the ordinary course of business in order to achieve Ambac’s investment objectives for the Financial Guarantee and Financial Services investment portfolios.

The following table provides the ratings distribution of the fixed income investment portfolio at September 30, 2007 and December 31, 2006:

Rating (1) : September 30, 2007:	Financial Guarantee		Financial Services		Combined
AAA	88	%	91	%	89	%
AA	11		4		8
A	1		5		3
BBB	<1		—		<1
Below investment grade	—		<1		<1
Not Rated	<1		—		<1
	100	%	100	%	100	%
December 31, 2006:
AAA	87	%	91	%	89	%
AA	11		3		8
A	1		5		3
BBB	<1		1		<1
Below investment grade	—		<1		<1
Not Rated	<1		—		<1
	100	%	100	%	100	%

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

54

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

Ambac’s fixed income portfolio includes securities covered by guarantees issued by Ambac Assurance (“insured securities”). The published ratings on these securities are triple-A by the major rating agencies as a result of the Ambac Assurance insurance policy and are reflected in the above table as AAA. Rating agencies generally do not publish separate underlying ratings (those ratings excluding the Ambac Assurance insurance) because the insurance cannot be legally separated from the underlying security by the insurer. Ambac obtains underlying ratings through ongoing dialog with rating agencies. In the event these underlying ratings are not available from the rating agencies, Ambac will assign an internal rating. At September 30, 2007, securities with a total carrying value of $666.3 million representing 3% of the investment portfolio with a weighted-average underlying rating of BBB was insured by Ambac. In determining this BBB rating, approximately $130.5 million of the securities were assigned internal ratings by Ambac.

Special Purpose and Variable Interest Entities. Information regarding special purpose and variable interest entities can be found in the Notes to the Unaudited Consolidated Financial Statements of this Form 10-Q.

Cash Flows. Net cash provided by operating activities was $827.9 million and $671.5 million during the nine months ended September 30, 2007 and 2006, respectively. These cash flows were primarily provided by Financial Guarantee operations. The increase in cash provided by operating activities is primarily due to net claim recoveries in 2007 and higher net insurance premium receipts, partially offset by the proceeds from the 2006 sale of three aircraft. Future net cash provided by operating activities will be impacted by the level of premium collections and claim payments.

Net cash provided by financing activities was $1,104.5 million and $511.1 million during the nine months ended September 30, 2007 and 2006, respectively. Financing activities for the nine months ended September 30, 2007 included $846.3 million in net investment and payment agreements issued (net of investment and payment agreement draws paid) and the proceeds of the issuance of DISCs of $393.3 million, partially offset by purchases of treasury shares of $449.4 million. Financing activities for the nine months ended September 30, 2006 included $511.3 million in net investment and payment agreements issued (net of investment and payment agreements draws paid) and purchases of treasury shares of $67.2 million.

Net cash used in investing activities was $1,937.5 million during the nine months ended September 30, 2007, of which $3,361.0 million, $374.4 million and $245.2 million, was used to purchase bonds, short-term securities and loans, respectively, partially offset by proceeds from sales and maturities of bonds of $1,765.9 million. For the nine months ended September 30, 2006, $1,169.6 million was used in investing activities, of which $3,936.9 million was used to purchase bonds, partially offset by the proceeds and maturities of bonds of $2,261.2 million.

Net cash (used in) provided by operating, investing and financing activities was ($5.1) million and $13.0 million during the nine months ended September 30, 2007 and 2006, respectively.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

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

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

All financial guarantees and credit derivatives issued are subject to a formal credit underwriting process. Various factors affecting the creditworthiness of the underlying obligation are evaluated during the underwriting process. Senior credit personnel approve all transactions prior to issuing a financial guarantee. Subsequent to the issuance of a financial guarantee, credit personnel perform periodic reviews of exposures according to a schedule based on the risk profile of the guaranteed obligations or as necessitated by specific credit events or other macro-economic variables. Proactive credit remediation can help secure rights and remedies which mitigate losses in the event of default.

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

To minimize exposure to significant losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of a rating downgrade of a reinsurer. Ambac Assurance held letters of credit and collateral amounting to approximately $379.2 million from its reinsurers as of September 30, 2007. The rating agencies continually review reinsurers providing coverage to the financial guarantee industry. The following table provides ceded par outstanding by financial strength rating of Ambac Assurance’s reinsurers, on a Standard and Poor’s (“S&P”) basis:

(Dollars in billions)	September 30, 2007		December 31, 2006
AAA	$	21.1	$	20.7
AA		34.0		27.7
Total	$	55.1	$	48.4

Market Risk. Market risk represents the potential for losses that may result from changes in the value of a financial instrument as a result of changes in market conditions. The primary market risks that would impact the value of Ambac’s financial instruments are interest

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

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

Financial instruments that may be adversely affected by changes in interest rates consist primarily of investment securities, loans, investment agreement liabilities, obligations under payment agreements, long-term debt, and interest rate derivative contracts.

Ambac, through its subsidiary Ambac Financial Services, is a provider of interest rate swaps to states, municipalities and their authorities and other entities in connection with their financings. Ambac Financial Services manages its municipal interest rate swaps business with the goal of being market neutral to changes in overall rates while retaining some basis risk. Ambac’s municipal interest rate swap portfolio may be adversely affected by changes in basis. If actual or projected tax-exempt interest rates increased in a parallel shift by 1% in relation to taxable interest rates, Ambac would experience a market-to-market loss of $0.04 million at both September 30, 2007 and December 31, 2006, respectively.

A portion of the municipal interest rate swaps transacted by Ambac Financial Services contain provisions that are designed to protect Ambac against certain forms of tax reform, thus mitigating its basis risk. The estimation of potential losses arising from adverse changes in market relationships, known as VaR, is a key element in management’s monitoring of basis risk for the municipal interest rate swap portfolio. Ambac has developed a VaR methodology to estimate potential losses using a one day time horizon and a 99% confidence level. This means that Ambac would expect to incur losses greater than that predicted by VaR estimates only once in every 100 trading days, or about 2.5 times a year. Ambac’s methodology estimates VaR using a 300-day historical “look back” period. This means that changes in market values are simulated using market inputs from the past 300 days. 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 credit derivative and total return contracts. Ambac, through its subsidiary Ambac Credit Products, enters into credit derivative contracts. These contracts require Ambac Credit Products to make payments upon the occurrence of certain defined credit events relating to an underlying obligation (generally a fixed income obligation). If credit

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

spreads of the underlying obligations change, the fair value of the related credit derivative changes. Market liquidity could also impact valuations of the underlying obligations. As such, Ambac Credit Products could experience mark-to-market gains or losses. Changes in credit spreads are generally caused by changes in the market’s perception of the credit quality of the underlying obligations. Ambac offers credit derivatives to provide credit protection enabling financial institutions to hedge portfolios of credit risk achieving either economic or regulatory relief. Ambac Credit Products structures its contracts with first loss or other financial protection. Such structuring mitigates Ambac Credit Products’ risk of loss and generally reduces the mark-to-market volatility of these credit derivatives.

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

The following table summarizes the estimated change in fair values on the net balance of Ambac’s net structured credit and total return swap derivative positions assuming immediate parallel shifts in spreads across all underlying asset classes at September 30, 2007:

(Dollars in millions) Change in Underlying Spreads	Estimated Net Cumulative Fair			Estimated Gain/ (Loss)
September 30, 2007:
100 basis point widening	$	(2,025	)	$	(1,229	)
50 basis point widening		(1,410	)		(614	)
25 basis point widening		(1,103	)		(307	)
10 basis point widening		(919	)		(123	)
Base scenario		(796	)		—
10 basis point narrowing		(674	)		122
25 basis point narrowing		(501	)		295
50 basis point narrowing		(273	)		523
100 basis point narrowing		(51	)		745

The impact of changes in credit spreads will vary based upon the volume, tenor, interest rates, and other market conditions at the time these fair values are determined. In addition, since each transaction has unique collateral and structure terms, the underlying change in fair value of each transaction may vary considerably and may be impacted differently in the current market environment. For instance, we have observed greater volatility and lower prices for CDOs containing exposure to lower investment grade RMBS. We expect these market dynamics to continue until uncertainty regarding investment grade collateral is reduced. During the third quarter of 2007, Ambac incurred net mark-to-market losses on credit derivative contracts of ($743.4) million related primarily to credit derivatives on CDOs of ABS containing sub-prime RMBS exposure and CLOs containing corporate credit risk. During the third quarter of 2007, spreads on the underlying CDO of ABS including CDO of CDO securities widened by an average of approximately 88 basis points, resulting in mark-to-market losses of ($529) million. Also during the third quarter of 2007, spreads on underlying corporate CLO obligations widened by an average of 40 basis points, causing a mark-to-market loss of ($122) million. This credit spread widening and resulting negative mark-to-market is driven by lower prices in certain structured finance asset classes which are reflected in the fair value of our credit derivatives. The lower prices were driven by uncertainty regarding the ultimate outcome of sub-prime mortgage losses and the quality of high yield corporate loans. These

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

uncertainties, along with reduced demand for certain structured asset classes, a lack of liquidity in the markets and forced selling by structured and/or leveraged investment vehicles, all combined to exacerbate pricing declines across the structured debt capital markets. In October 2007, the independent rating agencies downgraded a number of MBS and CDO transactions. Our CDO of ABS transactions contain exposures to some of these downgraded transactions, which may impact pricing of such securities. Reductions to the prices of these securities will cause mark-to-market losses in the fourth quarter of 2007.

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

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

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

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

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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. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on this evaluation, Ambac Financial Group’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Ambac Financial Group’s disclosure controls and procedures are effective at the reasonable assurance level in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Ambac Financial Group (including its consolidated subsidiaries) in the reports that it files or submits under the Exchange Act.

(b) Changes in Internal Controls Over Financial Reporting. There have not been any changes in Ambac Financial Group’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during Ambac Financial Group’s fiscal quarter ended September 30, 2007 that have materially affected, or are reasonably likely to materially affect, Ambac Financial Group’s internal control over financial reporting.

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PART II - OTHER INFORMATION

Items 1, 3, 4 and 5 are omitted either because they are inapplicable or because the answer to such question is negative.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds

The Board of Directors of Ambac, has authorized the establishment of a stock repurchase program that permits the repurchase of up to 24,000,000 shares of Ambac’s Common Stock. Ambac will only repurchase shares of its Common Stock under the repurchase program where it feels that it is economically attractive to do so and is in conformity with regulatory and rating agency guidelines. The following table summarizes Ambac’s repurchase program during the third quarter of 2007 and shares available at September 30, 2007:

	Total Shares Purchased (1)	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan (1)	Maximum Number of Shares That May Yet Be Purchased Under the Plan
July 2007	10,460	$	77.28	10,460	4,189,886
August 2007	250,229	$	75.55	250,229	3,939,657
September 2007	—	$	—	—	3,939,657
Third quarter 2007	260,689	$	75.62	260,689	3,939,657

(1) All shares repurchased were pursuant to a stock repurchase program authorized by Ambac’s Board of Directors, for settling awards under Ambac’s long-term incentive plans.

On February 12, 2007, Ambac issued $400 million of Directly-Issued Subordinated Capital Securities (“DISCS”). Ambac used the net proceeds from the offering and additional funds to purchase $400 million worth of shares of its common stock through an accelerated share repurchase program. Common stock purchased through the accelerated share repurchase program resulted in 4,459,223 shares being acquired during the nine months ended September 30, 2007.

From October 1, 2007 through November 2, 2007, Ambac has not repurchased any shares of its Common Stock under its stock repurchase program.

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PART II - OTHER INFORMATION (Continued)

Item 6 - Exhibits

The following are annexed as exhibits:

Exhibit Number	Description
10.45	Ambac Financial Group, Inc. Form of Amended and Restated Management Retention Agreement.
10.46	Ambac Financial Group, Inc. Deferred Compensation Plan for Outside Directors as amended through October 22, 2007.
10.47	Ambac Financial Group, Inc. 1997 Equity Plan Deferred Compensation Sub-Plan for Eligible Senior Officers amended through October 22, 2007.
10.48	Ambac Financial Group, Inc. Supplemental Pension Plan amended and restated as of January 1, 2008.
10.49	Ambac Financial Group, Inc. Non-Qualified Savings Incentive Plan amended and restated as of January 1, 2007.
10.50	Form of Stock Option Award.
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.
99.07	Ambac Assurance Corporation and Subsidiaries Consolidated Unaudited Financial Statements as of September 30, 2007 and December 31, 2006 and for the periods ended September 30, 2007 and 2006.

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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: November 9, 2007	By:	/s/ Sean T. Leonard
		Sean T. Leonard
		Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and Duly Authorized Officer)

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INDEX TO EXHIBITS

Exhibit Number	Description
10.45	Ambac Financial Group, Inc. Form of Amended and Restated Management Retention Agreement.
10.46	Ambac Financial Group, Inc. Deferred Compensation Plan for Outside Directors as amended through October 22, 2007.
10.47	Ambac Financial Group, Inc. 1997 Equity Plan Deferred Compensation Sub-Plan for Eligible Senior Officers amended through October 22, 2007.
10.48	Ambac Financial Group, Inc. Supplemental Pension Plan amended and restated as of January 1, 2008.
10.49	Ambac Financial Group, Inc. Non-Qualified Savings Incentive Plan amended and restated as of January 1, 2007.
10.50	Form of Stock Option Award.
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.
99.07	Ambac Assurance Corporation and Subsidiaries Consolidated Unaudited Financial Statements as of September 30, 2007 and December 31, 2006 and for the periods ended September 30, 2007 and 2006.

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EX-10.45

Exhibit 10.45

AMENDED AND RESTATED MANAGEMENT RETENTION AGREEMENT

AMENDED AND RESTATED MANAGEMENT RETENTION AGREEMENT (this “Agreement”), made as of [            ], 2007, by and between AMBAC FINANCIAL GROUP, INC., a Delaware corporation (the “Company”), and the executive officer named on the signature page of this Agreement (the “Executive”).

W I T N E S S E T H:

WHEREAS, the Executive is currently a valued key executive of the Company or one of its Affiliates (as defined below); and

WHEREAS, the Compensation Committee (the “Committee”) of the Board of Directors of the Company (the “Board”), recognizes that in the event of a future change in control of the Company, or any threatened change in control, uncertainty and questions could rise among management and could result in the departure or distraction of management personnel to the detriment of the Company and its stockholders; and

WHEREAS, the Company considers it essential to the best interests of its stockholders to foster the continuous employment of key management personnel, such as the Executive, in the event of any actual or threatened change in control by providing for the payment of severance and other benefits in the event of the Executive’s termination of employment following a change in control; and

WHEREAS, the Company and the Executive have previously entered into a Management Retention Agreement intended to achieve the purposes described in the foregoing Whereas clauses and now wish to amend and restate such Agreement so that its application does not subject the Executive to interest or additional tax under Section 409A of the Internal Revenue Code of 1986, as amended (together with the rules, regulations and guidance thereunder, the “Code”);

NOW, THEREFORE, in consideration of the covenants and agreements herein contained, the parties hereto agree as follows:

1. Employment and Duties.

The Company hereby agrees to employ the Executive in the capacity indicated on the signature page of this Agreement (or such other, superior position to which the Executive may be promoted by the Company in its discretion), and the Executive hereby accepts such employment. During the Term, as defined in Section 2 below, the Executive shall have such duties as may be assigned to the Executive from time to time by the Board or the Board’s designee which are commensurate with the duties of the Executive in the capacity indicated on the signature page of this Agreement (or such other, superior position to which the Executive may be promoted by the Company in its discretion). The Executive shall devote substantially all his business time, attention, skill and efforts during the Term to the faithful performance of his duties hereunder and shall not accept employment elsewhere during the Term.

2. Term.

The term of the Executive’s employment under this Agreement (the “Term”) shall commence on the date of any Change in Control (as defined in Section 8(i) of this Agreement)

occurring after the date hereof and shall continue in effect through the third anniversary thereof. Anything in this Agreement to the contrary notwithstanding, if a Change in Control occurs and if the Executive’s employment with the Company is terminated prior to the date on which the Change in Control occurs, and if it is reasonably demonstrated by the Executive that such termination of employment (i) was at the request of a third party who has taken steps reasonably calculated to effect a Change in Control or (ii) otherwise arose in connection with or anticipation of a Change in Control, then for all purposes of this Agreement the Term shall be considered to have commenced on the date immediately prior to the date of the Executive’s termination of employment, rather than on the date of such Change in Control. The provisions of this Agreement shall continue in effect beyond the Term to the extent necessary to carry out the intentions of the parties hereto.

3. Compensation.

During the Term, the Executive shall be entitled to the following compensation for his services to the Company:

(a) Base Salary. The Company shall pay, and the Executive shall accept, a base salary (the “Base Salary”) at a rate no less than the Executive’s base salary in effect immediately prior to the Change in Control, subject to increase in accordance with the immediately succeeding sentence. The Base Salary shall be payable biweekly in equal installments (or if the Company alters its payroll policy, in accordance with the Company’s customary payroll policies in force at the time of payment, but no less frequently than monthly), less any required or authorized payroll deductions. The Base Salary shall be reviewed at least annually by the Committee and may be increased, but not decreased, to reflect the Executive’s performance and shall be increased to provide the Executive with such other increases as shall be consistent with increases in base salary awarded in the ordinary course of business to other key executives of the Company or of any Affiliate.

(b) Cash Bonus. In addition to the Base Salary, the Executive shall be paid for each full or partial fiscal year of the Company during the Term, an annual cash bonus (the “Bonus”) pursuant to the current bonus and incentive plans of the Company, as may be amended or supplemented by the Company during the Term; provided, however, that such annual Bonus shall in no event be less than 70% of the Base Salary payable to the Executive for the relevant fiscal year. Bonuses shall be paid in cash to the Executive no later than 30 days following the close of each fiscal year during and immediately following the Term.

(c) Equity Awards. Upon the occurrence of a Change in Control, the Executive shall be fully vested in all stock options, restricted stock, restricted stock units and any other awards theretofore awarded to him under the Ambac Financial Group, Inc.’s 1997 Equity Plan, as amended (the “1997 Equity Plan”), or any successor thereto, on or after January 1, 1998 provided, however, that if any Person (as defined in Section 8 hereof) commences a tender offer for shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), which, if successfully completed, would result in a Change in Control, then the Executive shall be fully vested in all such stock options, restricted stock units and any other such awards, and any such awards that by their terms are to be paid or settled by the delivery of shares of Common Stock without the payment of any additional consideration by the Executive shall be so paid or settled, immediately prior to the scheduled expiration of such tender offer, and the Company shall have instituted procedures to enable the Executive, if he so desires, to tender the shares issued upon the exercise of such stock options or delivered in payment or settlement of such restricted stock units or other awards into such offer.

(d) Incentive, Savings and Retirement Plans. In addition to the Base Salary and Bonuses payable pursuant to this Agreement, the Executive shall be entitled to participate in incentive, savings and retirement plans and programs, whether qualified or non-qualified, of the

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Company and its Affiliates applicable to other key executives (including, without limitation, the following plans of the Company and its Affiliates: the 1997 Equity Plan, the Ambac Financial Group, Inc. Savings Incentive Plan, the Ambac Financial Group, Inc. 1997 Equity Plan - Senior Officer Deferred Compensation Sub-Plan of the 1997 Equity Plan, the Ambac Financial Group, Inc. Non-Qualified Savings Incentive Plan or substantially equivalent successor or substitute plans), providing, in each case, a level of compensation (including target payouts, where applicable) and benefits no less favorable than in effect immediately prior to the Change in Control. To the extent applicable, the benefits provided to the Executive pursuant to this Section 3(d) shall be provided and paid in compliance with the relevant requirements of Section 409A of the Code.

(e) Welfare Benefit Plans. The Executive and/or the Executive’s family, as the case may be, shall be eligible for participation in and shall receive all benefits under each welfare benefit plan of the Company applicable to other employees of the Company generally, including, without limitation, all medical, dental, disability, group life, accidental death and travel accident insurance plans and programs of the Company and its Affiliates, upon terms, and at a level of participation, no less favorable than applicable to other similarly situated employees of the Company and its Affiliates.

(f) Expenses. The Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by him in the performance of his duties for the Company which shall be paid to him in accordance with the policies and procedures of the Company as in effect at any time thereafter with respect to other similarly situated employees of the Company and its Affiliates.

(g) Fringe Benefits. The Executive shall be entitled to fringe benefits on the same terms as in effect immediately prior to the Change in Control.

(h) Office and Support Staff. The Executive shall be entitled to an office or offices of a size and with furnishings and other amenities, and to secretarial and other assistance, at least equal to those used by the Executive immediately prior to the Change in Control.

(i) Vacation. The Executive shall be entitled to four weeks of paid vacation per year, or such longer period as the Company shall institute for senior executives, and paid holidays in accordance with the policies of the Company as in effect at any time.

(j) Application of Severance Policies After the Term. Upon the expiration of the Term, the Executive shall become a participant in the most favorable severance policy applicable to similarly situated executives of the Company and its Affiliates (other than as agreed to as part of individual employment agreements), with all years of service with the Company and any Affiliate counted for purposes of the calculation of such severance benefits.

4. Termination of Employment.

(a) Termination for Cause; Resignation without Good Reason. The Company may terminate the Executive’s employment hereunder for Cause (as defined in Section 8(a) of this Agreement). If the Executive’s employment is terminated by the Company for Cause, or by the Executive for reasons other than Good Reason (as defined in Section 8(b) of this Agreement) prior to the expiration of the Term, the Company shall be obligated to make payment of any Compensation (as defined in Section 8(h) of this Agreement) earned prior to the Date of Termination (as defined in Section 8(d) of this Agreement) but not yet paid to the Executive and any payment from any employee benefit plan described in Section 3 of this Agreement which shall be paid in accordance with such plan and the continuation of coverage under any insurance program as required under any such benefit plan or which may be required by law. The Executive shall also be entitled to the

3

payment of any Bonus earned but not yet paid, including, without limitation, any deferred Bonus, and the pro rata amount of the guaranteed minimum Bonus under Section 3(b) of this Agreement if the Date of Termination occurs before the end of any fiscal year. Except as provided above, the Company shall not be obligated to make any additional payments of Compensation or benefits specified in Section 3 of this Agreement for any periods after the Date of Termination.

(b) Resignation for Good Reason; Termination without Cause. If the Executive’s employment is terminated by the Executive for Good Reason or by the Company without Cause, in either case at any time prior to the expiration of the Term, the Executive shall be entitled to the following benefits:

(i) In addition to the payment of all Base Salary and any Bonus earned but not paid, or a pro rata portion of the guaranteed minimum Bonus under Section 3(b) of this Agreement if the Date of Termination occurs prior to the end of any fiscal year, on a date (the “Payment Date”) that shall be determined by the Company and shall be within sixty (60) days following the date of the Executive’s Separation from Service (as defined in Section 8) the Company shall make a lump sum payment to the Executive equal to two times the sum of:

(x) his highest Base Salary, plus

(y) the highest Bonus percentage paid or payable to the Executive at any time prior to his Date of Termination times his highest Base Salary

(the sum of the amounts described in the foregoing clauses (x) and (y) being referred to as the “Reference Amount”). For purposes of calculating the Reference Amount, “Bonus” shall include cash bonus, including any portion of cash bonus that is deferred at the election of the Executive (including deferrals in the form of restricted stock or restricted stock units or other awards granted in lieu of cash), but shall exclude the value of any other awards.

(ii) On the Payment Date, the Company shall make a lump sum payment to the Executive equal to the amount that the Company would have contributed for the Executive’s account under the Ambac Financial Group, Inc. Savings Incentive Plan (or any successor plan) (the “SIP”) in respect of the two years following the Termination Date, based on (A) the formula for determining employer contributions in effect on the Termination Date and (B) the Base Salary (and, if such formula takes account of bonus compensation, the Bonus) used for purposes of determining the Reference Amount, and calculated without giving effect to the limitations provided for in Sections 401(a)(17) and 415 of the Code or any successor provisions thereto.

(iii) In accordance with the terms of the Ambac Financial Group, Inc. Non-Qualified Savings Incentive Plan (which is a nonqualified plan maintained by the Company and its Affiliates to provide benefits in excess of those permitted under the Code to be provided by the SIP), on the date that is six months and one day following the date that the Executive incurs a Separation from Service, the Executive shall receive a lump sum payment of his account balance. The amount of such distribution shall be based upon the Executive’s account balance as of the date of the Executive’s Separation from Service.

(iv) For a period of two years following the Date of Termination (the “Continuation Period”), the Executive and his dependents, if any, shall continue to participate (at no greater expense to them than was the case for such coverage prior to his termination) in the employee benefit arrangements described in Section 3(e) and 3(g) above, provided, however, that the benefits described in Section 3(e) shall cease to the extent the Executive begins coverage under plans of a subsequent employer.

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(v) At the end of the Continuation Period, the Executive and his family shall be entitled for the remainder of his life to retiree medical and dental benefits under the applicable plans and programs of the Company as if he retired on the last day of the Continuation Period, with such benefits to commence immediately at the end of the Continuation Period and with the amount of contribution by the Executive to be no greater than that of any other employee of the Company who had retired on the last day of the Continuation Period (it being understood and agreed that contribution rates may be changed, and the terms of such benefits may be modified, to the extent permitted under the relevant plans, from those in effect on the date hereof).

(vi) During the Continuation Period, the Company shall provide the Executive with reasonable individual outplacement services and financial planning at the Company’s expense.

(vii) To the extent not previously vested pursuant to Section 3(c) above, the Executive shall be fully vested in all stock options, restricted stock, restricted stock units and any other awards theretofore awarded to him under the Company’s 1991 Stock Incentive Plan, as amended, or the 1997 Equity Plan, or any successor thereto.

(viii) The Executive shall receive all amounts due to him under any compensatory plan or arrangement of the Company and not specifically addressed above, in accordance with the terms of the relevant plan or arrangement.

In the interest of clarity, it is noted that this Section 4(b) shall not apply in the event the Executive’s employment terminates by reason of death, Permanent Disability or Retirement, and that the consequences of such terminations of employment shall instead be governed by Section 4(c), 4(d) or 4(e), as applicable.

(c) Death Before End of Term. If the Executive dies prior to the expiration of the Term, the Company shall be under no obligation to make additional payments of the Compensation and benefits described in Section 3 of the Agreement to the Executive’s estate after the Date of Termination except, however, for any Compensation earned prior to the Date of Termination but not yet paid, including, without limitation, any deferred Bonus and the pro rata amount of the guaranteed minimum Bonus under Section 3(b) of this Agreement if the Date of Termination occurs before the end of a fiscal year, and all benefits payable under the various plans described in Section 3 of this Agreement, which shall be paid in accordance with the terms of all such applicable plans. The Company shall also continue to provide any benefits to the Executive’s survivors as required by law.

(d) Disability. In the event of the Executive’s Permanent Disability (as defined in Section 8(h) of this Agreement) prior to the expiration of the Term, the Executive’s employment shall terminate on the date specified in the definition of “Separation from Service” set forth in Section 8(j) of this Agreement. In that event, the Executive shall be entitled to continue to receive payment in a lump sum of the Compensation and benefits described in Section 3 of the Agreement that the Executive would have earned through the end of the Term had his employment not been terminated, less the amount of any payment to the Executive on account of disability from any employer sponsored disability insurance plan. The Company shall make such lump sum payment to the Executive on a date that shall be determined by the Company and that shall be within sixty (60) days following the date of the Executive’s Separation from Service. In addition, the Executive shall receive all benefits payable under the various plans described in Section 3 of this Agreement, which shall be paid in accordance with the terms of all such applicable plans.

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(e) Retirement. The Executive may terminate his employment on account of Retirement (as defined in Section 8(f) of this Agreement). The Executive shall not be entitled to any further payments of Compensation or other benefits provided under Section 3 of this Agreement after the Date of Termination, other than any retirement benefit payments from any employer sponsored plan, any Compensation earned prior to the date of Retirement but not yet paid, including, without limitation, any deferred Bonus and the pro rata amount of the guaranteed minimum Bonus under Section 3(b) of this Agreement if the Date of Termination occurs before the end of a fiscal year, and all benefits payable under the various plans described in Section 3 of this Agreement, which shall be paid in accordance with the terms of all such applicable plans.

(f) Notice of Termination Required. No termination of employment by the Executive or by the Company pursuant to this Section 4 shall be effective unless the terminating party shall have delivered a Notice of Termination (as defined in Section 8(c) of this Agreement) to the other party.

(g) Nature of Payments. Any amounts due under this Section 4 are in the nature of severance payments, liquidated damages, or both, and are not in the nature of a penalty.

5. No Obligation to Mitigate.

Following termination of the Executive’s employment, the Executive shall be under no obligation to seek other employment or otherwise to mitigate damages resulting from his termination of employment. In addition, there shall be no offset against amounts due to the Executive under any provision of this Agreement, on account of any remuneration to which the Executive becomes entitled from any Person for whom the Executive subsequently provides services (as an officer, director, employee, independent contractor or otherwise), other than as provided in Section 4(b)(v) relating to continuation of benefits coverage.

6. Certain Additional Payments by the Company.

(a) Anything in this Agreement to the contrary notwithstanding, in the event it shall be determined that any payment or distribution by the Company to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise, but determined without regard to any additional payments required under this Section 6) (a “Payment”) would be subject to the excise tax imposed by the Code or any interest or penalties are incurred by the Executive with respect to such excise tax (such excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the “Excise Tax”), then the Executive shall be entitled to receive an additional payment (a “Gross-Up Payment”) in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments.

(b) Subject to the provisions of Section 6(c), all determinations required to be made under this Section 6, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by KPMG LLP or such other certified public accounting firm as may be jointly designated by the Executive and the Company (the “Accounting Firm”), which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the receipt of notice from the Executive that there has been a Payment, or such earlier time

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as is requested by the Company. All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 6, shall be paid by the Company to the Executive within five days of the receipt of the Accounting Firm’s determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made (“Underpayment”), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to Section 6(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive.

(c) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten business days after the Executive is informed in writing of such claim and shall apprize the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which it gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall:

(i) give the Company any information reasonably requested by the Company relating to such claim,

(ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company,

(iii) cooperate with the Company in good faith in order effectively to contest such claim, and

(iv) permit the Company to participate in any proceedings relating to such claim;

provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 6(c), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further

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provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company’s control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority.

(d) If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 6(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company’s complying with the requirements of Section 6(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 6(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid.

(e) In the event any provision of this Agreement results in the Executive incurring additional taxes (including interest and penalties with respect thereto) under Section 409A of the Code (such additional tax, including such interest and penalties, being referred to as “Section 409A Tax”) on any compensation to which the Executive is entitled pursuant to this Agreement, then the Executive shall be entitled to receive an additional payment (a “Section 409A Gross-Up Payment”) in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) imposed upon the Section 409A Gross-Up Payment, the Executive retains an amount of the Section 409A Gross-Up Payment equal to the Section 409A Tax that he incurs. The Executive shall notify the Company promptly if he believes he has incurred Section 409A Tax on any compensation to which he is entitled under this Agreement.

(f) Notwithstanding the other provisions of this Section 6 and of Section 18(b), all Gross-Up Payments, Underpayments and Section 409A Gross-Up Payments shall be made to the Executive not later than the end of the calendar year following the year in which the Executive remits the related taxes and any reimbursement of the costs and expenses described in Section 6(c) shall be paid not later than the end of the calendar year following the year in which there is a final and nonappealable resolution of, or the taxes are remitted that are the subject of, the related claim.

7. 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) Remedies. The Executive acknowledges that a breach of any of the covenants contained in this Section 7 may result in material irreparable injury to the Company or its Affiliates for which there is no adequate remedy at law, that it will not be possible to measure damages for such injuries precisely and that, in the event of such breach or threat thereof, the Company shall be entitled, in addition to any other rights or remedies it may have, to obtain a temporary restraining

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order and/or a preliminary or permanent injunction enjoining or restraining the Executive from engaging in activities prohibited by this Section 7. In no event, however, shall an asserted violation of the provisions of this Section 7 constitute a basis for deferring or withholding any amounts otherwise payable to the Executive under this Agreement, unless the Company shall have first obtained a final decision, in an arbitration conducted in accordance with Section 17 of this Agreement, finding that the Executive has materially breached the provisions of this Section 7.

8. Definitions.

As used in this Agreement, the following terms shall have the following meanings:

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

(b) Cause. Each of the following shall constitute “Cause”:

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

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

(iii) a material breach of any of the covenants set forth in Section 7 of this Agreement.

Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Cause unless there shall have been delivered to him, together with a Notice of Termination, a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths (3/4ths) of the entire membership of the Board at a meeting of the Board called and held for such purpose (after reasonable notice to the Executive and an opportunity for the Executive, together with his counsel, to be heard before the Board), finding that in the good faith opinion of the Board the Executive was guilty of conduct set forth above in clause (i), (ii) or (iii) above and specifying the particulars thereof in detail.

(c) Change in Control. For purposes of this Agreement, a “Change in Control” shall be deemed to occur on the date on which one of the following events occurs:

(i) the acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Securities Exchange Act of 1934, as amended) of 20% or more of the Common Stock then outstanding, but shall not include any such acquisition by:

(A) the Company;

(B) any Subsidiary of the Company;

(C) any employee benefit plan of the Company or of any Subsidiary of the Company;

(D) any Person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan;

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(E) any Person who as of January 31, 1996 was the beneficial owner of 15% or more of the shares of Common Stock outstanding on such date unless and until such Person, together with all affiliates and associates of such Person, becomes the beneficial owner of 25% or more of the shares of Common Stock then outstanding whereupon a Change in Control shall be deemed to have occurred; or

(F) any Person who becomes the Beneficial Owner of 20% or more, or, with respect to a Person described in clause (E) above, 25% or more, of the shares of Common Stock then outstanding as a result of a reduction in the number of shares of Common Stock outstanding due to the repurchase of shares of Common Stock by the Company unless and until such Person, after becoming aware that such Person has become the beneficial owner of 20% or more, or 25% or more, as the case may be, of the then outstanding shares of Common Stock, acquires beneficial ownership of additional shares of Common Stock representing 1% or more of the shares of Common Stock then outstanding, whereupon a Change in Control shall be deemed to have occurred; or

(ii) individuals who, as of January 29, 1997, constitute the Board, and subsequently elected members of the Board whose election is approved or recommended by at least a majority of such current members or their successors whose election was so approved or recommended (other than any subsequently elected members whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board), cease for any reason to constitute at least a majority of such Board; or

(iii) approval by the stockholders of the Company of (A) a merger or consolidation of the Company with any other corporation, (B) the issuance of voting securities of the Company in connection with a merger or consolidation of the Company (or any Subsidiary) pursuant to applicable stock exchange requirements, or (C) sale or other disposition of all or substantially all of the assets of the Company or the acquisition of assets of another corporation (each, a “Business Combination”), unless, in each case, immediately following such Business Combination, all or substantially all of the individuals and entities who were the beneficial owners of the Common Stock outstanding immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of the then outstanding shares of common stock and 70% of the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company’s assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the Common Stock.

As used herein, “Person” means any individual, firm, corporation, partnership or other entity, and “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.

(d) Compensation. The term “Compensation” shall mean all amounts paid or payable to the Executive pursuant to Sections 3(a), 3(b) and 3(c) of this Agreement.

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(e) Date of Termination. “Date of Termination” shall mean:

(i) in the case of Retirement or death, the date of such event;

(ii) if the Executive’s employment is terminated for Permanent Disability, thirty (30) days after a Notice of Termination is given (provided that the Executive shall not have returned, to the full-time performance of the Executive’s duties during such thirty (30) day period); and

(iii) if the Executive’s employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a termination by the Company (whether with or without Cause) shall not be less than thirty (30) days, and in the case of a resignation by the Executive (whether with or without Good Reason) shall not be less than thirty (30) nor more than sixty (60) days, from the date such Notice of Termination is given).

(f) Good Reason. For purposes of this Agreement, “Good Reason” shall mean, without the Executive’s express written consent, any of the following:

(i) a substantial adverse alteration in the nature or status of the Executive’s authority, duties or responsibilities;

(ii) a material diminution in the Executive’s base compensation (including as “base compensation” any amount permitted to be so included under Treas. Reg. §1.409A-(n)(2)(ii)(A) or any successor provision);

(iii) the relocation of the office of the Executive to a location more than 25 miles from the location where the Executive is employed immediately prior to the Change in Control;

(iv) Any other action or inaction that constitutes a material breach by the Company of this Agreement.

In connection with the foregoing, the Executive and the Company acknowledge and agree that the Compensation and other benefits provided for in this Agreement, and the obligations of the Company pursuant to Section 9, are material terms hereof, and that the Company’s breach of any such provision (excluding for this purpose any isolated, insubstantial and inadvertent breach not taken in bad faith) will be considered a material breach of this Agreement. None of the events or circumstances set forth in clauses (i) through (iv) above shall constitute Good Reason unless the Executive has provided notice to the Company of such event or circumstances within a period of 90 days of the initial existence of the event or circumstance, and the Company has failed to remedy such event or circumstances to the reasonable satisfaction of the Executive within 30 days of its receipt of such notice. In addition, the Executive’s Separation from Service will not be considered to have been for Good Reason unless it occurs not more than two years following the initial existence of the event or circumstance that constitutes Good Reason. The fact that an Executive is eligible for Retirement shall not cause the Executive’s termination of employment to fail to qualify as a Separation from Service for Good Reason.

(g) Notice of Termination. For purposes of this Agreement, a “Notice of Termination” shall mean a written notice which shall indicate the specific termination provision in this Agreement relied upon and, in the case of a termination of the Executive’s employment by the Company for Cause or by the Executive for Good Reason, shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive’s employment under the provision so indicated.

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(h) Permanent Disability. “Permanent Disability” shall mean a disability within the meaning of the long-term disability plan of the Company which covers the Executive immediately prior to the Change in Control.

(i) Retirement. “Retirement” shall mean the voluntary termination of the Executive’s employment by the Executive at age 55 or older after at least five years of continuous service with the Company and its subsidiaries (including service with a corporation or other entity acquired by the Company).

(j) Separation from Service. “Separation from Service” shall mean either (i) the termination of the Executive’s employment with the Company and its affiliates, provided that such termination of employment meets the requirements of a separation of service determined using the default provisions set forth in Treasury Regulation §1.409A-(1)(h) or the successor provision thereto or (ii) such other date that constitutes a separation from service with the Company and its affiliates meeting the requirements of the default provisions set forth in Treasury Regulation §1.409A-(1)(h) or the successor provision thereto; provided, however, that, in the event of the Executive’s Permanent Disability, “Separation from Service” means the date that is 29 months after the first day of disability. For purposes of this definition, “affiliate” means any corporation that is in the same controlled group of corporations (within the meaning of Section 414(b) of the Code) as the Company and any trade or business that is under common control with the Company (within the meaning of Section 414(c) of the Code), determined in accordance with the default provision set forth in Treasury Regulation §1.409A-(1)(h)(3).

9. Successors; Binding Agreement.

(a) The Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company to expressly assume and 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. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as the Executive would be entitled hereunder if the Executive had terminated his employment for Good Reason, except that for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination.

(b) This Agreement shall inure to the benefit of and be enforceable by the Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive should die while any amount would still be payable hereunder if the Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the Executive’s devisee, legatee or other designee or, if there is no such designee, to the Executive’s estate.

10. Indemnification.

The Company will indemnify the Executive to the fullest extent permitted (including payment of expenses in advance of final disposition of a proceeding) by the laws of the State of Delaware, as in effect at the time of the subject act or omission, or by the Certificate of Incorporation and By-Laws of the Company, as in effect at such time or on the date of this Agreement, whichever affords or afforded greatest protection to the Executive, and the Executive shall be entitled to the protection of any insurance policies the Company may elect to maintain generally for the benefit of its directors and officers (and to the extent the Company maintains such

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an insurance policy or policies, the Executive shall be covered by such policy or policies, in accordance with its or their terms, to the maximum extent of the coverage provided for any Company officer or director), against all costs, charges and expenses whatsoever incurred or sustained by him or his legal representatives at the time such costs, charges and expenses are incurred or sustained, in connection with any action, suit or proceeding to which he may be made a party by reason of his being or having been a director, officer or employee of the Company or any subsidiary thereof, or his serving or having served any other enterprise as a director, officer or employee at the request of the Company.

11. 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 address first set forth below in the case of the Company, and to the address set forth on the signature page hereof in the case of the Executive (or, in either case, to such other address as may from time to time be designated by notice by any party hereto for such purpose):

Ambac Financial Group, Inc.

One State Street Plaza

New York, New York 10004

Attn: Chief Executive Officer

Notice shall be deemed given, if by personal delivery, on the date of such delivery or, if by telex or telecopy, on the business day following receipt of answer back or telecopy confirmation or, if by certified mail, on the date shown on the applicable return receipt.

12. Amendment and Waiver.

No provision of this Agreement may be amended, modified, waived or discharged unless such amendment, modification, waiver or discharge is agreed to in writing and signed by the Executive and such officer as may be specifically designated by the Board; provided, however, that the Company and the Executive each agrees to execute and deliver any reasonable amendment to this Agreement as the Company or the Executive requests, after consultation with respective counsel, to comply with Section 409A of the Code and avoid imposition on the Executive of any Section 409A Tax; and provided, further, that the Company agrees that any such amendment shall maintain, to the maximum extent practicable, the original intent and economic benefit to the Executive of the applicable provision without violating the provisions of Section 409A of the Code. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time.

13. Merger of Prior Negotiations.

This Agreement sets forth all of the promises, agreements, conditions and understandings between the parties hereto respecting the subject matter hereof and supersedes all prior negotiations, conversations, discussions, correspondence, memoranda and agreements between the parties concerning such subject matter.

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14. Partial Invalidity.

If the final determination of a court of competent jurisdiction or arbitrator declares, after the expiration of the time within which judicial review (if permitted) of such determination may be perfected, that any term or provision hereof is invalid or unenforceable, (a) the remaining term and provisions hereof shall be unimpaired and (b) the invalid or unenforceable term or provision shall be deemed replaced by a term or provision that is valid and enforceable and that comes closest to expressing the intention of the invalid or unenforceable term or provision.

15. Governing Law; Code Provisions.

(a) This Agreement is to be governed by and interpreted in accordance with the laws of the State of New York.

(b) All references to sections of the Code shall be deemed also to refer to any successor provisions to such sections and the applicable regulations and guidance thereunder.

16. Counterparts.

This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.

17. Arbitration; Legal Fees.

(a) Any dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in New York, New York in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator’s award in any court having jurisdiction; provided, however, that the Executive shall be entitled to seek specific performance of the Executive’s right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement.

(b) The Company shall reimburse the Executive for all legal fees and expenses incurred by the Executive in connection any claim to enforce his rights under this Agreement; provided, however, that notwithstanding Section 18(b), no reimbursement pursuant to this Section 17(b) shall be paid in respect of an expense incurred after the last day of the sixth (6^th) calendar year following the calendar year in which the applicable statute of limitations for breach of contract claims expires; and provided, further, that if, in an arbitration conducted in accordance with subsection (a) above, it is determined that the Executive has acted in bad faith in asserting one or more claims under this Agreement, the Executive shall reimburse the Company for all legal fees and expenses previously paid to him pursuant to this Section 17(b) in connection therewith.

(c) In addition to the reimbursement provided for in subsection (b) above, within five (5) business days following a Change in Control, the Company shall make a lump-sum payment to the Executive of $15,000 intended to cover legal, accounting and financial expenses incurred after a Change in Control in connection with this Agreement (whether or not the Executive’s employment is terminated), including without limitation in connection with financial planning and the investigation of the Executive’s rights hereunder.

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18. Section 409A Provisions

(a) This Agreement is intended to satisfy the requirements of Section 409A of the Code with respect to amounts subject thereto and shall be interpreted and construed and shall be performed by the parties consistent with such intent, and the Company shall have no right to accelerate any payment or the provision of any benefits under this Agreement or to make or provide any such payment or benefits if such payment or provision of such benefits would, as a result, be subject to tax under Section 409A of the Code.

(b) Except as expressly provided otherwise herein, no reimbursement payable to the Executive pursuant to any provisions of this Agreement or pursuant to any plan or arrangement of the Company covered by this Agreement shall be paid later than the last day of the calendar year following the calendar year in which the related expense was incurred, and no such reimbursement during any calendar year shall affect the amounts eligible for reimbursement in any other calendar year, except, in each case, to the extent that the right to reimbursement does not provide for a “deferral of compensation” within the meaning of Section 409A of the Code.

(c) It is the intention of the parties that all amounts and benefits to which the Executive becomes entitled upon a Separation from Service by virtue of this Agreement shall qualify for exemption from Section 409A either as short-term deferral with the meaning of Treasury Regulation §409A-1(b)(4) (in the case, without limitation, of payment of the Reference Amount and the amount provided for in Section 4(b)(ii) and payment of the lump sum benefit provided for in Section 4(d) following termination of employment by reason of permanent disability) or otherwise. Notwithstanding the other provisions of this Agreement, if, as of the date of the Executive’s Separation from Service, the Executive is a Specified Employee, then, to the extent that this Agreement provides for a “deferral of compensation” within the meaning of Section 409A of the Code, the following shall apply:

1) No payment that constitutes a deferral of compensation and that is owed to the Executive as a result of such Separation from Service shall be made, and no taxable benefits shall be provided to the Executive (except for any benefits for which the Executive pays the full premium or other cost (including the Company’s share thereof)), in each case, during the period beginning on the date the Executive incurs a Separation from Service and ending on the six-month anniversary of such date or, if earlier, the date of Executive’s death.

2) On the first business day of the first month following the month in which occurs the six-month anniversary of the Executive’s Separation from Service or, if earlier, Executive’s death, the Company shall make a one-time, lump-sum cash payment to the Executive in an amount equal to the sum of (x) the amounts otherwise payable to the Executive under this Agreement during the period described in clause 1 above, (y) the amount paid by the Executive during the period described in clause 1 above as premium or other cost for benefits and (z) interest on the foregoing amounts at the applicable federal rate for instruments of less than one year.

For purposes of this Agreement, “Specified Employee” shall mean each officer of the Company and its affiliates, up to a maximum of fifty, having annual compensation in excess of $145,000 (as adjusted), a five percent owner of the Company and a one percent owner of the Company having annual compensation in from the Company and its affiliates in excess of $150,000, in each case determined pursuant to Section 416(i)(1)(A)(i), (ii) or (iii) of the Code (applied in accordance with the regulations thereunder and disregarding Section 416(i)(5) of the Code) any time during the 12-month period ending on December 31st of a calendar year (based on taxable wages as reported in Box 1 of Form W-2 for the 12-month period ending on December 31st of such calendar year plus

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amounts that would be included in wages for such 12-month period but for pre-tax deferrals to a tax-favored retirement plan or cafeteria plan or for qualified transportation benefits) who performed services for the Company and its affiliates at any time during the 12-month period ending on December 31st of such calendar year. The Executive shall be treated as a “Specified Employee” for the 12-month period beginning on March 1st of the calendar year following the calendar year for which the determination pursuant to this definition is made.

IN WITNESS WHEREOF, the parties hereto, having entered into this Agreement as of [            ], 2007.

AMBAC FINANCIAL GROUP, INC.

By:

EXECUTIVE

Name:

Title:

Address:

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EX-10.46

Exhibit 10.46

AMBAC FINANCIAL GROUP, INC.

DEFERRED COMPENSATION PLAN

FOR OUTSIDE DIRECTORS

Effective as of December 1, 1993,

As Amended through October 22, 2007

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AMBAC FINANCIAL GROUP, INC.

DEFERRED COMPENSATION PLAN FOR

OUTSIDE DIRECTORS

1. Definitions

“Account” and “Deferred Compensation Account” are used interchangeably and mean the bookkeeping record established for each Participant. A Deferred Compensation Account is established only for purposes of measuring a Deferred Benefit and not to segregate assets or to identify assets that may be used to pay a Deferred Benefit.

“Account Value” means the amount reflected on the books and records of the Company as the value of a Participant’s Deferred Compensation Account at any date of determination, as determined in accordance with this Plan.

“Affiliate” means any corporation that is in the same controlled group of corporations (within the meaning of Section 414(b) of the Code) as the Company and any trade or business that is under common control with the Company (within the meaning of Section 414(c) of the Code) determined in accordance with the default provision set forth in Treasury Regulation §1.409A-1(h)(3).

“Annual Fees” means the cash portion of (i) any annual fee payable to an Outside Director for service on the Board, (ii) any other fee determined on an annual basis and payable for service on (as distinguished from attendance at meetings of), or for acting as chairperson of, any committee of, or as Presiding Director of the Board and (iii) any similar annual fee payable in respect of service on the board of directors of any Subsidiary or any committee of any such board of directors.

“Beneficiary” or “Beneficiaries” means a person or other entity designated by a Participant on a Beneficiary Designation Form to receive Deferred Benefit payments in the event of the Participant’s death.

“Beneficiary Designation Form” means a document, in form approved by the Committee, to be used by Participants to name their respective Beneficiaries.

“Board” means the Board of Directors of the Company.

“Cash Deferral Option” means a Performance Option under which the Deferred Amount credited to a Participant’s Deferred Compensation Account is carried as a cash balance to which interest equivalents are credited from time to time as provided in Section 6(c)(i).

“Code” means the Internal Revenue Code of 1986, as amended, and all applicable rulings and regulations thereunder.

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“Committee” means the Compensation Committee of the Board or any successor committee thereto.

“Common Stock” means the Company’s common stock, par value $0.01 per share.

“Company” means Ambac Financial Group, Inc., a Delaware corporation.

“Conversion Date” has the meaning assigned to such term in Section 6(e).

“Deemed Capital Gain Tax Charge” has the meaning assigned to such term in Section 6(c).

“Deferral Election” means the election of a Participant, made in accordance with the terms and conditions of the Plan, to defer all or a portion of his/her Directors Fees for a Deferral Year.

“Deferral Election Form” means a document, in form approved by the Committee, pursuant to which a Participant makes a Deferral Election.

“Deferral Year” means the calendar year, starting with calendar year 1994. If an individual becomes eligible to participate in the Plan after the commencement of a Deferral Year, the Deferral Year for the individual shall be the remainder of such Deferral Year starting from the first day after the individual submits a Deferral Election for such Deferral Year. (By way of illustration, if an individual first becomes eligible to participate in the Plan on May 1, 2008 and submits a Deferral Election on May 15, 2008, the initial Deferral Year for such individual will be the period May 18, 2008 through December 31, 2008.)

“Deferred Amount” means the amount of Directors Fees, deferred by a Participant pursuant to a Deferral Election.

“Deferred Benefit” means the amount that will be paid on a deferred basis under the Plan to a Participant who has made a Deferral Election. A Participant’s Deferred Benefit will equal the Account Value of his or her Deferred Compensation Account, calculated as provided herein.

“Director Fees” means the aggregate of a Participant’s Annual Fees and Meeting Fees.

“Election Date” means December 31 of the year preceding the beginning of the Deferral Year, provided, however, that if an individual becomes an Outside Director for the first time during a Deferral Year and does not have any rights or interests under any other deferred compensation plan, program or arrangement of the Company that are required to be aggregated with rights under this Plan for purposes of Section 409A, that Outside Director’s Election Date for such Deferral Year is the thirtieth (30^th) day following the date he/she becomes an Outside Director.

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“Exchange Act” means the Securities Exchange Act of 1934, as amended.

“Fair Market Value” of a share of Common Stock means the closing price of a share of Common Stock as reported on the composite tape for securities listed on the New York Stock Exchange, or such other national securities exchange as may be designated by the Committee, or in the event that the Common Stock is not listed for trading on a national securities exchange but is quoted on an automated quotation system, on such automated quotation system, in any such case on the valuation date (or if there were no sales on the valuation date, the closing price as reported on such composite tape or automated quotation system for the most recent day during which a sale occurred).

“Meeting Fees” means (i) any meeting fee payable in respect of attendance at or participation in meetings of the Board or any committee of the Board or any meeting of the stockholders of the Company and (ii) any similar meeting fee payable in respect of service on the board of directors of any Subsidiary or any committee of any such board of directors.

“Outside Director” means a duly-elected member of the Board who is not an employee of the Company or any Subsidiary.

“Participant” means an Outside Director who participates in the Plan pursuant to Section 4.

“Performance Option” means the performance options made available from time to time for selection by Participants to measure the return (positive or negative) to be attributed to Deferred Amounts.

“Phantom Stock Option” means a Performance Option under which a Deferred Amount is credited to a Participant’s Deferred Compensation Account as a number of Phantom Stock Units.

“Phantom Stock Unit” means a bookkeeping unit representing one share of Common Stock.

“Section 409A” means Section 409A of Code and the applicable rulings and regulations promulgated thereunder.

“Subsidiary” means any corporation 50 percent or more of the voting stock of which is owned directly or indirectly by the Company.

2. Purpose

The purpose of the Plan is to provide the Company’s Outside Directors an opportunity to defer payment of all or part of their Directors Fees in accordance with the terms and conditions set forth herein.

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3. Administration

(a) Authority. The Committee will be responsible for administering the Plan. The Committee will have authority to adopt such rules as it may deem appropriate to carry out the purposes of the Plan, and shall have authority to interpret and construe the provisions of the Plan and any agreements under the Plan and to make determinations pursuant to any Plan provision. Each interpretation, determination or other action made or taken by the Committee pursuant to the Plan shall be final and binding on all persons. No member of the Committee shall be liable for any action or determination made in good faith, and the members of the Committee shall be entitled to indemnification and reimbursement in the manner provided in the Company’s Amended and Restated Certificate of Incorporation as it may be amended from time to time.

(b) Delegation. The Committee may designate a committee composed of one or more members of the Board to carry out its responsibilities under such conditions as it may set.

4. Eligibility

(a) Directors. Any Outside Director may participate in the Plan.

(b) Becoming a Participant. An Outside Director becomes a Participant for any Deferral Year by filing a Deferral Election Form according to Section 5 of the Plan.

5. Deferral Elections

(a) General Provisions. A Participant may elect to defer all or a specified percentage (in multiples of 10 percent) of Directors Fees for a Deferral Year, in the manner provided in this Section 5. A Participant’s Deferred Benefit is at all times nonforfeitable.

(b) Procedures for Making a Deferral Election. Before the Election Date applicable to a Deferral Year, each Outside Director will be provided with a Deferral Election Form and a Beneficiary Designation Form. In order for an Outside Director to participate in the Plan for a given Deferral Year, the Outside Director must complete and deliver a Deferral Election Form to the Secretary of the Board or the Chief Administrative Officer of the Company on or prior to the close of business on the applicable Election Date, using the procedures established by the Company (which may include or require electronic submission of forms). An Outside Director electing to participate in the Plan for a given Deferral Year shall indicate on his/her Deferral Election Form:

(i) the percentage of Director Fees for the applicable Deferral Year to be deferred;

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(ii) the allocation of the Deferred Amount among the several Performance Options then available to Participants, in accordance with the terms and conditions of Section 6(b);

(iii) the Participant’s election either to have distribution of his/her Deferred Benefit commence following termination of service as a member of the Board or to have such distribution commence as of a date specified on such Form, provided, however, that any such election concerning the commencement of distribution of a Participant’s Deferred Benefit shall be subject to the terms and conditions of Section 6(e); and

(iv) the Participant’s election either to have distribution of his/her Deferred Benefit paid in a single lump sum or in a series of annual or quarterly installments, provided, however, that if the Participant elects to have his/her Deferred Benefit paid in a series of installments, the Participant shall also specify the period, not to exceed five years, over which such installments shall be paid.

Deferral Elections may be amended or revoked by modifying or canceling the applicable Deferral Election Form and delivering such modification or cancellation to the Secretary of the Board or the Chief Administrative Officer of the Company by the close of business on the applicable Election Date. As of the close of business on the applicable Election Date, all Deferral Elections shall be irrevocable.

(c) Effect of No Deferral Election. An Outside Director who does not submit a completed and signed Deferral Election Form to the Secretary of the Board or the Chief Administrative Officer of the Company before the relevant Election Date is not a Participant for the Deferral Year and may not defer his/her Directors Fee for the Deferral Year.

(d) Revocation of Deferral Election.

(i) A Participant may revoke a Deferral Election applicable to a Deferral Year, but only pursuant to the procedure described in subsection (ii) below. Any purported revocation that does not comply with subsection (ii) below will not be given effect.

(ii) To be effective, a revocation must be in writing and signed by the Participant, must express the Participant’s intention to revoke his Deferral Election applicable to that Deferral Year, and must be delivered to the Secretary of the Board or the Chief Administrative Officer of the Company before the close of business on the Election Date applicable to such Deferral Year. For example, to revoke a Deferral Election relating to calendar year 2008, a written revocation of such Deferral Election must be delivered before the close of business on December 31, 2007.

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6. Deferred Compensation Accounts; Distributions

(a) Deferred Compensation Accounts.

(i) Establishment of Accounts. A Participant’s deferrals will be credited to a Deferred Compensation Account set up for that Participant. Each Deferred Compensation Account will be credited with Deferred Amounts, as provided in Section 6(b), and credited (or charged) with earnings (or loss) as provided in Section 6(c).

(ii) Crediting of Deferred Amounts. As of the dividend payment date following the last calendar quarter, an Outside Director’s Deferred Compensation Account will be credited with (A) 25% of Annual Fees deferred for the Deferral Year in which such quarter occurs and (B) 100% of deferred Meeting Fees earned during such quarter.

(b) Allocations Among Performance Options. A Participant shall have the right to allocate the Deferred Amount for any Deferral Year, in minimum allocations of at least 10%, among one or more Performance Options made available from time to time under the Plan. The Performance Options generally available to Participants shall include:

(i) A Cash Deferral Option;

(ii) A Phantom Stock Option; and

(iii) Such other Performance Options as the Committee may make available to Participants from time to time. Deemed allocations among the available Performance Options shall be made exclusively for the purpose of determining the Account Value from time to time, and the Company will have no obligation to invest amounts corresponding to Deferred Amounts in investment vehicles corresponding to the Performance Options selected by the Participant. Participants may change the deemed allocation of their Account Value among the Performance Options then available under the Plan in accordance with procedures established by the Committee from time to time; provided, however, that, unless otherwise determined by the Committee, no such reallocation shall be made more frequently than quarterly; and provided further that no such reallocation may result in less than 10% of the Account Value being deemed allocated to any single Performance Option.

(c) Determination of Account Value.

The Company will from time to time calculate the Account Value based on the Participant’s Deferred Amounts and his/her then-effective elections with respect to deemed allocation of the Account among the available Performance Options. Such calculation will be based on the best information available to the Company as of the date of determination, which information may include estimates. In addition, the following shall apply:

(i) Amounts allocated to the Cash Deferral Option (including amounts resulting from the conversion of Phantom Stock Units as provided in Section 6(c)(ii)), will be credited with interest equivalents as of the first business day of each calendar quarter based upon the average daily balance credited to such Cash Option (which balance shall include any earnings on amounts so credited pursuant to this Section 6(c)(i)) during the preceding quarter). Interest equivalents will be calculated using the 90-day commercial paper composite rate published by the Federal Reserve Bank as of the last business day of such preceding calendar quarter, or such other rate as the Committee may designate from time to time by resolution.

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(ii) The number of Phantom Stock Units credited to a Participant’s Deferred Compensation Account (including fractions of Phantom Stock Units) will be determined by dividing (A) the amount of Director Fees deferred by (B) the Fair Market Value of a share of Common Stock on the date of crediting.

(iii) If the Company pays any cash or other dividend or makes any other distribution in respect of the Common Stock, each Phantom Stock Unit credited to the Deferred Compensation Account of a Participant will be credited with an additional number of Phantom Stock Units (including fractions thereof) determined by dividing (A) the amount of cash, or the value (as determined by the Committee) of any securities or other property, paid or distributed in respect of one outstanding share of Common Stock by (B) the Fair Market Value of a share of Common Stock on the date of such payment or distribution. Such credit shall be made effective as of the date of the dividend or other distribution in respect of the Common Stock.

(iv) In determining the value attributable to that portion of a Participant’s Deferred Compensation Account allocated to Performance Options other than the Cash Deferral Option and the Phantom Share Option, the Company will track the rate of return (positive or negative) over the relevant measurement period of the investment fund, index or other vehicle by reference to which the Performance Option is defined.

(v) Upon any reallocation of all or any portion of a Participant’s Deferred Compensation Account from one Performance Option to any other Performance Option, the Company may charge such Account with an amount not to exceed 5% of the amount so reallocated. The amount of the charge shall be determined by the Company in its discretion and may vary depending on the Performance Options from which and into which the Account is being reallocated.

(vi) In addition, the returns attributable to a Deferred Compensation Account shall be subject to the following adjustments:

(A) Returns attributable to any Performance Option other than the Phantom Stock Option shall be reduced to reflect the amount that a corporate taxpayer in the highest tax bracket for federal corporate tax purposes would pay on the interests, dividends, distribution or similar items of income that it would receive if it had invested in the commercial paper, investment fund, index or other vehicle by reference to which the Performance Option is defined for the period of time, and in the same amounts, that the relevant Deferred Compensation Account was deemed allocated to such Performance Option.

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(B) Upon any change in the deemed allocation of a Participant’s Deferred Compensation Account among the Performance Options then available, the Account shall be charged with the amount (if any) (the “Deemed Capital Gain Tax Charge”) of capital gains tax that a corporate taxpayer in the highest bracket for federal corporate tax purposes would pay upon the amount of gain it would recognize had it invested in the investment fund, index or other vehicle by reference to which the Performance Option is defined for the period of time, and in the same amounts, that the relevant Deferred Compensation Account was deemed allocated to such Performance Option. No credit shall be made to an Account for any loss that would be recognized by a corporate taxpayer that had invested in such Performance Option for such period and in such amount.

The amount of the adjustments described in this subparagraph (vi) shall be determined by the Company in its discretion. The Company shall use its best efforts to apply adjustments on a consistent basis to all Participants who invest in any particular Performance Option.

(d) Manner of Payment of Deferred Benefit. All payments of Deferred Benefits under the Plan will be in cash. The Company shall pay a Participant’s Deferred Benefit for a given Deferral Year either in a single lump sum or in a series of installments, as elected by the Participant pursuant to Section 5(b). If a Participant has elected installment payments, the amount of each installment shall be determined by dividing the balance credited to the Participant’s Account in respect of the relevant Deferral Year by the number of installments remaining to be made (including the installment with respect to which the calculation is made). The unpaid portion of a Participant’s Deferred Benefit shall continue to be credited with earnings as provided in Section 6(c) until paid.

(e) Commencement of Payment of Deferred Benefit. For purposes of the Plan a “Conversion Date” means the earliest to occur of:

(i)(A) termination of service as a member of the Board or such later date as constitutes the Participant’s separation from service as a director or independent contractor with the Company and its Affiliates for purposes of Section 409A determined using the default provisions set forth in Treasury Regulation §1.409A(1)(h) or the successor regulation thereto;

(ii) the date specified in the Deferral Election Form executed by the Participant; or

(iii) the Participant’s death.

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Notwithstanding any other term or provision of this Plan, upon the occurrence of a Conversion Date, any portion of a Participant’s Deferred Compensation Account that is allocated either to the Phantom Unit Option or to any Performance Option other than the Cash Deferral Option will be converted into the Cash Deferral Option based upon (X) in the case of amounts allocated to the Phantom Unit Option, the Fair Market Value of the Common Stock as of the Conversion Date and (Y) in the case of any Performance Option other than the Phantom Stock Option, the net asset value or other relevant valuation measure of the investment fund, index or other vehicle by reference to which the Performance Option is defined, determined as of the Conversion Date or, if such net asset value or other valuation information is not available as of the Conversion Date, as of the latest date preceding the Conversion Date for which the same is generally available. The amount credited to the Cash Deferral Option as a result of such conversion shall, in the case of conversions from any Performance Option other than the Phantom Stock Option, be subject to the Deemed Capital Gain Tax Charge as described in Section 6(c) above. Following conversion, amounts so credited to the Cash Deferral Option will be credited with interest equivalents as provided in Section 6(c)(i). Except as provided in Section 6(f), a Participant’s Deferred Benefit shall be paid (if payable in a lump sum), or commence to be paid (if payable in a series of installments), to the Participant as soon as practicable (but in no event more than 60 days) after the Conversion Date; provided, however, that as of the date of the Conversion Date, the Participant is a Specified Employee (as defined below) and the Participant has elected to have distribution of his/her Deferred Benefit commence following termination of service as a member of the Board, then the following shall apply:

1) No payments of the Participant’s Deferred Benefit shall be made during the period during the six months following the Conversion Date (except in the case of the Participant’s earlier death); and

2) On the first business day of the first month following the month in which occurs the six-month anniversary of the Conversion Date or, if earlier, the Participant’s death, the Company shall make a one-time, lump-sum cash payment to the Participant (or his/her beneficiary or estate as applicable) in an amount equal to the amounts otherwise payable to the Participant during the period described in clause 1 above, plus interest on such amount at the applicable federal rate for instruments of less than one year.

For purposes of this Agreement, “Specified Employee” shall mean each officer of the Company and its affiliates, up to a maximum of fifty, having annual compensation in excess of $145,000 (as adjusted), a five percent owner of the Company and a one percent owner of the Company having annual compensation in from the Company and its affiliates in excess of $150,000, in each case determined pursuant to Section 416(i)(1)(A)(i), (ii) or (iii) of the Code (applied in accordance with the regulations thereunder and disregarding Section 416(i)(5) of the Code) any time during the 12-month period ending on December 31st of a calendar year (based on taxable wages as reported in Box 1 of Form W-2 for the 12-month period ending on December 31st of such calendar year plus amounts that would be included in wages for such 12-month period but for pre-tax deferrals to a tax-favored retirement plan or cafeteria plan or for qualified transportation benefits) who performed services for the Company and its affiliates at any time during the 12-month period ending on December 31st of such calendar year. A Participant shall be treated as a “Specified Employee” for the 12-month period beginning on March 1st of the calendar year following the calendar year for which the determination pursuant to this definition is made.

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(f) Death. In the event of a Participant’s death, the Participant’s entire Deferred Benefit (including any unpaid portion thereof corresponding to installments not yet paid at the time of death), to the extent not distributed earlier pursuant to Section 6(e), will be distributed in a lump sum to the Participant’s Beneficiary or Beneficiaries (or, in the absence of any Beneficiary, to the Participant’s estate) on a date, selected by the Committee, no more than 90 days after the Participant’s date of death.

(g) Statements. The Company will furnish each Participant with a statement setting forth the value of the Participant’s Deferred Compensation Account as of the end of each calendar year and all credits to and payments from the Deferred Compensation Account during such year. Such statement will be furnished no later than 60 days after the end of each calendar year.

7. Designation of Beneficiary

(a) Beneficiary Designations. Each Participant may designate a Beneficiary to receive any Deferred Benefit due under the Plan upon the Participant’s death by executing a Beneficiary Designation Form. A Beneficiary designation is not binding on the Company until the Secretary of the Board or the Chief Administrative Officer of the Company receives the Beneficiary Designation Form. If no designation is made or no designated Beneficiary is alive (or in the case of an entity designated as a Beneficiary, in existence) at the time of the Participant’s death, payments due under the Plan will be made to the Participant’s estate.

(b) Change of Beneficiary Designation. A Participant may change an earlier Beneficiary designation by executing a later Beneficiary Designation Form. The execution of a Beneficiary Designation Form revokes and rescinds any prior Beneficiary Designation Form.

8. Amendments

(a) General Power of Committee. Subject to Section 8(b), the Plan may be altered, amended, suspended, or terminated at any time by the Committee in its sole discretion.

(b) When Participants’ Consents Required. Except for a termination of the Plan caused by the Committee’s determination that the laws upon which the Plan is based have changed in a manner that negates the Plan’s objectives, the Committee may not alter, amend, suspend, or terminate the Plan without the consent of any Participant to the extent that such action would result in the distribution to such Participant of amounts then credited to his/her Deferred Compensation Account in any manner other than as provided in the Plan or could reasonably be expected to result in the immediate taxation to such Participant of Deferred Benefits or to subject a Participant to interest or additional tax under Section 409A.

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9. Company’s Obligation

This Plan is unfunded. A Deferred Compensation Account represents at all times an unfunded and unsecured contractual obligation of the Company. Each Participant or Beneficiary will be an unsecured creditor of the Company. Amounts payable under the Plan will be satisfied solely out of the general assets of the Company subject to the claims of the Company’s creditors. No Participant, Beneficiary or any other person shall have any interest in any fund or in any specific asset of the Company by reason of any amount credited to him/her hereunder, nor shall any Participant, Beneficiary or any other person have any right to receive any distribution under the Plan except as, and to the extent, expressly provided in the Plan. The Company will not segregate any funds or assets for Deferred Benefits or issue any notes or security for the payment of any Deferred Benefits. Any reserve or other asset that the Company may establish or acquire to assure itself of the funds to provide benefits under the Plan shall not serve in any way as security to any Participant, Beneficiary or other person for the performance of the Company under the Plan.

10. No Control by Participant

A Participant shall have no control over his Deferred Compensation Account except for (i) designating initial allocation among Performance Options and subsequently revising such allocation, in all cases to the extent permitted by the Plan, (ii) designating the date and form of distribution of benefits on his Deferral Election Form (which designation shall be subject to the terms and conditions of the Plan, including without limitation Section 6) and (iii) designating his or her Beneficiary on a Beneficiary Designation Form.

11. Restrictions on Transfer

The Company shall pay all amounts payable under the Plan only to the Participant or Beneficiary designated under the Plan to receive such amounts. Neither a Participant nor his Beneficiary shall have any right to anticipate, alienate, sell, transfer, assign, pledge, encumber or change any benefits to which he may become entitled under the Plan, and any attempt to do so shall be void. A Deferred Benefit shall not be subject to attachment, execution by levy, garnishment, or other legal or equitable process for a Participant’s or Beneficiary’s debts or other obligations.

13. Waivers

The waiver of a breach of any provision in the Plan shall not operate as and may not be construed as a waiver of any later breach.

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14. Governing Law

The Plan shall be construed in accordance with and governed by the laws of the State of New York.

15. Effective Date

The Plan became as of December 1, 1993 and Deferral Elections could be made beginning with Eligible Compensation earned during the year beginning January 1, 1994.

16. Construction

The headings in the Plan have been inserted for convenience of reference only and are to be ignored in any construction of the Plan’s provisions. If a provision of the Plan is not valid or enforceable, that fact shall in no way affect the validity or enforceability of any other Provision. Use of one gender includes the other, and the singular and plural include each other. The provisions of the Plan are binding on the Company and its respective successors or assigns, and on the Participants, their Beneficiaries, heirs, and personal representatives.

17. Tax Withholding

The Company shall have the right, in connection with any Deferral Election, (i) to require the Participant to remit to the Company an amount sufficient to satisfy any Federal, state or local tax withholding requirements, (ii) to withhold an amount necessary to satisfy such requirements from other cash compensation owed to the Participant or (iii) to reduce the amount of Director Fees deferred pursuant to the Plan in order to ensure that all such requirements are satisfied. The Company shall also have the right to deduct from all cash payments made pursuant to the Plan any Federal, state or local taxes required to be withheld with respect to such payments.

18. No Right to Reelection

Nothing in the Plan shall be deemed to create any obligation on the part of the Board to nominate any of its members for reelection by the Company’s stockholders, nor confer upon any Outside Director the right to remain a member of the Board for any period of time, or at any particular rate of compensation.

19. No Stockholder Rights

The crediting of Phantom Stock Units to a Participant’s Deferred Compensation Account shall not confer on the Participant any rights as a stockholder of the Company, nor shall such Units confer on any Participant any right to receive stock of the Company in settlement thereof.

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20. Adjustment of and Changes in Shares

In the event of any merger, consolidation, recapitalization, reclassification, stock dividend, special cash dividend or other change in corporate structure affecting the Common Stock, the Committee shall make such adjustments, if any, as it deems appropriate in the number of Phantom Stock Units credited to a Participant’s Deferred Compensation Account. The foregoing adjustments shall be decided by the Committee in its discretion.

21. About the Plan

The Deferred Compensation Plan for Outside Directors and Senior Officers was established as of December 1, 1993 by Ambac Inc. In 1997 Ambac Inc. became Ambac Financial Group, Inc. The Plan was amended on October 28, 1998 in order to offer its participants more investment options.

The Plan was amended and restated, effective October 26, 1999 to provide that this Plan be available only to Outside Directors. Senior Officers no longer participate in this Plan as a new deferred plan has been adopted for them.

The Plan was amended and restated, effective October 22, 2007 to take account of Section 409A so that participation in the Plan will not cause an Outside Director to recognize income for United States federal income tax purposes prior to the time of payment of his/her Deferred Benefit or to incur interest or additional tax under Section 409A.

14

EX-10.47

Exhibit 10.47

AMBAC FINANCIAL GROUP, INC. 1997 EQUITY PLAN

AMENDED AND RESTATED

DEFERRED COMPENSATION SUB-PLAN FOR

ELIGIBLE SENIOR OFFICERS

Effective as of October 26, 1999

As Amended through October 22, 2007

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 2 of 10

AMBAC FINANCIAL GROUP, INC. 1997 EQUITY PLAN —

DEFERRED COMPENSATION SUB-PLAN FOR

ELIGIBLE SENIOR OFFICERS

AMBAC FINANCIAL GROUP, INC., a Delaware corporation (the “Company”), adopts the Ambac Financial Group, Inc. 1997 Equity Plan - Deferred Compensation Sub-Plan for Eligible Senior Officers (the “Plan”), effective as of October 26, 1999. The Plan provides for selected officers of the Company the opportunity to elect to defer a portion of their annual cash bonus in the form or restricted stock units awarded under the Ambac Financial Group, Inc. 1997 Equity Plan (the “Equity Plan”).

1. Definitions

For purposes of the Plan, unless defined below, the definitions set forth in the Equity Plan are applicable to the Plan.

“Account Value” means the amount reflected on the books and records of the Company as the value of a Participant’s Deferred Compensation Account at any date of determination, as determined in accordance with this Plan.

“Beneficiary” or “Beneficiaries” means a person or other entity designated by a Participant on a Beneficiary Designation Form to receive shares delivered in settlement of a Participant’s RSUs in the event of the Participant’s death.

“Beneficiary Designation Form” means a document, in form approved by the Committee, to be used by Participants to name their respective Beneficiaries.

“Deferral Election” means the election of a Participant, made in accordance with the terms and conditions of the Plan, to defer all or a portion of his/her Eligible Compensation for a Deferral Year.

“Deferral Election Form” means a document, in form approved by the Committee, pursuant to which a Participant makes a Deferral Election.

“Deferral Year” means the calendar year, starting with calendar year 1999. If an individual becomes eligible to participate in the Plan after the commencement of a Deferral Year, the Deferral Year for the individual shall be the remainder of such Deferral Year starting from the first day after the individual submits a Deferral Election for such Deferral Year. (By way of illustration, if an individual first becomes eligible to participate in the Plan on May 1, 2008 and submits a Deferral Election on May 15, 2008, the initial Deferral Year for such individual will be the period May 18, 2008 through December 31, 2008.).

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 3 of 10

“Deferred Compensation Account” means a bookkeeping record established for each Participant. A Deferred Compensation Account is established only for purposes of recording and valuing RSUs awarded to a Participant, including additional RSUs resulting from dividend equivalents, and not to segregate assets or to identify assets that may be settle the Company’s obligations to a Participant under the Plan.

“Election Date” means a date during the year preceding the beginning of the Deferral Year that is designated by the Company as the deadline for Deferral Election relating to such Deferral Year.

“Eligible Compensation” means the cash portion of such Participant’s bonus for the relevant Deferral Year (it being understood that the amount of such bonus may not be determined until after the end of the relevant Deferral Year).

“Eligible Officer” means a senior officer of the Company or a Participating Subsidiary who is eligible to participate in the Plan pursuant to Section 4(b).

“Employer” means the Company or a Participating Subsidiary, as the case may be, that employs an Eligible Officer.

“Participant” means an Eligible Officer who participates in the Plan pursuant to Section 4.

“Participating Subsidiary” means any Subsidiary that has, by resolution of its board of directors, agreed to participate in the Plan with respect to, and to be responsible for the amounts under the Plan owed to, Eligible Officers who are employed by it.

“Restricted Stock Unit.” A restricted stock unit ( or “RSU”) represents the right to receive one share of Common Stock, subject to the terms and conditions of the applicable award, including applicable vesting requirements.

“Retirement” means the voluntary termination of a Participant’s employment by the Participant at age 55 or older after at least five years of continuous service with the Company and its Subsidiaries (including service with a corporation or other entity acquired by the Company).

“Section 409A” means Section 409A of the Code.

“Separation from Service” means either (i) the termination of a Participant’s employment with the Company and its affiliates, provided that such termination of employment meets the requirements of a separation of service determined using the default provisions set forth in Treasury Regulation §1.409A-(1)(h) or the successor provision thereto or (ii) such other date that constitutes a separation from service with the Company and its affiliates meeting the requirements of the default provisions set forth in Treasury Regulation §1.409A-(1)(h) or the

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 4 of 10

successor provision thereto; provided, however, that, with respect to a Participant who incurs a permanent disability (meaning a disability within the meaning of the long-term disability plan of the Company which covers the Participant), “Separation from Service” means the date that is 29 months after the first day of disability. For purposes of this definition, “affiliate” means any corporation that is in the same controlled group of corporations (within the meaning of Section 414(b) of the Code) as the Company and any trade or business that is under common control with the Company (within the meaning of Section 414(c) of the Code), determined in accordance with the default provision set forth in Treasury Regulation §1.409A-(1)(h)(3).

“Specified Employee” means each officer of the Company and its affiliates, up to a maximum of fifty, having annual compensation in excess of $145,000 (as adjusted), a five percent owner of the Company and a one percent owner of the Company having annual compensation in from the Company and its affiliates in excess of $150,000, in each case determined pursuant to Section 416(i)(1)(A)(i), (ii) or (iii) of the Code (applied in accordance with the regulations thereunder and disregarding Section 416(i)(5) of the Code) any time during the 12-month period ending on December 31st of a calendar year (based on taxable wages as reported in Box 1 of Form W-2 for the 12-month period ending on December 31st of such calendar year plus amounts that would be included in wages for such 12-month period but for pre-tax deferrals to a tax-favored retirement plan or cafeteria plan or for qualified transportation benefits) who performed services for the Company and its affiliates at any time during the 12-month period ending on December 31st of such calendar year. A Participant shall be treated as a “Specified Employee” for the 12-month period beginning on March 1st of the calendar year following the calendar year for which the determination pursuant to this definition is made.

“Subsidiary” means any corporation 50 percent or more of the voting stock of which is owned directly or indirectly by the Company.

2. Purpose

The purpose of the Plan is to provide the Company’s Eligible Officers an opportunity to defer payment of all or part of their Eligible Compensation in accordance with the terms and conditions set forth herein.

3. Administration

(a) Authority. The Committee will be responsible for administering the Plan. The Committee will have authority to adopt such rules as it may deem appropriate to carry out the purposes of the Plan, and shall have authority to interpret and construe the provisions of the Plan and any agreements under the Plan and to make determinations pursuant to any Plan provision. Each interpretation, determination or other action made or taken by the Committee pursuant to the Plan shall be final and binding on all persons. No member of the Committee shall be liable for any action or determination made in good faith, and the members of the Committee shall be entitled to indemnification and reimbursement in the manner provided in the Company’s Amended and Restated Certificate of Incorporation as it may be amended from time to time.

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 5 of 10

(b) Delegation. The Committee may designate a committee composed of one or more members of the Board to carry out its responsibilities under such conditions as it may set.

4. Eligibility

(a) Officers. Officers of the Company or Ambac Assurance who are appointed Managing Director, or any officer title senior to Managing Director as well as such other senior officers of the Company and its Subsidiaries as may be designated from time to time by the Chief Administrative Officer, may participate in the Plan.

(b) Becoming a Participant. An Eligible Officer becomes a Participant for any Deferral Year by filing a Deferral Election Form according to Section 5 of the Plan.

5. Deferral Elections

(a) General Provisions. A Participant may elect to defer all or a specified percentage (in multiples of 5 percent) of his/her Eligible Compensation for a Deferral Year, in the manner provided in this Section 5. Deferrals under the Plan will be in the form of RSUs having the terms and conditions specified herein.

(b) Procedures for Making a Deferral Election. Before the Election Date applicable to a Deferral Year, each Eligible Officer will be provided with a Deferral Election Form and a Beneficiary Designation Form. In order for an Eligible Officer to participate in the Plan for a given Deferral Year, the Eligible Officer must complete and submit a Deferral Election Form to Human Resources on or prior to the close of business on the applicable Election Date, using the procedures established by the Company (which may include or require electronic submission of forms). An Eligible Officer electing to participate in the Plan for a given Deferral Year shall indicate on his/her Deferral Election Form:

(i) the percentage of Eligible Compensation for the applicable Deferral Year to be deferred;

(ii) the Participant’s election either to have settlement of the RSUs resulting from his/her deferral made upon the applicable vesting dates or to have such settlement made as of one or more dates specified on such Form (none of which dates may be earlier than the vesting date for the RSUs to be settled), provided, however, that any such election concerning the commencement of distribution of a Participant’s RSUs shall be subject to the terms and conditions of Section 6(e).

Deferral Elections may be amended or revoked by modifying or canceling the applicable Deferral Election Form and delivering such modification or cancellation to Human Resources by the close of business on the applicable Election Date. As of the close of business on the applicable Election Date, all Deferral Elections shall be irrevocable.

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 6 of 10

(c) Effect of No Deferral Election. An Eligible Officer who does not submit a completed Deferral Election Form to Human Resources before the close of business on the applicable Election Date is not a Participant for the relevant Deferral Year and may not defer his/her Eligible Compensation for such Deferral Year.

6. Restricted Stock Units; Settlement

(a) Number of RSUs.

(i) First 25% of Eligible Compensation. The number of RSUs awarded in respect of a Participant’s deferral of 25% (or less) of Eligible Compensation for a Deferral Year will be determined by dividing (A) the dollar amount of Eligible Compensation that the Participant has elected to defer by (B) the product of 0.75 times the Fair Market Value of a share of Common Stock on the date of grant. If the foregoing calculation results in a fractional RSU, the total number of RSUs awarded will be rounded up to the nearest whole number.

(ii) Amounts in Excess of 25% of Eligible Compensation. The number of RSUs awarded in respect of a Participant’s deferral of any amount in excess of 25% of Eligible Compensation for a Deferral Year will be determined by dividing (A) the dollar amount of such excess amount by (B) the Fair Market Value of a share of Common Stock on the date of grant. If the foregoing calculation results in a fractional RSU, the total number of RSUs awarded will be rounded up to the nearest whole number.

(iii) Date of Grant. The date of grant of RSUs awards in respect of a Deferral Year shall be the date of the Committee meeting to approve annual bonuses to the Company’s senior officers in respect of that Deferral Year. RSUs will be credited to a Participant’s Deferred Compensation Account.

(b) Vesting. Unless the Committee determines otherwise, RSUs granted under the Plan will vest in equal installments on the first, second and third anniversaries of the date of grant; any fractional RSUs resulting from the application of the vesting schedule will be aggregated and will vest on the first anniversary of the date of grant. Notwithstanding the preceding sentence, all RSUs representing the 25% discount to Fair Market Value provided for in Section 6(a)(i) above will vest on the fourth anniversary of the date of grant. Except as otherwise provided by the Committee, each portion of a Participant’s RSUs will vest only if the Participant continues to provide services to the Company by remaining in continuous employment with the Company or a Participating Subsidiary through the applicable vesting date; provided, however, that all RSUs credited to a Participant’s Deferred Compensation Account will vest immediately upon termination of the Participant’s employment by reason of death, permanent disability or Retirement.

(c) Dividend Equivalents. If the Company pays any cash or other dividend or makes any other distribution in respect of the Common Stock, each Restricted Stock Unit credited to the Deferred Compensation Account of a Participant will be credited with an

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 7 of 10

additional number of Restricted Stock Units (including fractions thereof) determined by dividing (A) the amount of cash, or the value (as determined by the Committee) of any securities or other property, paid or distributed in respect of one outstanding share of Common Stock by (B) the Fair Market Value of a share of Common Stock on the date of such payment or distribution. Such credit shall be made effective as of the date of the dividend or other distribution in respect of the Common Stock. Any such additional RSUs will vest and be settled at the same time as the underlying RSUs.

(d) Manner of Settlement. Subject to Section 16, all Restricted Stock Units will be settled in shares of Common Stock. Subject to the other terms and conditions of the Plan, including Section 6(e), the Company shall settle a Participant’s RSUs for a Deferral Year at a single time or in a series of settlements, as elected by the Participant pursuant to Section 5(b). The unsettled portion of a Participant’s RSUs shall continue to be credited with dividend equivalents as provided in Section 6(c) until settled.

(e) Separation from Service. Notwithstanding a Participant’s election pursuant to Section 5(b), upon a Participant’s Separation from Service all vested RSUs credited to the Participant’s Deferred Compensation Account will be settled by the delivery of shares of Common Stock on a date, selected by the Company, no more than [60] days following the date of the Participant’s Separation from Service; provided, however, that if as of the date of the Participant’s Separation from Service, the Participant is a Specified Employee, none of the Participant’s RSUs shall be settled during the period beginning on the date the Participant incurs a Separation from Service and ending on the six-month anniversary of such date or, if earlier, the date of the Participant’s death, and such RSUs shall instead be settled by the delivery of Common Stock to the Participant on the first business day of the first month following the month in which occurs the six-month anniversary of the Participant’s Separation from Service or, if earlier, upon the Participant’s death in the manner provided in Section 6(f); and provided, further, that the six-month delay provided for in the preceding proviso shall not apply to any RSUs which, by virtue of an election made by the Participant pursuant to Section 5(b), are scheduled to be settled during the six months following the Participant’s Separation from Service.

(f) Death. In the event a Participant’s employment terminates by reason of death, all RSUs credited to the Participant’s Deferred Compensation Account will vest and, to the extent not settled earlier pursuant to Section 6(e), will be settled by the delivery of the corresponding shares of Common Stock to the Participant’s Beneficiary or Beneficiaries (or, in the absence of any Beneficiary, to the Participant’s estate) on a date, selected by the Company, no more than 90 days after the Participant’s date of death.

7. Designation of Beneficiary

(a) Beneficiary Designations. Each Participant may designate a Beneficiary to receive all or part of the shares to be delivered in settlement of the Participant’s RSUs in the event of the Participant’s death. Participants shall designate a Beneficiary by executing a Beneficiary Designation Form. A Beneficiary designation is not binding on the Company until the Secretary of the Board receives the Beneficiary Designation Form. If no designation is made

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 8 of 10

or no designated Beneficiary is alive (or in the case of an entity designated as a Beneficiary, in existence) at the time of the Participant’s death, any shares that become payable under the Plan will be delivered to the Participant’s estate. If there is any question as to the legal right of any Beneficiary to receive shares under the Plan, the Company may determine in its sole discretion to deliver the shares in question to the Participant’s estate. The Company’s determination shall be binding and conclusive on all persons and it will have no further liability to anyone with respect to such shares.

(b) Change of Beneficiary Designation. A Participant may change an earlier Beneficiary designation by executing a later Beneficiary Designation Form. The execution of a Beneficiary Designation Form revokes and rescinds any prior Beneficiary Designation Form.

8. Amendments

(a) General Power of Committee. Subject to Section 8(b), the Plan may be altered, amended, suspended, or terminated at any time by the Committee in its sole discretion. Without limiting the generality of the foregoing, the Committee may amend the Plan in any manner it considers necessary or appropriate to avoid subjecting Participants to United States federal, state or local income tax, or any equivalent taxes in jurisdictions outside the United States, prior to the time that a Participant’s RSUs are settled or to interest or additional tax under Section 409A. In addition, the Committee shall have discretion to add one or more performance options to be made available from time to time for selection by Participants to measure the return (positive or negative) to be attributed to deferred amounts.

(b) When Participants’ Consents Required. Except for a termination of the Plan caused by the Committee’s determination that the laws upon which the Plan is based have changed in a manner that negates the Plan’s objectives, the Committee may not alter, amend, suspend, or terminate the Plan without the consent of any Participant to the extent that such action would result in the distribution to such Participant of amounts then credited to his/her Deferred Compensation Account in any manner other than as provided in the Plan or could reasonably be expected to result in the immediate taxation to such Participant of deferred amounts.

9. Employer’s Obligation

This Plan is unfunded. A Deferred Compensation Account represents at all times an unfunded and unsecured contractual obligation of the relevant Employer. Each Participant or Beneficiary will be an unsecured creditor of the relevant Employer, as the case may be. Amounts payable under the Plan will be satisfied solely out of the general assets of the relevant Employer subject to the claims of the Employer’s creditors. No Participant, Beneficiary or any other person shall have any interest in any fund or in any specific asset of the Company or any other Employer by reason of any amount credited to him/her hereunder, nor shall any Participant, Beneficiary or any other person have any right to receive any distribution under the Plan except as, and to the extent, expressly provided in the Plan. The Employer will segregate any funds or assets for amounts credited to Deferred Compensation Accounts or issue any notes or security for the payment of any amount owed to Participants. Any reserve or other asset that the

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 9 of 10

Company or any other Employer may establish or acquire to assure itself of the funds to provide benefits under the Plan shall not serve in any way as security to any Participant, Beneficiary or other person for the performance of the Company or any other Employer under the Plan.

10. No Control by Participant

A Participant shall have no control over his/her Deferred Compensation Account except for (i) designating initial allocation among Performance Options and subsequently revising such allocation, in all cases to the extent permitted by the Plan, (ii) designating the date of initial distribution of benefits on his/her Deferral Election Form (which designation shall be subject to the terms and conditions of the Plan, including without limitation Section 6) and (iii) designating his/ her Beneficiary on a Beneficiary Designation Form.

11. Restrictions on Transfer

The Company or the relevant Employer, as the case may be, shall pay all amounts payable under the Plan only to the Participant or Beneficiary designated under the Plan to receive such amounts. Neither a Participant nor his/her Beneficiary shall have any right to anticipate, alienate, sell, transfer, assign, pledge, encumber or change any benefits to which he/she may become entitled under the Plan, and any attempt to do so shall be void. Deferred Compensation Accounts shall not be subject to attachment, execution by levy, garnishment, or other legal or equitable process for a Participant’s or Beneficiary’s debts or other obligations.

12. Waivers

The waiver of a breach of any provision in the Plan shall not operate as and may not be construed as a waiver of any later breach.

13. Governing Law

The Plan shall be construed in accordance with and governed by the laws of the State of New York.

14. Effective Date

The Plan became effective as of October 26, 1999. The Plan was amended and restated, effective October 22, 2007, to take account of Section 409A so that participation in the Plan will not cause Participants to recognize income for United States federal income tax purposes prior to settlement of their RSUs or to incur interest or additional tax under Section 409A.

15. Construction

The headings in the Plan have been inserted for convenience of reference only and are to be ignored in any construction of the Plan’s provisions. If a provision of the Plan is not valid or enforceable, that fact shall in no way affect the validity or enforceability of any other

Ambac Financial Group, Inc.

Deferred Compensation Sub-Plan

For Eligible Senior Officers

Page 10 of 10

Provision. Use of one gender includes the other, and the singular and plural include each other. The provisions of the Plan are binding on the Company, each Participating Subsidiary and their respective successors or assigns, and on the Participants, their Beneficiaries, heirs, and personal representatives.

16. Tax Withholding

The Company shall have the right, in connection with any Deferral Election or any settlement of RSUs (i) to require the Participant to remit to the Company or the relevant Participating Subsidiary an amount sufficient to satisfy any Federal, state or local tax withholding requirements and/or (ii) to withhold from settlement of RSUs a number of shares of Common Stock necessary to satisfy such requirements. The Company shall also have the right to deduct from cash payments (if any) made pursuant to the Plan any Federal, state or local taxes required to be withheld with respect to such payments. Unless otherwise determined by the Company, all withholding pursuant to this Section 16 shall be effected at the minimum statutory rate, and no Participant shall have the right to require the Company to withhold at any higher rate.

17. No Right to Reelection or Continued Employment

Nothing in this Plan shall be deemed to confer on any Eligible Officer a right to continued employment, or to limit or restrict the right of the Company or a Participating Subsidiary to terminate an Eligible Officer’s employment at any time, for any reason, with or without cause.

18. No Stockholder Rights

The crediting of Restricted Stock Units to a Participant’s Deferred Compensation Account shall not confer on the Participant any rights as a stockholder of the Company.

19. Adjustment of and Changes in Shares

In the event of any merger, consolidation, recapitalization, reclassification, stock dividend, special cash dividend or other change in corporate structure affecting the Common Stock, the Committee shall make such adjustments, if any, as it deems appropriate in the number of Restricted Stock Units credited to a Participant’s Deferred Compensation Account. The foregoing adjustments shall be decided by the Committee in its discretion.

AMBAC FINANCIAL GROUP, INC. 1997 EQUITY PLAN

Sub Plan —

DEFERRED COMPENSATION FOR

ELIGIBLE SENIOR OFFICERS

Beneficiary Designation Form

To: Human Resources

Ambac Financial Group, Inc.

I designate                      as my primary Beneficiary(ies) of any benefits that become payable under the Ambac Financial Group, Inc. 1997 Equity Plan, Sub Plan, Deferred Compensation for Eligible Senior Officers (the “Plan”) as a result of my death.

If a designated Beneficiary survives me but dies (or if a trust, terminates) before all benefits have been paid to the Beneficiary, I direct the remainder of the payments to be made as the Beneficiary designates or, if the Beneficiary fails to properly execute a Beneficiary designation, to the Beneficiary’s estate, or, if a trust, to the trustee to be distributed in accordance with the terms of the trust.

This designation revokes and rescinds any prior Beneficiary designation made by me.

If a Beneficiary is not named, or if there is no Beneficiary otherwise in existence at the time of my death, I understand that payments will be made according to Section 7(a) of the Plan.

I understand that this Beneficiary designation applies until revoked by my written request.

I also understand that, in executing this Beneficiary designation, I agree to be bound by the terms and conditions of the Plan and agree that such terms and conditions are binding upon my Beneficiary(ies), distributee(s), and personal representative(s).

	Signature
Date	Name (Please Print)

EX-10.48

Exhibit 10.48

AMBAC FINANCIAL GROUP, INC.

SUPPLEMENTAL PENSION PLAN

(Amended and Restated as of January 1, 2008, Unless Otherwise Provided)

AMBAC FINANCIAL GROUP, INC. SUPPLEMENTAL PENSION PLAN

Article I. Purpose

Ambac Financial Group, Inc. Supplemental Pension Plan (the “Supplemental Plan”) is an unfunded supplemental retirement plan established with the purpose of providing a select group of management or highly-compensated employees (within the meaning of ERISA) of Ambac Financial Group, Inc. and its successors (the “Company”) with certain of the retirement benefits that would be otherwise unavailable under the Ambac Financial Group, Inc. Pension Plan, as amended through December 31, 2006 (the “Pension Plan”), due to restrictions imposed by Code Section 401(a)(17) , which limits each Employee’s annual compensation that may be taken into account under the Pension Plan and Code Section 415, which limits the annual benefits payable under the Pension Plan. The Supplemental Plan is amended and restated as of January 1, 2008 (the “Effective Date”) (unless otherwise provided) and is an amendment and restatement of the Ambac Supplemental Retirement Plan effective as of October 1, 2001 and the Ambac Financial Group, Inc. Excess Benefits Pension Plan (the “Excess Plan”), which is merged into the Supplemental Plan effective January 1, 2008.

Article II. Definitions; Construction

2.1 Definitions. Capitalized terms used in this Supplemental Plan and not defined herein shall have the same meaning as set forth in the Pension Plan. Whenever used herein, the following terms shall have the meaning set forth below:

“Administrator” means the Senior Vice President, Chief Administrative Officer & Employment Counsel or the successor thereto or other person designated by the Committee in accordance with Section 7.3.

“Ambac” means Ambac Financial Group, Inc.

“Applicable Transition Relief” means the following transition guidance, as applicable, with respect to the application of Section 409A: (i) I.R.S. Notice 2005-1, I.R.B. 274 (published as modified on January 6, 2005), (ii) Section XI.C. of the preamble to the proposed Treasury Regulations under Section 409A, (70 F.R. 57930; October 4, 2005), and (iii) I.R.S. Notice 2006-79, I.R.B. 2006-43.

“Board” means the Board of Directors of Ambac.

“Committee” means the Plan Administrative Committee of Ambac and any successor thereto, or any other committee that is delegated, from time to time, with the administration of the Plan.

“Excluded Individual” means any individual who is treated or designated by the Company as an independent contractor, leased employee (including, without limitation, a Statutory Leased Employee), temporary employee provided through an agency, consultant, or any individual who performs services for the Company under an agreement or arrangement (which may be written, oral or evidenced by the payroll practices of the Company) with the individual or with another organization that provides the services of the individual to the Company under which

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the individual is treated as an independent contractor or is otherwise treated as an employee of an entity other than the Company (such as a leasing organization), or a student hired for a specified period known as a “co-op” or an “intern”. If any Excluded Individual shall be determined by a court or a federal, state or local regulatory or administrative authority to have served as a common law employee of the Employer, such determination shall not alter this exclusion as an eligible employee (determined pursuant to Section 3.1) for purposes of this Plan. For purposes of this definition, “Statutory Leased Employee” means any person (other than an employee on the payroll of the Company) who, pursuant to an agreement between the Company and any other person, has performed services for the Company (or for the Company and related persons, determined in accordance with Code Section 414(n)(6)) on a substantially full-time basis for a period of at least one year, and such services are performed under the primary direction or control by the Company.

Excluded Individual shall also mean (a) any employee of the Company whose terms of employment are the subject of a collective bargaining agreement unless that agreement provides for his participation in this Plan, (b) any employee of the Company who is a nonresident alien of the United States with no United States source earned income from the Company and (c) any individual who is a temporary employee who has less than 500 Hours of Service during the relevant computation period.

“Participant” means an Employee, other than an Excluded Individual, who has satisfied the requirements of Section 3.1 of the Supplemental Plan.

“Pension Plan Preretirement Death Benefit” means the benefit payable for any given month to a surviving spouse under Article VIII of the Pension Plan.

“Pension Plan Retirement Benefit” means the Normal Retirement Benefit, Deferred Retirement Benefit, Early Retirement Benefit or Disability Retirement Benefit paid to an individual under the Pension Plan for a given month, as calculated under the terms of the Pension Plan and reflecting the actual elections with respect to retirement date and annuity form.

“Plan Year” means the calendar year.

“Prior Plan” means the terms of the Supplemental Plan and the Excess Plan in effect immediately prior to the Effective Date, as set forth in the Company’s written documentation, rules, practices and procedures applicable to the Plan.

“Section 409A” means Code Section 409A and the applicable rulings and regulations promulgated thereunder.

“Section 409A Compliance” has the meaning set forth in Section 4.8(b).

“Separation from Service” means either (i) the termination of a Participant’s employment with the Company and its Affiliates, provided that such termination of employment meets the requirements of a separation of service determined using the default provisions set forth in Treasury Regulation 1.409A-(1)(h) or the successor thereto or (ii) such other date that constitutes a separation from service with the Company and its Affiliates meeting the requirements of the default provisions set forth in Treasury Regulation 1.409A-(1)(h) or the successor; provided, however, that, with respect to a Participant who incurs a Total and Permanent Disability,

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Separation from Service means the date that is 29 months after the first day of disability. For purposes of this definition, “Affiliate” means any corporation that is in the same controlled group of corporations (within the meaning of Code Section 414(b)) as the Company and any trade or business that is under common control with the Company (within the meaning of Code Section 414(c)), determined in accordance with the default provision set forth in Treasury Regulation Section 1.409A-(1)(h)(3). Notwithstanding the foregoing, if a Participant would otherwise incur a Separation from Service in connection with a sale of assets of the Company, the Company shall retain the discretion to determine whether a Separation from Service has occurred in accordance with Treasury Regulation Section 1.409A-1(h)(4) or the successor regulation thereto.

“Specified Employee” means each (a) officer of the Company and its Affiliates, up to a maximum of fifty, having annual compensation in excess of $145,000 (as adjusted), (b) five percent owner of the Company and (c) one percent owner of the Company having annual compensation in from the Company and its Affiliates in excess of $150,000, in each case determined pursuant to Section 416(i)(1)(A)(i), (ii) or (iii) of the Code (applied in accordance with the regulations thereunder and disregarding Section 416(i)(5) of the Code) any time during the 12-month period ending on December 31^st of a calendar year (based on taxable wages as reported in Box 1 of Form W-2 for the 12-month period ending on December 31^st of such calendar year plus amounts that would be included in wages for such 12-month period but for pre-tax deferrals to a tax-favored retirement plan or cafeteria plan or for qualified transportation benefits) who performed services for the Company and its Affiliates at any time during the 12-month period ending on December 31^st of such calendar year. A Participant shall be treated as a “Specified Employee” for the 12-month period beginning on March 1^st of the calendar year following the calendar year for which the determination pursuant to this definition is made.

“Supplemental Plan Compensation” means Compensation as defined by the Pension Plan, but without the limitations imposed on and after January 1, 1989 pursuant to Code Section 401(a)(17).

“Supplemental Plan Final Average Compensation” means Final Average Compensation as determined under the Pension Plan, but substituting Supplemental Plan Compensation in lieu of Compensation throughout the determination.

“Supplemental Plan Preretirement Death Benefit” means the benefit described in Section 4.5.

“Supplemental Plan Retirement Benefits” means the retirement benefits provided under Article IV of the Supplemental Plan.

“Total and Permanent Disability” shall have the meaning assigned to such term or similar term under the long-term disability plan of the Company applicable to such Participant.

2.2 Gender and Number. Except where otherwise indicated by the context, any masculine terminology used herein shall also include the feminine gender, and the definition of any term herein in the singular shall also include the plural.

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Article III. Eligibility and Participation

3.1 Eligibility. Subject to Section 3.2, any Employee who (a) was hired and rehired (if applicable) by the Company prior to January 1, 2006, (b) was not an Excluded Individual, (c) was a participant in the Pension Plan on December 31, 2006 and (d) whose retirement benefits under the Pension Plan were limited by the benefit limitation set forth in Code Sections 401(a)(17) and 415 was eligible to participate in this Supplemental Plan. Excluded Individuals were not eligible to participate in or receive benefits under the Supplemental Plan.

3.2 Participation Frozen. Notwithstanding anything in the Supplemental Plan to the contrary, effective as of December 31, 2006, participation in the Supplemental Plan shall be frozen and no Employee who was not a Participant on December 31, 2006 shall become a Participant after December 31, 2006. No Employee who is hired or rehired by the Company on or after January 1, 2006 shall become a Participant in or earn any benefit under the Plan.

Article IV. Retirement Benefits

4.1 Supplemental Plan Retirement Benefit. Subject to the December 31, 2006 limitation on service credit set forth in Section 4.2, the Company will pay or cause to be paid to each Participant who commences payment after December 31, 2007, a Supplemental Plan Retirement Benefit equal to (a) minus (b) (provided that the difference is greater than zero) where—

(a) is the Pension Plan Retirement Benefit that would be payable as of the month in which payment of the Supplemental Plan Retirement Benefit commences pursuant to Section 4.3 determined without regard to any requirement in the Pension Plan regarding the date on which such payment may actually commence and if (i) the limitations under Code Section 415 are not imposed and (ii) Supplemental Plan Compensation and Supplemental Plan Final Average Compensation have the meaning given such terms under Article II of this Supplemental Plan; and

(b) is the Pension Plan Retirement Benefit that would be payable as of such month if the limitations under Code Sections 401(a)(17) and 415 were imposed, determined as if such benefit were paid as a Single Life Annuity and without regard to any requirements in the Pension Plan regarding the date on which such payment may actually commence.

For purposes of this Section 4.1, the Supplemental Plan Retirement Benefit shall be determined in accordance with the early commencement factors set forth in the Pension Plan.

4.2 Supplemental Plan Retirement Benefit Frozen. Notwithstanding anything in the Plan to the contrary, effective as of December 31, 2006, the Supplemental Plan Retirement Benefit of each Participant shall be frozen and no additional Supplemental Plan Retirement Benefit shall accrue on or after December 31, 2006 on behalf of any Participant or any other individual. Hours of Service performed after December 31, 2006 and Supplemental Plan Compensation earned after December 31, 2006 shall not be considered for purposes of determining the Supplemental Plan Retirement Benefit pursuant to Section 4.1 or the amount of any other benefit under the Supplemental Plan. Credited Service shall not be earned for periods after December 31, 2006.

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4.3 Payment to Participants Not in Pay Status as of December 31, 2007.

(a) The Supplemental Plan Retirement Benefit of a Participant who, as of December 31, 2007, has not commenced payment of his Supplemental Plan Retirement Benefit shall be paid on March 2, 2008 in a single lump sum that is the Actuarial Equivalent of a Participant’s Supplemental Plan Retirement Benefit calculated as of March 2, 2008; provided, however, that if a Participant incurs a Separation from Service in 2007 and is a Specified Employee on the date of the Separation from Service, such payment shall be calculated as of as of March 2, 2008 and paid the later of (i) March 2, 2008 and (ii) the date determined in accordance with Section 4.8(a). To the extent that payment of the Supplemental Plan Retirement Benefit is delayed pursuant to this Section 4.3(a) due to a Participant’s status as a Specified Employee, interest at the rate(s) specified in Section 4.3(d) shall be paid on such delayed payment for the period between March 2, 2008 and the date of payment. If a Participant whose payment is delayed pursuant to this Section 4.3(a) dies after March 2, 2008 and before his Supplemental Plan Retirement Benefit is paid to such Participant, such lump sum Actuarial Equivalent of the Participant’s Supplemental Plan Retirement Benefit (with interest at the rate(s) specified in Section 4.3(d) for the period between March 2, 2008 and the date of death) shall be paid to the surviving Spouse, or, if none, to the Participant’s estate on the first day of the month following the date of death.

(b) Notwithstanding anything in Section 4.3(a) to the contrary, the Committee may delay payment of a Participant’s Supplemental Plan Retirement Benefit pursuant to Section 4.3(a) to the extent that the Committee reasonably anticipates that, if all or any portion of the payment were made pursuant to Section 4.3(a), the Company’s deduction with respect to the amount of such payment would not be permitted due to application of Code Section 162(m). In the event of a delay pursuant to this Section 4.3(b), payment of the Supplemental Plan Retirement Benefit shall be made, subject to Section 4.8(a), during the period beginning on the Participant’s Separation from Service and ending on the later of the last day of the Company’s taxable year in which such Separation from Service occurs and the 15^th day of the third month following such Separation from Service. No election shall be provided to the Participant with respect to the timing of payment pursuant to this Section 4.3(b). To the extent that payment of the Supplemental Plan Retirement Benefit is delayed pursuant to this Section 4.3(b) by reason of Code Section 162(m), interest at the rate(s) specified in Section 4.3(d) shall be paid on such delayed payment for the period between March 2, 2008 and the date of payment. If a Participant whose payment is delayed pursuant to this Section 4.3(b) dies after March 2, 2008 and before his entire Supplemental Plan Retirement Benefit is paid to such Participant, the unpaid portion of such lump sum Actuarial Equivalent of the Participant’s Supplemental Plan Retirement Benefit (with interest at the rate(s) specified in Section 4.3(d) for the period between March 2, 2008 and the date of death) shall be paid to the surviving Spouse of the Participant or, if none, to the Participant’s estate in accordance with this Section 4.3(b).

(c) If a Participant would, under the terms of the Prior Plan and the Pension Plan in effect as of December 31, 2004, commence payment of the Supplemental Plan Retirement Benefit in the 2007 Plan Year, such Participant’s Supplemental Plan Retirement Benefit shall be paid, subject to Sections 4.4 and 4.8(a), in the same annuity form as such Participant’s benefit under the Pension Plan (as provided for in the Prior Plan) and commencing on the date in 2007 on which such Participant’s benefit under the Pension Plan commences (as provided in the Prior Plan).

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(d) To the extent that interest is to be paid pursuant to Section 4.3(a) or 4.3(b), such interest shall be determined using the average annual interest rate on 30-year Treasury securities (as specified by the Commissioner of the Internal Revenue Service in revenue rulings, notices or other guidance published in the Internal Revenue Bulletin) for the November preceding the month containing the first day of the Plan Year(s) comprising the period of delay.

(e) A surviving Spouse who receives payment pursuant to Section 4.3(a) or 4.3(b) shall not be eligible to receive payment pursuant to Section 4.6.

4.4 Payment to Participants and Joint Annuitants in Pay Status as of December 31, 2007.

(a) A Participant or surviving Spouse or other surviving joint annuitant, as the case may be, who commences payment of his Supplemental Plan Retirement Benefit or survivor annuity prior to January 1, 2008 shall be permitted to elect to cease, as of December 31, 2008, monthly payments of such benefit and to receive the unpaid portion of either his Supplemental Plan Retirement Benefit or survivor annuity, as the case may be, as an Actuarial Equivalent single lump sum paid on January 5, 2009. Such lump sum payable to a Participant also shall reflect the value of any survivor annuity option previously elected by such Participant; provided that the Spouse or other joint annuitant is alive as of January 5, 2009. To make an election pursuant to this Section 4.4(a), a Participant must obtain the written, notarized consent of his Spouse (if any). Any election pursuant to this Section 4.4 shall not apply to the portion of such Supplemental Plan Retirement Benefit or survivor annuity that would otherwise be paid in 2007 in accordance with the Prior Plan. Any election pursuant to this Section 4.4. may be changed at any time before December 1, 2007 and shall become irrevocable as of December 1, 2007.

(b) If an eligible Participant who is receiving payment of his Supplemental Plan Retirement Benefit in the form of a joint and survivor annuity makes the election permitted pursuant to Section 4.4(a), and dies after December 31, 2007 and prior to January 5, 2009, the value of any survivor annuity option previously elected by such Participant and still in effect shall be paid on the first day of the month following the date of the Participant’s death to the surviving Spouse (if any) or other surviving joint annuitant (if any), as the case may be, in a single lump sum that is the Actuarial Equivalent of such survivor annuity as of the date immediately prior to the date of the Participant’s death. A surviving Spouse or other joint annuitant of a Participant receiving payment of his Supplemental Plan Retirement Benefit in the form of a single life annuity shall not be eligible for the payment pursuant to this Section 4.4(b).

(c) A survivor annuity shall not be paid to the surviving Spouse or other joint annuitant (if any) of a Participant who elects an Actuarial Equivalent single lump sum pursuant to Section 4.4.

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4.5 Supplemental Plan Preretirement Death Benefit. Subject to Sections 4.2 and 4.6(d), the Company shall pay or cause to be paid on behalf of each Participant who, on the date of his death, has a surviving Spouse to whom such Participant has been married for at least one year, for any month in which a Pension Plan Preretirement Death Benefit is payable, a Supplemental Plan Retirement Benefit equal to the excess (if any) of (a) over the sum of (b) and (c) where:

(a) is the Pension Plan Preretirement Death Benefit that would be payable for the month in which payment is made determined as if (i) the limitations imposed by Code Sections 401(a)(17) and 415 are not imposed and determined without regard to any requirement in the Pension Plan regarding the date on which such payment may actually commence and (ii) Supplemental Plan Compensation and Supplemental Plan Final Average Compensation have the meaning given such terms under Article II of this Supplemental Plan;

(b) is the Pension Plan Preretirement Death Benefit that would be payable for such month determined as if such benefit were paid as a Single Life Annuity and without regard to any requirement in the Pension Plan regarding the date on which such payment may actually commence; and

(c) is the Preretirement Death Benefit actually payable for such month from the Excess Plan.

For purposes of this Section 4.5, the Supplemental Plan Preretirement Death Benefit shall be determined in accordance with the early commencement factors set forth in the Pension Plan.

4.6 Payment of Supplemental Plan Preretirement Death Benefit.

(a) Subject to Section 4.2, payment of a Supplemental Plan Preretirement Death Benefit to a surviving Spouse (if any) who has not commenced payment as of December 31, 2007 shall be paid as an Actuarial Equivalent single lump sum on March 2, 2008.

(b) If the surviving Spouse of a Participant would, under the terms of the Prior Plan and the Pension Plan in effect as of December 31, 2004, commence payment of the Supplemental Plan Preretirement Death Benefit in the 2007 Plan Year:

(i) such benefit shall be paid, subject to Section 4.6(b)(ii), to the surviving Spouse as an Actuarial Equivalent single life annuity commencing on the date in 2007 provided for in the Prior Plan; and

(ii) annuity payments to the surviving Spouse of a Participant pursuant to Section 4.6(b)(i) from the Supplemental Plan shall cease as of February 28, 2008 and the unpaid portion of the Supplemental Plan Preretirement Death Benefit payable to such surviving Spouse shall be paid as an Actuarial Equivalent single lump sum on March 2, 2008.

(c) Notwithstanding anything in the Plan to the contrary, the surviving Spouse, if any, of a Participant who commences payment of his Supplemental Plan Retirement Benefit prior to such Participant’s death shall not be eligible to receive a Supplemental Plan Preretirement Death Benefit.

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4.7 Actuarial Equivalence. The actuarial equivalence of lump sum payments of the Supplemental Plan Retirement Benefit shall be determined using an annual interest rate of 4.69% and the 1994 Group Annuity Reserving table, weighted 50% male and 50% female, projected by scale AA to 2002 as defined in Revenue Ruling 2001-62.

4.8 Delay in Payment. Notwithstanding anything in Article IV to the contrary:

(a) to the extent that (i) a Participant’s Supplemental Plan Retirement Benefit is to be paid or commence to be paid in connection with such Participant’s Separation from Service for any reason other than his death during the period beginning on such Separation from Service and ending on the six-month anniversary of such date and (ii) at the time of such Separation from Service, the Participant is a Specified Employee, payment of the Supplemental Plan Retirement Benefit shall be delayed for six months and paid on the first day of the seventh month following such Separation from Service. The first payment following such six-month period shall be an amount equal to the monthly payments (if any) which would otherwise have been paid to the Participant during the first six months following the Separation from Service, plus the amount due for the seventh month.

(b) neither the Committee nor the Administrator shall have the discretionary authority to delay payment of a Supplemental Plan Retirement Benefit or Supplemental Plan Preretirement Death Benefit except to the extent that the Committee or the Administrator determines in its discretion, that any such delay will not cause any person to incur any tax, interest payment or penalty pursuant to Section 409A (“Section 409A Compliance”).

Payment of any amount delayed pursuant to this Section 4.8 shall be without interest and made in a manner that results in Section 409A Compliance.

4.9 Acceleration of Payment. Notwithstanding anything in this Article IV to the contrary, neither the Committee nor the Administrator shall have the discretionary authority to accelerate payment of any Supplemental Plan Retirement Benefit and Supplemental Plan Preretirement Death Benefit except to the extent the Committee or the Administrator determines that any such acceleration may be effected in a manner that will result in Section 409A Compliance.

Article V. Rights of Participants

5.1 Vesting. A Participant shall have a nonforfeitable right at all times to Supplemental Plan Retirement Benefits.

5.2 Contractual Obligation. Payment of Supplemental Plan Retirement Benefits under this Supplemental Plan shall be made out of the Company’s general assets and shall represent only an unfunded, unsecured obligation of the Company.

5.3 Unsecured Interest. No Participant or beneficiary shall have any interest whatsoever in any specific asset of the Company. To the extent any person acquires a right to receive payments under this Supplemental Plan, such right shall be no greater than the right of any unsecured general creditor of the Company.

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5.4 Employment. Nothing in this Supplemental Plan shall interfere with or limit in any way the right of an Employer to terminate any Participant’s employment at any time, nor confer upon any Participant any right to continue in the employ of an Employer.

Article VI. Non-Alienation of Benefits

6.1 Nontransferability. Benefits payable under this Supplemental Plan shall not be subject, in any manner, to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, charge, garnishment, execution or levy of any kind, either voluntary or involuntary, including any such liability which is for alimony or other payments for the support of a spouse or former spouse, or for any other relative of the Employee. Prior to the time of payment hereunder, a Participant or a beneficiary shall have no rights by way of anticipation or otherwise dispose of any interest under this Supplemental Plan nor shall such rights be assigned or transferred by operation of law. Notwithstanding anything in this Section 6.1 to the contrary, the Administrator shall have the authority, in its discretion, to honor a domestic relations order that the Administrator determines to be qualified (based on the criteria set forth in Sections 401(a)(13) and 414(p) of the Code) with respect to a Participant’s Supplemental Plan Retirement Benefit.

Article VII. Administration

7.1 Administration. The Supplemental Plan shall be administered by the Committee. The Committee may from time to time establish rules for the administration of this Supplemental Plan that are not inconsistent with the provisions of this Supplemental Plan.

7.2 Interpretation of the Supplemental Plan; Finality of Determination. The general supervision of the Supplemental Plan shall be the responsibility of the Committee, which, in addition to such other powers as it may have as provided herein, shall have the power: (a) to determine eligibility to participate in, and the amount of benefit to be provided to any Participant under, the Supplemental Plan; (b) to make and enforce such rules and regulations as it shall deem necessary or proper for the efficient administration of the Supplemental Plan; (c) to determine all questions arising in connection with the Supplemental Plan, to interpret and construe the Supplemental Plan, to resolve ambiguities, inconsistencies or omissions in the text of the Supplemental Plan, to correct any defects in the text of the Supplemental Plan and to take such other action as may be necessary or advisable for the orderly administration of the Supplemental Plan; (d) to make any and all legal and factual determinations in connection with the administration and implementation of the Supplemental Plan; (e) to review actions taken by any other person to whom authority is delegated under the Supplemental Plan; and (f) to employ and rely on legal counsel, actuaries, accountants and any other agents as may be deemed to be advisable to assist in the administration of the Supplemental Plan. All such actions of the Administrator shall be conclusive and binding upon all persons. The Committee shall be entitled to rely conclusively upon all tables, valuations, certificates, opinions, and reports furnished by any actuary, accountant, controller, counsel, or other person employed or engaged by the Company with respect to the Supplemental Plan. If any member of the Committee is a Participant, such representative shall not resolve, or participate in the resolution of, any matter relating to such

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member’s eligibility for a Retirement Benefit or the calculation or determination of such member’s Retirement Benefit. Neither the Committee nor any member thereof nor the Company shall be liable for any action or determination made in good faith with respect to the Supplemental Plan or the rights of any person under the Supplemental Plan.

7.3 Delegation. The Committee shall have the power to delegate to any person or persons the authority to carry out such administrative duties, powers and authority relative to the administration of the Supplemental Plan as the Committee may from time to time determine. Any action taken by any person or persons to whom the Committee makes such a delegation shall, for all purposes of the Supplemental Plan, have the same force and effect as if undertaken directly by the Committee.

7.4 Administrator. The Administrator shall be responsible for the day-to-day operation of the Plan, having the power (except to the extent such power is reserved to the Committee) to take all action and to make all decisions necessary or proper in order to carry out his duties and responsibilities under the provisions of the Plan. If the Administrator is a Participant, the Administrator shall not resolve, or participate in the resolution of, any question which relates directly or indirectly to him and which, if applied to him, would significantly vary his eligibility for, or the amount of, any benefit to him under the Plan. The Administrator shall report to the Committee at such times and in such manner as the Committee shall request concerning the operation of the Plan.

7.5 Expenses. The cost of payment from this Supplemental Plan and the expenses of administering the Supplemental Plan shall be borne by the Company.

Article VIII. Unfunded Arrangement

8.1 The Supplemental Plan is an unfunded arrangement. The benefits under the Supplemental Plan represent at all times an unfunded and unsecured contractual obligation of the Company. Each Participant or beneficiary will be an unsecured creditor of the Company. Amounts payable under the Supplemental Plan will be satisfied solely out of the general assets of the Company, subject to the claims of the Company’s creditors. No Participant or beneficiary shall have any interest in any fund or any specific asset of the Company by reason of any amount credited to such person hereunder, nor shall any Participant, Beneficiary or other person have any right to receive any distribution under the Supplemental Plan except as, and to the extent, expressly provided in the Supplemental Plan. The Company will not segregate any funds or assets for the payment of benefits hereunder or issue any notes or securities for the payment of such benefits. Any reserve or other asset that the Company may establish or acquire to insure itself of the funds to provide benefits hereunder shall not serve in any way as security to any Participant, beneficiary or other person for the performance of the Company’s obligations.

8.2 Tax Withholding. The Company shall have the right to deduct from all payments made from the Supplemental Plan any federal, state, local or foreign taxes required by law to be withheld with respect to such payments. In lieu thereof, the Company shall have the right, to the extent permitted by law, to withhold the amount of such taxes from any other sums due or to become due from the Company to the Participant upon such terms and conditions as the Committee may prescribe.

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Article IX. Indemnification

9.1 Indemnification. To the extent permitted by law, the Committee, the Administrator, the Compensation and Organization Committee of Ambac Financial Group, Inc., each member of each such committee, and any Employee of the Company whom fiduciary responsibilities have been delegated shall be indemnified by the Company against any claims, and the expenses of defending against such claims, resulting from any action or conduct relating to the administration of the Supplemental Plan except claims arising from gross negligence, willful neglect, or willful misconduct. No person shall be deemed a fiduciary of the Supplemental Plan solely on account of this Section 10.1.

Article X. Claims Procedure

10.1 Claims. In the event any person or his authorized representative (a “Claimant”) disputes the amount of, or his entitlement to, any benefits under the Plan or their method of payment, such Claimant shall be required to file a claim in writing with the Administrator for the benefits to which he believes he is entitled, setting forth the reason for his claim. The Claimant shall have the opportunity to submit written comments, documents, records and other information relating to the claim and shall be provided, upon request and free of charge, reasonable access to and copies of all documents, records or other information relevant to the claim. The Administrator shall consider the claim, and, within 90 days of receipt of such claim, unless special circumstances exist, the Administrator shall inform such person of its decision with respect to the claim. In the event of special circumstances, the response period can be extended for an additional 90 days as long as the Claimant receives before the end of the initial 90-day response period written notice advising of the special circumstances (the “Extension Notice”) and the date by which a decision is expected to be made. If the Administrator denies the claim, the Administrator shall give to such person (a) a written notice setting forth the specific reason or reasons for the denial of the claim, including references to the applicable provisions of the Plan, (b) a description of any additional material or information necessary to perfect such claim along with an explanation of why such material or information is necessary, (c) appropriate information as to the procedure to be followed for review of such claim by the Committee, including time limits and (d) the Claimant’s right to commence a civil action under Section 502(a) of ERISA.

10.2 Appeal of Denial. A Claimant whose claim is denied by the Administrator and who wishes to appeal such denial must request a review of the Administrator’s decision by filing a written request with the Committee for such review within 60 days after the Claimant’s receipt of such claim denial. Such request for review shall contain, and the Committee shall review all comments, documents, records and other information relating to the claim for benefits that the Claimant wishes the Committee to review, without regard as to whether such information was submitted or considered in the initial review of the claim by the Administrator. In connection with that review, the Claimant shall be provided, upon request and free of charge, reasonable access to and copies of all documents, records or other information relevant to the claim. Written notice of the decision on review shall be furnished to the Claimant within 60 days after receipt by the Committee of a request for review. However, in the event of special circumstances, the response period can be extended for an additional 60 days, as long as the Claimant receives an Extension Notice before the end of the initial 60-day response period indicating the reasons for the extension and the date by which the Committee expects to make a decision. The Committee’s

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decision on review shall include (a) the specific reasons for the adverse determination, (b) references to applicable Supplemental Plan provisions, (c) a statement that the Claimant is entitled to receive, free of charge, reasonable access to, and copies of, all documents, records and other information relevant to the claim and (d) a statement of the Claimant’s right to bring an action under Section 502(a) of ERISA following an adverse benefit determination on a review and a description of the applicable limitations period under the Supplemental Plan.

10.3 Statute of Limitations. A Claimant wishing to seek judicial review of an adverse benefit determination under the Supplemental Plan, whether in whole or in part, must file any suit or legal action, including, without limitation, a civil action under Section 502(a) of ERISA, within three years of the date the final decision on the adverse benefit determination on review is issued or should have been issued under Section 11.2 or lose any rights to bring such an action. If any such judicial proceeding is undertaken, the evidence presented shall be strictly limited to the evidence timely presented to the Committee. Notwithstanding anything in the Supplemental Plan to the contrary, a Claimant must exhaust all administrative remedies available to such Claimant under the Supplemental Plan before such Claimant may seek judicial review pursuant to Section 502(a) of ERISA.

Article XI. Amendment; Termination; Acceleration

11.1 Amendment and Termination. The Company does hereby reserve the right to amend, modify, or terminate the Supplemental Plan at any time by action of its Board. Any such amendment, modification, or termination shall not reduce or diminish such person’s right to receive any benefit accrued hereunder prior to the date of such amendment, modification, or termination. Notice of such amendment or termination shall be given in writing to each Participant and beneficiary of a deceased Participant having an interest in the Supplemental Plan. Upon termination of the Supplemental Plan for any reason, payment of the Supplemental Plan Retirement Benefit Accounts shall be made in accordance with Article IV, unless the Committee, in its discretion, determines to accelerate payment and such acceleration may be effected in a manner than results in Section 409A Compliance. For purposes of any acceleration upon termination of the Supplemental Plan due to a change of control event of the Company that is a change in control event under Section 409A, change of control event shall have the meaning assigned thereto under the default definition set forth in Treasury Regulation Section 1.409A-3(i)(5) or the successor regulation thereto.

11.2 409A Amendments. Without limiting the generality of Section 12.1, the Committee and the Senior Vice President, Chief Administrative Officer & Employment Counsel or the successor thereto (the “SVP”) shall each have the unilateral right to amend or modify the Supplemental Plan without the consent of any Participant, to the extent that the Committee or SVP deems such amendment or modification to be necessary or advisable to ensure Section 409A Compliance and such action can be effected in a manner that will result in Section 409A Compliance. Any determinations made by the Committee or the SVP under this Section 12.2 shall be final, conclusive and binding on all persons.

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Article XII. General Provisions

12.1 No Contract of Employment. Nothing contained herein shall be construed as conferring upon any person the right to be employed or continue in the employ of the Company.

12.2 Notices. Notices may be delivered to the Participant at the offices of the Company at which the Participant is principally employed. Any Participant who ceases to be an employee of the Company shall be responsible for furnishing the Committee with the current and proper address for the mailing of notices and delivery of payments. Any notice required or permitted to be given to such a Participant shall be deemed given if directed to the person to whom addressed at such address and mailed by regular United States mail, first-class and prepaid. If any item mailed to such address is returned as undeliverable to the addressee, mailing will be suspended until the Participant furnishes the proper address.

12.3 Severability. If any provision of the Supplemental Plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions hereof, and the Supplemental Plan shall be construed and enforced as if such provisions had not been included.

12.4 Incapacity of Participant. In the event a Participant, surviving Spouse or other joint annuitant is declared incompetent and a conservator or other person legally charged with the care of his person or his estate is appointed, any benefits under the Plan to which such Participant, surviving Spouse or other joint annuitant is entitled shall be paid to such conservator or other person legally charged with the care of his person or estate.

12.5 Headings and Captions. The headings and captions herein are provided for reference and convenience only, shall not be considered part of the Supplemental Plan, and shall not be employed in the construction of the Supplemental Plan.

12.6 Applicable Law. The Supplemental Plan shall be construed under the laws of the State of New York to the extent that such laws are not pre-empted by federal law.

Article XIII. 409A Transition Rules

13.1 Transition Rules.

(a) Participant payment elections permitted by Article IV and the amendments to Article IV regarding the time and form of payment of the Supplemental Plan Retirement Benefit and Supplemental Plan Preretirement Death Benefit shall be pursuant to the Applicable Transition Relief Notice.

(b) To the extent that any Participant receives during calendar year 2005 a distribution of all, or any portion of, his Supplemental Plan Retirement Benefit, such distribution shall be deemed a termination of such Participant’s participation in this Plan with respect to all or such portion of such Participant’s Supplemental Plan Retirement Benefit in accordance with the Applicable Transition Relief.

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(c) The time and form of payment of the Supplemental Plan Retirement Benefit of a Participant who commences payment prior to January 1, 2008 shall be linked to the time and form of payment of the Retirement Benefit under the Pension Plan in accordance with the Applicable Transition Relief and the Prior Plan as in effect prior to October 3, 2004.

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EX-10.49

Exhibit 10.49

THE AMBAC FINANCIAL GROUP, INC.

NON-QUALIFIED SAVINGS INCENTIVE PLAN

(Amended and Restated as of January 1, 2007, Unless Otherwise Provided)

THE AMBAC FINANCIAL GROUP, INC.

NON-QUALIFIED SAVINGS INCENTIVE PLAN

1. Purpose

The Ambac Financial Group, Inc. Non-Qualified Savings Incentive Plan (the “Plan”) is established for the purpose of providing certain eligible officers and key executive employees of the Company with benefits which would otherwise be provided under the Savings Plan but for the Applicable Limits. The Plan is an unfunded deferred compensation plan for a select group of management or highly compensated employees within the meaning of ERISA, and shall be construed and administered accordingly.

The Plan is an amendment and restatement of the Prior Plan, effective as of the Effective Date, unless otherwise provided.

Capitalized words not otherwise defined in the text hereof have the meanings set forth in Section 2.

2. Definitions; Construction

2.1 Definitions. Wherever used herein, the following terms shall have the meanings set forth in this Section 2.1. Capitalized terms not otherwise defined herein shall have the meaning set forth in the Savings Plan.

“Account” means a bookkeeping account established on the records of the Company to record the amounts credited or paid to a Participant from time to time under the Plan, together with all applicable income, gains and losses credited or charged to such Account from time to time.

“Administrator” means the person designated by the Committee in accordance with Section 15.2.

“Ambac” means Ambac Financial Group, Inc.

“Applicable Limits” means the Section 402(g) Limit, the limit on qualified plan compensation imposed by Section 401(a)(17) of the Code, the limit on qualified plan contributions under Section 415 of the Code and the limit on elective contributions under the Savings Plan.

“Applicable Transition Relief” means the following transition guidance, as applicable, with respect to the application of Section 409A: (i) I.R.S. Notice 2005-1, I.R.B. 274 (published as modified on January 6, 2005), (ii) Section XI.C. of the preamble to the proposed Treasury Regulations under Section 409A, (70 F.R. 57930; October 4, 2005), and (iii) I.R.S. Notice 2006-79, I.R.B. 2006-43.

“Base Compensation” means, for a given Plan Year, “Base Compensation” as such term is defined in the Savings Plan, without regard to any limit on compensation imposed under Section 401(a)(17) of the Code. Base Compensation payable after December 31 of a

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calendar year for services performed during the final payroll period of such calendar year containing such December 31 shall be treated as Base Compensation for the subsequent calendar year.

“Beneficiary” means the person or persons designated by a Participant in accordance with Section 11 to receive benefits under the Plan in the event of the Participant’s death.

“Board” means the Board of Directors of Ambac.

“Cause” means (a) a Participant’s conviction of a felony, (b) fraud or a dishonest act against the Company by the Participant, (c) the Participant’s willful conduct or negligence which results in material harm to the business or reputation of the Company or (d) the Participant’s employment with a competitor of the Company following his Separation from Service with the Company.

“Code” means the Internal Revenue Code of 1986, as amended, and all applicable rulings and regulations thereunder.

“Committee” means the Plan Administrative Committee of Ambac and any successor thereto, or any other committee that is delegated, from time to time, with the administration of the Plan.

“Company” means, collectively, Ambac and each direct or indirect Subsidiary thereof.

“Deferral Election” means an election by an Eligible Employee regarding the rate of his Savings Plan Deferral in accordance with the Savings Plan.

“Effective Date” means January 1, 2007.

“Eligible Employee” means an employee of Ambac or a Subsidiary who (a) is eligible to make Savings Plan Deferrals and to receive a Matching Contribution and a Profit Sharing Contribution under the Savings Plan for such year and (b) has an annual rate of Base Compensation for a calendar year in excess of the limit under Section 401(a)(17) of the Code for such calendar year. The limit under Section 401(a)(17) of the Code shall be adjusted for cost-of-living increases in the same manner as the limit under Section 401(a)(17)(A) of the Code is adjusted in accordance with Section 401(a)(17)(B) of the Code.

“Eligibility Date” has the meaning set forth in Section 3.2.

“ERISA” means the Employee Retirement Income Security Act of 1974, as amended, and the applicable rulings and regulations thereunder.

“Excluded Individual” means any individual who is treated or designated by the Company as an independent contractor, leased employee (including, without limitation, a Statutory Leased Employee), temporary employee provided through an agency, consultant, or any individual who performs services for the Company under an agreement or arrangement

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(which may be written, oral or evidenced by the payroll practices of the Company) with the individual or with another organization that provides the services of the individual to the Company under which the individual is treated as an independent contractor or is otherwise treated as an employee of an entity other than the Company (such as a leasing organization), or a student hired for a specified period known as a “co-op” or an “intern”. Excluded Individuals are not eligible to participate in or receive benefits under the Plan. If any Excluded Individual shall be determined by a court or a federal, state or local regulatory or administrative authority to have served as a common law employee of the Employer, such determination shall not alter this exclusion as an Eligible Employee for purposes of this Plan. For purposes of this definition, “Statutory Leased Employee” means any person (other than an employee on the payroll of the Company) who, pursuant to an agreement between the Company and any other person, has performed services for the Company (or for the Company and related persons, determined in accordance with Section 414(n)(6) of the Code) on a substantially full-time basis for a period of at least one year, and such services are performed under the primary direction or control by the Company.

Excluded Individual shall also mean (a) any employee of the Company whose terms of employment are the subject of a collective bargaining agreement unless that agreement provides for his participation in this Plan, (b) any employee of the Company who is a nonresident alien of the United States with no United States source earned income from the Company and (c) any individual who is a temporary employee who has less than 500 Hours of Service during the relevant computation period.

“Investment Fund” means the Vanguard Wellington Fund or any other mutual fund designated by the Committee in lieu thereof.

“Matching Contributions” means the employer matching contributions to the Savings Plan credited to the account of a Participant under the Savings Plan in accordance with the terms of the Savings Plan.

“Participant” means an individual, other than an Excluded Individual, who is an Eligible Employee and has satisfied the participation requirements of Section 3(a).

“Plan” has the meaning set forth in Section 1.

“Plan Matching Credit” means, for a given calendar year, the amounts credited to a Participant’s Account under Section 4 below.

“Plan Year” means the calendar year.

“Prior Plan” means the terms of this Plan in effect immediately prior to the Effective Date, as set forth in the Company’s written documentation, rules, practices and procedures applicable to the Plan.

“Profit Sharing Contribution” means a profit sharing contribution under the Savings Plan made in accordance with the terms of the Savings Plan.

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“Profit Sharing Credit” means, for a given calendar year, the amounts credited to a Participant’s Account under Section 5 of the Plan.

“Savings Plan” means the Ambac Financial Group Inc. Savings Incentive Plan, as in effect on the Effective Date or as thereafter amended.

“Savings Plan Deferral” means the elective deferrals under the Savings Plan made by a Participant in accordance with the terms of the Savings Plan.

“Section 402(g) Limit” means, for a given calendar year, the applicable limit on elective deferrals under Section 402(g) of the Code (including the limit on catch-up contributions, if applicable).

“Section 409A” means Section 409A of the Code and the applicable rulings and regulations promulgated thereunder.

“Section 409A Compliance” has the meaning set forth in Section 13.1.

“Separation from Service” means either (i) the termination of a Participant’s employment with the Company and its Affiliates, provided that such termination of employment meets the requirements of a separation of service determined using the default provisions set forth in Treasury Regulation 1.409A-(1)(h) or the successor thereto or (ii) such other date that constitutes a separation from service with the Company and its Affiliates meeting the requirements of the default provisions set forth in Treasury Regulation 1.409A-(1)(h) or the successor; provided, however, that, with respect to a Participant who incurs a Total and Permanent Disability, Separation from Service means the date that is 29 months after the first day of disability. For purposes of this definition, “Affiliate” means any corporation that is in the same controlled group of corporations (within the meaning of Code Section 414(b)) as the Company and any trade or business that is under common control with the Company (within the meaning of Code Section 414(c)), determined in accordance with the default provision set forth in Treasury Regulation Section 1.409A-(1)(h)(3). Notwithstanding the foregoing, if a Participant would otherwise incur a Separation from Service in connection with a sale of assets of the Company, the Company shall retain the discretion to determine whether a Separation from Service has occurred in accordance with Treasury Regulation Section 1.409A-1(h)(4) or the successor regulation thereto.

“Subsidiary” means any corporation in respect of which Ambac beneficially owns directly or indirectly 50% or more of the securities of such corporation entitled to vote in the election of directors thereof.

“Total and Permanent Disability” shall have the meaning assigned to such term or similar term under the long-term disability plan of the Employer applicable to such Participant.

2.2 Rules of Construction. The masculine gender shall be construed to include the feminine gender, and the singular form of a word shall be deemed to include the plural form, unless the context requires otherwise. Unless indicated otherwise, references herein to articles and sections are to articles and sections of the Plan.

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3. Participation in the Plan

3.1 Continuing Participants. Any Eligible Employee on the Effective Date who was a participant in the Prior Plan immediately prior to the Effective Date will be a Participant in the Plan on the Effective Date, subject to the terms and provisions hereof.

3.2 New Participants. An Employee who does not become a Participant in the Plan in accordance with Section 3.1 shall be eligible to commence participation in the Plan on the date that such Employee first becomes an Eligible Employee.

3.3 Exclusions. No employee of the Company who is not an Eligible Employee shall be eligible to participate in the Plan and no Excluded Individual may be an Eligible Employee. Anything in Section 3.2 to the contrary notwithstanding, the Committee may, in its sole discretion, preclude an individual who meets the qualification requirements set forth in this Section 3 from participating in the Plan if the Committee determines that excluding such individual from the Plan may be in the best interests of the Company or necessary or advisable to comply with the requirements for “top hat” plans under ERISA or the requirements of other applicable law. Any dispute as to whether an individual qualifies as a Participant shall be resolved by the Committee in its sole discretion, and any such determination by the Committee shall be final and binding on all interested persons.

4. Plan Matching Credits

4.1 General Rule. Subject to Section 4.2, the Company shall credit to the Account of an Eligible Employee an aggregate Plan Matching Credit for a Plan Year equal to the difference between A and B, where:

“A” equals the aggregate Matching Contribution based on such Participant’s Deferral Election that the Participant would have received under the Savings Plan for a Plan Year in the absence of the Applicable Limits; and

“B” equals the Participant’s aggregate actual Matching Contribution based on such Participant’s Deferral Election under the Savings Plan for such Plan Year.

4.2 Restrictions and Limitations. Anything in the Plan to the contrary notwithstanding, the Account of an Eligible Employee shall not be credited with a Plan Matching Credit for a Plan Year unless the Savings Plan Deferrals actually made by or on behalf of such Eligible Employee for such Plan Year are in an amount equal to the Section 402(g) Limit for such Plan Year.

4.3 Time of Crediting. The Company shall credit to each Participant’s Account the Plan Matching Credit (if any) determined under this Section 4 for a given Plan Year during the first calendar quarter of the following Plan Year.

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5. Plan Profit Sharing Credits

5.1 General Rule. For each Plan Year, the Company shall credit to the Account of each Participant a Profit Sharing Credit determined in accordance with the formula [C - D], where

“C” equals the profit sharing contribution that would have been allocated to the Participant’s account under the Savings Plan for such Plan Year if the Applicable Limits did not apply to the Savings Plan; and

“D” equals the profit sharing contribution for such Plan Year actually allocated to a Participant’s account under the Savings Plan.

5.2 Limitations. Effective as of January 1, 2008, a change to a Participant’s Deferral Election that would otherwise affect amounts credited under the Plan as Plan Profit Sharing Credits for a Plan Year shall not result in an increase or decrease for such Plan Year in the amount credited to such Participant’s Account as Plan Profit Sharing Credits in excess of the aggregate amount permitted under the Section 402(g) Limit with respect to such Participant for such Plan Year.

5.3 Time of Crediting. The Company shall credit to each Participant’s Account the Profit Sharing Credit determined under this Section 5 for a given Plan Year during the first calendar quarter of the next Plan Year.

6. Supplemental Account Credits

In its sole discretion, the Committee may elect at any time to credit additional amounts to a Participant’s Account under the Plan. Any such action by the Committee with respect to a given Participant shall not obligate the Committee to take any similar action with respect to any other Participant or obligate the Committee to take the same or similar action at any later date with respect to any Participant.

7. Investment Fund

7.1 General Rule. Subject to the provisions of this Section 7, amounts credited to a Participant’s Account shall be deemed to be notionally invested in units of the Investment Fund as of the date such amounts are credited to the Participant’s Account under the Plan and shall be credited with the amounts of any income, gains and losses which would be attributable to a corresponding investment of an equal cash amount in the Investment Fund. A Participant’s Account shall be automatically credited with additional units in each Investment Fund based upon the number of units that would have been credited on an equivalent cash investment as a result of the automatic reinvestment of distributions from the Investment Fund received in respect of such investment.

7.2 Valuation. To the extent applicable, the notional purchase or sale of an interest in an Investment Fund shall be based on the closing net asset value of the Investment Fund on the date such notional purchase or sale is deemed to have occurred. The value of a Participant’s Account shall be determined on each business day by an administrator selected by the Committee for this purpose.

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8. Vesting

Subject to the next sentence, a Participant’s interest in his Account shall be fully vested and nonforfeitable at all times. Notwithstanding the previous sentence, a Participant shall immediately forfeit the entire balance in his Account and shall have no further interest under the Plan if the Participant’s employment with the Company is terminated for Cause.

9. Payment of Benefits

9.1 Time and Form. Except as otherwise provided in Section 13, effective as of January 1, 2007, a Participant’s entire Account balance shall be paid to the Participant or, in the event of the death of the Participant, the Beneficiary, in a single cash lump sum on the date that is six (6) months and one day following the date that the Participant incurs a Separation from Service for any reason other than a Separation from Service by the Company for Cause. The amount of such distribution shall be based upon the Account balance as of the date of the Participant’s Separation from Service.

9.2 No Loans or In-Service Withdrawal. No loan or in-service or hardship withdrawals shall be permitted under the Plan.

10. Designation of Beneficiary

10.1 General Rule. Subject to applicable law, each Participant shall have the right to designate the Beneficiary or Beneficiaries who shall be entitled to receive the amount payable under the Plan upon the death of the Participant. A Participant may, from time to time, revoke or change such Beneficiary designation without the consent of any prior Beneficiary by filing a new written designation with the Committee. The last such designation received by the Committee shall be controlling; provided, however, that no designation, change or revocation thereof shall be effective unless received by the Committee prior to the Participant’s death, and in no event shall it be effective as of a date prior to such receipt.

10.2 No or Uncertain Beneficiary. If no such Beneficiary designation is in effect at the time of a Participant’s death, if no designated Beneficiary survives the Participant, or if such designation conflicts with applicable law, the amount, if any, payable under the Plan upon the Participant’s death shall be paid to the beneficiary or beneficiaries designated by the Participant under the Savings Plan who are to receive the Participant’s account balance under the Savings Plan or, if no such beneficiary has been designated under the Savings Plan, to the Participant’s estate. If the Committee is in doubt as to the right of any person to receive any amount, the Committee may retain such amount until the rights thereto are determined, or the Committee may pay such amount into any court of appropriate jurisdiction, and such payment shall be a complete discharge of the liability of the Plan, the Company and the Committee therefor.

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11. Indemnification

To the extent permitted by law, the Administrator, the Committee, the Compensation Committee of Ambac Financial Group, Inc., each member of each such committee, and any Employee of the Company to whom fiduciary responsibilities have been delegated shall be indemnified by the Company against any claims, and the expenses of defending against such claims resulting from any action or conduct relating to the administration of the Plan except claims arising from gross negligence, willful neglect or willful misconduct. No person shall be deemed a fiduciary of the Plan solely on account of this Section 11.

12. Unfunded Arrangement

The Plan is an unfunded arrangement. The benefits under the Plan represent at all times an unfunded and unsecured contractual obligation of the Company. Each Participant or Beneficiary will be an unsecured creditor of the Company. Amounts payable under the Plan will be satisfied solely out of the general assets of the Company, subject to the claims of the Company’s creditors. No Participant or Beneficiary shall have any interest in any fund or any specific asset of the Company by reason of any amount credited to such person hereunder, nor shall any Participant, Beneficiary or other person have any right to receive any distribution under the Plan except as, and to the extent, expressly provided in the Plan. The Company will not segregate any funds or assets for the payment of benefits hereunder or issue any notes or securities for the payment of such benefits. Any reserve or other asset that the Company may establish or acquire to insure itself of the funds to provide benefits hereunder shall not serve in any way as security to any Participant, Beneficiary or other person for the performance of the Company’s obligations.

13. Amendment; Termination; Acceleration of Payment

13.1 Amendment or Termination. The Board or any committee (including the Committee) delegated by the Board with such authority shall have the right to amend the Plan at any time and from time to time in any fashion and to terminate it at will at any time. Any such action by the Board, or any committee to which such authority is delegated hereunder, shall be undertaken by a resolution duly adopted at a meeting of the Board or such committee, as the case may be, or by written consent of the Board or such committee, as the case may be, in lieu of a meeting. In the event of a termination of the Plan, unless the Board or such committee determines otherwise, no further credits shall be made to Account balances under the Plan following the date of such termination. Upon termination of the Plan for any reason, payment of Participant Accounts shall be made in accordance with Section 9.1, unless the Committee, in its discretion, determines to accelerate payment and such acceleration may be effected in a manner that will not cause any person to incur any tax, interest payment or penalty under Section 409A (“Section 409A Compliance”). For purposes of any such acceleration upon termination of the Plan following a change of control event of the Company that is a change in control event under Section 409A, change of control event shall have the meaning assigned thereto under the default definitions set forth in Treasury Regulation Section 1.409A-3(i)(5).

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13.2 409A Amendments. Without limiting the generality of Section 13.1, the Senior Vice President, Chief Administrative Officer & Employment Counsel or the successor thereto (“SVP”) shall have the unilateral right to amend or modify the Plan without the consent of any Participant, to the extent that the SVP, in its discretion, deems such amendment or modification to be necessary or advisable to ensure Section 409A Compliance and such amendment or modification can be effected in a manner that will result in Section 409A Compliance. Any determinations made under this Section 13.2 shall be final, conclusive and binding on all persons.

13.3 Acceleration or Delay of Payment. The Board and the Committee shall not have the discretionary authority to accelerate payment or delay payment of any Account, unless the Board or Committee, in its discretion, determines that such acceleration may be effected in a manner that will result in Section 409A Compliance.

14. Nonalienation of Benefits

Benefits payable under this Plan shall not be subject, in any manner, to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, charge, garnishment, execution or levy of any kind, either voluntary or involuntary, including any such liability which is for alimony or other payments for the support of a Spouse or former Spouse, or for any other relative of the Employee. Prior to the time of payment hereunder, a Participant or a Beneficiary shall have no rights by way of anticipation or otherwise dispose of any interest under this Plan nor shall such rights be assigned or transferred by operation of law. Notwithstanding anything in this Section 14 to the contrary, the Administrator shall have the authority to honor a domestic relations order that the Administrator determines to be qualified (based on the criteria set forth in Sections 401(a)(13) and 414(p) of the Code) with respect to a Participant’s Account.

15. Administration

15.1 General Authority. The general supervision of the Plan shall be the responsibility of the Committee, which, in addition to such other powers as it may have as provided herein, shall have the power: (a) to determine eligibility to participate in, and the amount of benefit to be provided to any Participant under, the Plan; (b) to make and enforce such rules and regulations as it shall deem necessary or proper for the efficient administration of the Plan; (c) to determine all questions arising in connection with the Plan, to interpret and construe the Plan, to resolve ambiguities, inconsistencies or omissions in the text of the Plan, to correct any defects in the text of the Plan and to take such other action as may be necessary or advisable for the orderly administration of the Plan; (d) to make any and all legal and factual determinations in connection with the administration and implementation of the Plan; (e) to review actions taken by the Administrator or any other person to whom authority is delegated under the Plan; and (f) to employ and rely on legal counsel, actuaries, accountants and any other agents as may be deemed to be advisable to assist in the administration of the Plan. All such actions of the Committee shall be conclusive and binding upon all persons. The Committee shall be entitled to rely conclusively upon all tables, valuations, certificates, opinions, and reports furnished by any actuary, accountant, controller, counsel, or other person employed or engaged by the Company with respect to the Plan. If any member of the Committee is a Participant, such member shall not resolve, or participate in the resolution of, any matter relating to such member’s eligibility for a Plan Matching Credit or Profit Sharing Credit or the calculation or determination of such member’s Plan Matching Credit or Profit Sharing Credit. Neither the Committee nor any member thereof nor the Company shall be liable for any action or determination made in good faith with respect to the Plan or the rights of any person under the Plan.

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15.2 Delegation. The Committee shall have the power to delegate to any person or persons the authority to carry out such administrative duties, powers and authority relative to the administration of the Plan as the Committee may from time to time determine. Any action taken by any person or persons to whom the Committee makes such a delegation shall, for all purposes of the Plan, have the same force and effect as if undertaken directly by the Committee.

15.3 Administrator. The Administrator shall be responsible for the day-to-day operation of the Plan, having the power (except to the extent such power is reserved to the Committee) to take all action and to make all decisions necessary or proper in order to carry out his duties and responsibilities under the provisions of the Plan. If the Administrator is a Participant, the Administrator shall not resolve, or participate in the resolution of, any question which relates directly or indirectly to him and which, if applied to him, would significantly vary his eligibility for, or the amount of, any benefit to him under the Plan. The Administrator shall report to the Committee at such times and in such manner as the Committee shall request concerning the operation of the Plan.

16. Claim and Appeal Procedures

16.1 Claims. In the event any person or his authorized representative (a “Claimant”) disputes the amount of, or his entitlement to, any benefits under the Plan or their method of payment, such Claimant shall be required to file a claim in writing with the Administrator for the benefits to which he believes he is entitled, setting forth the reason for his claim. The Claimant shall have the opportunity to submit written comments, documents, records and other information relating to the claim and shall be provided, upon request and free of charge, reasonable access to and copies of all documents, records or other information relevant to the claim. The Administrator shall consider the claim, and, within 90 days of receipt of such claim, unless special circumstances exist, the Administrator shall inform such person of its decision with respect to the claim. In the event of special circumstances, the response period can be extended for an additional 90 days as long as the Claimant receives before the end of the initial 90-day response period written notice advising of the special circumstances (the “Extension Notice”) and the date by which the Administrator expects to make a decision. If the Administrator denies the claim, the Administrator shall give to such person (a) a written notice setting forth the specific reason or reasons for the denial of the claim, including references to the applicable provisions of the Plan, (b) a description of any additional material or information necessary to perfect such claim along with an explanation of why such material or information is necessary, (c) appropriate information as to the procedure to be followed for review of such claim by the Committee, including time limits and (d) the Claimant’s right to commence a civil action under Section 502(a) of ERISA following a denial of an appeal.

16.2 Appeal of Denial. A Claimant whose claim is denied by the Administrator and who wishes to appeal such denial must request a review of the Administrator’s decision by filing a written request with the Committee for such review within

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60 days after the Claimant’s receipt of the claim denial. Such request for review shall contain, and the Committee shall review, all comments, documents, records and other information relating to the claim for benefits that the Claimant wishes the Committee to review, without regard as to whether such information was submitted or considered in the initial review of the claim by the Administrator. In connection with that review, the Claimant shall be provided, upon request and free of charge, reasonable access to and copies of all documents, records or other information relevant to the claim. Written notice of the decision on review shall be furnished to the Claimant within 60 days after receipt by the Committee of a request for review. In the event of special circumstances, the response period can be extended for an additional 60 days, as long as the Claimant receives an Extension Notice before the end of the initial 60-day response period indicating the reasons for the extension and the date by which the Committee expects to make a decision. The Committee’s decision on review shall include (a) the specific reasons for the adverse determination, (b) references to applicable Plan provisions, (c) a statement that the Claimant is entitled to receive, free of charge, reasonable access to, and copies of, all documents, records and other information relevant to the claim and (d) a statement of the Claimant’s right to bring an action under Section 502(a) of ERISA following an adverse benefit determination on a review and a description of the applicable limitations period under the Plan.

16.3 Statute of Limitations. A Claimant wishing to seek judicial review of an adverse benefit determination under the Plan, whether in whole or in part, must file any suit or legal action, including, without limitation, a civil action under Section 502(a) of ERISA, within three years of the date the final decision on the adverse benefit determination on review is issued or should have been issued under Section 16.2 or lose any rights to bring such an action. If any such judicial proceeding is undertaken, the evidence presented shall be strictly limited to the evidence timely presented to the Committee. Notwithstanding anything in the Plan to the contrary, a Claimant must exhaust all administrative remedies available to such Claimant under the Plan before such Claimant may seek judicial review pursuant to Section 502(a) of ERISA.

17. No Contract of Employment

Nothing contained herein shall be construed as conferring upon any person the right to be employed or continue in the employ of the Company.

18. Withholding Taxes

For purposes of satisfying its obligations to withhold federal, state, local or foreign taxes incurred by reason of payments pursuant to the Plan, the Company shall have the right to withhold such taxes required by law from any payments made pursuant to the Plan. In lieu thereof, the Company shall have the right, to the extent permitted by law, to withhold the amount of such taxes from any other sums due or to become due from the Company to the Participant upon such terms and conditions as the Committee may prescribe.

19. Notices

Notices may be delivered to the Participant at the offices of the Company at which the Participant is principally employed. Any Participant who ceases to be an employee of the Company shall be responsible for furnishing the Committee with the current and proper

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address for the mailing of notices and delivery of payments. Any notice required or permitted to be given to such a Participant shall be deemed given if directed to the person to whom addressed at such address and mailed by regular United States mail, first-class and prepaid. If any item mailed to such address is returned as undeliverable to the addressee, mailing will be suspended until the Participant furnishes the proper address.

20. Severability of Provisions

If any provision of the Plan shall be held invalid or unenforceable, such invalidity or unenforceability shall not affect any other provisions hereof, and the Plan shall be construed and enforced as if such provisions had not been included.

21. Headings and Captions

The headings and captions herein are provided for reference and convenience only, shall not be considered part of the Plan, and shall not be employed in the construction of the Plan.

22. Incapacity of Participant

In the event a Participant or Beneficiary is declared incompetent and a conservator or other person legally charged with the care of his person or his estate is appointed, any benefits under the Plan to which such Participant or Beneficiary is entitled shall be paid to such conservator or other person legally charged with the care of his person or estate.

23. Applicable Law

The Plan shall be construed under the laws of the State of New York to the extent that such laws are not pre-empted by federal law.

24. 409A Transition Rules

(a) The amendments to the Plan regarding the time of payment of a Participant’s Account shall be pursuant to the Applicable Transition Relief.

(b) To the extent that any Participant receives during calendar year 2005 a distribution of all, or any portion of, his Account, such distribution shall be deemed a termination of such Participant’s participation in this Plan with respect to all or such portion of such Participant’s Account in accordance with the Applicable Transition Relief.

(c) The time and form of payment of the Account of a Participant who commences payment prior to January 1, 2007 shall be linked to the time and form of payment of such Participant’s account under the Savings Plan in accordance with the Applicable Transition Relief.

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EX-10.50

Exhibit 10.50

Ambac 1997 Equity Plan

2008 NOTICE OF 2007 STOCK OPTION AWARD

Table of Contents

1.	Incorporation of Plan Terms	1
2.	Grant of Option	1
3.	Terms and Conditions of the Option	1
4.	Termination of Employment	3
5.	Transfer; Option Exercisable Only by Participant and Permitted Transferees	5
6.	Tax Withholding	6
7.	No Restriction on Right to Effect Corporate Changes; No Right to Employment	6
8.	Adjustment of and Changes in Shares	6
9.	Change in Control	6
10.	Preemption of Applicable Laws and Regulations	7
11.	Committee Decisions Final	8
12.	Amendments	8
13.	Notice Requirements	8
14.	Governing Law	8
15.	Entire Agreement; Headings	8
Annex A: Stock Option Award and Vesting Schedule

Ambac 1997 Equity Plan

2008 NOTICE OF 2007 STOCK OPTION AWARD

Ambac Financial Group, Inc., a Delaware corporation (the “Company”), has adopted the Ambac 1997 Equity Plan, as amended (the “Plan”), for the purposes of providing an incentive to selected employees of the Company and its affiliates to remain in its employ and to increase their interest in the success of the Company by providing them with opportunities to increase their proprietary interest in the Company and to receive compensation based upon the Company’s success.

This 2007 Notice of 2006 Stock Option Award (the “Award Agreement”) sets forth the terms and conditions of the stock options granted pursuant to the Plan. Annex A of this Award Agreement (“Annex A”) names the individual to whom the option is granted (the “Participant”) and sets forth the number of shares of common stock of the Company (“Common Stock”) subject to the option, the exercise price of such option, the date of grant and the expiration date of such option and the vesting schedule applicable thereto.

1. Incorporation of Plan Terms.

This Award Agreement and the option granted hereby shall be subject to the Plan, the terms of which are incorporated herein by reference, and in the event of any conflict or inconsistency between the Plan and this Award Agreement, the Plan shall govern. Capitalized terms used herein without definition shall have the meanings assigned to them in the Plan, a copy of which has been furnished to the Participant.

2. Grant of Option.

Subject to the conditions contained herein and in the Plan, the Company grants to the Participant, as of the date of grant indicated on Annex A (the “Date of Grant”), an option (the “Option”) to purchase the number of shares of Common Stock specified on Annex A, at an exercise price (the “Exercise Price”) specified on Annex A. The shares of Common Stock issuable upon exercise of the Option are from time to time referred to herein as the “Option Shares.” The grant of an Option shall impose no obligation on the part of the Participant to exercise the Option. The Option shall vest and be exercisable as hereinafter provided.

3. Terms and Conditions of the Option.

The Option is granted subject to the following terms and conditions:

(a) Vesting; Exercisability. The Option shall vest and become exercisable in accordance with the vesting schedule set forth on Annex A, unless the Option has earlier vested or been forfeited in accordance with the terms hereof.

(b) Term of the Option. The Option shall terminate and no longer be exercisable on the earlier of (i) the seventh anniversary of the Date of Grant or (ii) the date specified for termination of the Option in Sections 4(a), 4(b) and 4(c) below; provided, however, if the termination date falls on a date which the Participant is prohibited by Corporation policy in effect on such date, from engaging in transactions in the Corporation’s securities, such termination date shall be extended to the first date that the Participant is permitted to engage in transactions in the Corporation’s securities under such Corporation policy.

(c) Notice of Exercise. Subject to Sections 3(d), 3(f) and 4 hereof, the Participant may exercise all or any portion of the Option (to the extent vested) by giving notice of exercise to the Company or the Company’s agent, provided, however, that no less than 10 Option Shares may be purchased upon any exercise of the Option unless the

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number of Option Shares purchased at such time is the total number of Option Shares in respect of which the Option is then exercisable, and provided, further, that in no event shall the Option be exercisable for a fractional share. The date of exercise of an Option shall be the later of (i) the date on which the Company or the Company’s agent receives such notice or (ii) the date on which the conditions provided in Sections 3(d) and 3(f) are satisfied. Notwithstanding any other provision of this Award Agreement, the Participant may not exercise the Option, whether in whole or in part, and no Option Shares will be issued by the Company in respect of any such attempted exercise, at any time when such exercise is prohibited by Company policy then in effect concerning transactions by the Participant in the Company’s securities.

(d) Payment. Prior to the issuance of a certificate pursuant to Section 3(g) hereof evidencing the Option Shares in respect of which all or a portion of the Option shall have been exercised, the Participant shall have paid to the Company the Exercise Price for all Option Shares purchased pursuant to the exercise of such Option. Payment may be made by personal check, bank draft or postal or express money order (such modes of payment are collectively referred to as “cash”) payable to the order of the Company in U.S. dollars. Payment may also be made in mature shares of Common Stock owned by the Participant, or in any combination of cash or such mature shares as the Committee in its sole discretion may approve. Such shares shall be valued at their Fair Market Value as of the date of exercise. Payment of the Exercise Price in mature shares of Common Stock owned by the Participant shall be made by delivering to the Company the share certificate(s) representing the required number of shares, with the Participant signing his or her name on the back, or by attaching executed stock powers (with the signature of the Participant guaranteed in either case); payment of the exercise price in mature shares of Common Stock owned by the Participant may also be made through constructive surrender, by submission of an attestation of ownership in the form approved by the Company and with such signatures or other guarantees as may be required by the Company. The Company may also permit the Participant to pay for such Option Shares by directing the Company to withhold shares of Common Stock that would otherwise be received by the Participant, pursuant to such rules as the Committee may establish from time to time. In the discretion of the Committee, and in accordance with rules and procedures established by the Committee (or by any person to whom authority to establish such rules and procedures shall have been delegated by the Committee), the Participant may be permitted to make a “cashless” exercise of all or a portion of the Option.

(e) Stockholder Rights. The Participant shall have no rights as a stockholder with respect to any shares of Common Stock issuable upon exercise of the Option until the Participant shall become the holder of record thereof, and no adjustment shall be made for dividends or distributions or other rights in respect of any share for which the record date is prior to the date upon which the Participant shall become the holder of record thereof.

(f) Limitation on Exercise. The Option shall not be exercisable unless the offer and sale of Common Stock pursuant thereto has been registered under the Securities Act of 1933, as amended (the “1933 Act”), and qualified under applicable state “blue sky” laws or the Company has determined that an exemption from registration under the 1933 Act and from qualification under such state “blue sky” laws is available.

(g) Issuance of Shares. Subject to the foregoing conditions, as soon as is reasonably practicable after its receipt of a proper notice of exercise and payment of the Exercise Price for the number of shares with respect to which the Option is exercised, the Company either (i) shall deliver or cause to be delivered to the Participant (or to such person to whom the Option has been transferred pursuant to Section 5 hereof; or following the Participant’s death, to such other person entitled to exercise the Option), at the principal office of the Company or at such other location as may be acceptable to the Company and the Participant (or such other person), one or more stock certificates in the name of the Participant (or of the person or persons to whom such option was transferred by will or the laws of descent and distribution or pursuant to a Qualified Domestic Relations Order) for the appropriate number of shares of Common Stock issued in connection with such exercise or (ii) shall transfer the appropriate number of shares of Common Stock issued in connection with such exercise to the brokerage account designated by the Participant to the Company in writing prior to exercise. Such shares shall be fully paid and nonassessable.

(h) Non-qualified Status of the Option. The Option granted hereby is not intended to qualify, and shall not be treated, as an “incentive stock option” within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”).

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(i) Cancellation. Notwithstanding any other provision of this Award Agreement, the Committee may cancel all or any unexercised portion of the Option, whether or not vested, if at any time the Participant initiates or becomes a party to any lawsuit or other legal action in any federal or state court in which the Participant seeks damages or injunctive or other equitable relief from or against the Company, any of its Subsidiaries or any of its officers, employees or directors in connection with any claim arising from or relating to the Participant’s employment with the Company or any of its Subsidiaries or the termination of such employment (and regardless of whether any such termination is the result of the Participant’s voluntary resignation or retirement or of the involuntary termination of the Participant’s employment by the Company or one of its subsidiaries). This Section 3(i) is not intended as a waiver by the Participant of any claims the Participant may have against the Company, any of its subsidiaries or any of its officers, employees or directors. Instead, it provides for the consequences specified in the second preceding sentence in the event the Participant engages in the conduct described therein.

(j) Acceptance of Award Terms. Notwithstanding any other provision of this Award Agreement, the Participant shall have no further rights in the Option represented by this Award Agreement, and this Award Agreement and the Option represented thereby shall automatically be cancelled, unless the Participant accepts the terms and conditions of the grant by signing this Award Agreement in the space provided for below and returning a signed copy of this award agreement to the Company’s Human Resources Department, or by electronically acknowledging receipt and acceptance of the terms of this Award Certificate in the manner indicated to the Participant by the Company, in either case no more than [            ] business days after the Date of Grant.

(k) Notice Period. By the Participant’s acceptance of the Option and the terms of this Award Agreement in the manner provided for in Section 3(j), the Participant agrees to provide the Company or the Subsidiary that employs the Participant with at least three months advance written notice (the “Minimum Notice”) prior to termination of employment. Notwithstanding any other provision of this Award Agreement, the Committee may cancel all or any unexercised portion of the Option, whether or not vested, if the Participant resigns his or her employment with the Company and its Subsidiaries without having provided the Company or the Subsidiary that employs the Participant with the Minimum Notice. During the period covered by the Minimum Notice (the “Notice Period”), the Participant (i) shall remain employed by the Company and its Subsidiaries and receive base salary and certain benefits, but will not accrue any rights to a bonus, and (ii) shall not commence employment with any other employer or directly or indirectly induce or solicit any client of the Company or any of its subsidiaries to terminate or modify its relationship with any of them.

4. Termination of Employment.

(a) General. Subject to Section 4(c) hereof, if the Participant’s employment with the Company and its Subsidiaries terminates for any reason other than death or Permanent Disability (as defined herein) prior to the satisfaction of any vesting period requirement under Section 3(a) hereof, the unvested portion of the Option shall be forfeited to the Company, and the Participant shall have no further right or interest therein, unless the Committee in its sole discretion shall determine otherwise, provided, however, that in the case of a termination of employment mutually agreed to by the Participant and the Company (or the relevant employer Subsidiary), but not in the case of a termination for Cause (as defined herein), if the Participant (A) signs a waiver and a release, in the form requested by the Company, irrevocably waiving any and all claims and liabilities relating to the Participant’s employment with the Company and its affiliates and the termination thereof, (B) signs a noncompetition agreement in the form requested by the Company, and (C) takes any further action requested by the Company to perfect such release and waiver, then at the Company’s discretion, the Option shall be deemed to have vested in full as of the date of the Participant’s termination of employment.

(b) Exercise Following Termination of Employment. If the Participant’s employment with the Company and its Subsidiaries terminates for any reason other than death, Permanent Disability or Retirement (as defined herein) after the Option has vested in accordance with Sections 3(a) and 4(a) hereof with respect to all or a portion of the shares of Common Stock subject to the Option, the Participant shall have the right, subject to the terms and conditions hereof and of the Plan, to exercise the Option, to the extent it has vested as of the date of such termination of employment, at any time within one year after the date of such termination, subject to the earlier expiration of the Option as provided in Section 3(b).

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(c) Exercise Following Termination of Employment Due to Death, Permanent Disability or Retirement.

(i) If the Participant’s employment with the Company and its Subsidiaries terminates due to (A) death or (B) Permanent Disability or (C) Retirement at age 55 or older after at least five years of continuous service with the Company and its Subsidiaries (including service with a corporation or other entity acquired by the Company), in any such case prior to the satisfaction of any vesting period requirement under Section 3(a) hereof, the Option shall be deemed to have vested in full as of the date of death, termination due to Permanent Disability or such Retirement.

(ii) Following termination of employment due to death or Permanent Disability, the Option may be exercised by the Participant, or the Participant’s Permitted Transferee, estate, personal representative or beneficiary, as the case may be, within three years after the date of death or termination of employment due to Permanent Disability, subject to the earlier expiration of the Option as provided in Section 3(b). In the event of Retirement (whether or not Retirement results in full vesting of the Option pursuant to clause (i) above), the Participant or the Participant’s Permitted Transferee may exercise the Option, to the extent it has vested as of the date of Retirement, within three years after the date of Retirement, subject to the earlier expiration of the Option as provided in Section 3(b).

(d) Definitions. For purposes hereof, the following terms shall have the meanings specified below:

(i) Termination of Employment. The employment of the Participant shall be deemed terminated if the Participant is no longer employed by the Company or any of its Subsidiaries for any reason. The Committee shall have discretion to determine whether military or government service or an authorized leave of absence (as a result of disability or otherwise) shall constitute a termination of employment for purposes hereof.

(ii) Cause. Each of the following shall constitute “Cause” for termination of employment:

(a) the willful commission by the Participant of acts that are dishonest and demonstrably and materially injurious to the Company or any of its Subsidiaries or affiliates, monetarily or otherwise;

(b) the conviction of the Participant for a felonious act resulting in material harm to the financial condition or business reputation of the Company or any of its Subsidiaries or affiliates; or

(c) except for actions taken in the course of the Participant’s employment or as required by law, the Participant’s divulgation, furnishing or making accessible to any person any information of a confidential or proprietary nature obtained while in the employ of the Company or any of its Subsidiaries of affiliates, or the Participant’s failure, upon termination of his employment with the Company or any of its Subsidiaries or affiliates, to return to the Company all such information which exists in written or any other form (including without limitation in the form of computer files or disks) and all copies thereof in his possession or under his control.

Notwithstanding the foregoing, if the Company or any of its Subsidiaries or affiliates has entered or enters into any employment, management retention, change in control, severance or similar agreement with the Participant, which agreement sets forth a definition of “Cause”, then such definition, rather than the definition set forth above, shall control for purposes of this Award Agreement.

(iii) Permanent Disability. “Permanent Disability” shall mean circumstances that entitle the Participant to receive benefits under the long-term disability policy maintained by the Company or any of its Subsidiaries for the Participant.

(iv) Retirement. “Retirement” shall mean the termination of the Participant’s employment on or after age 55 and at least 5 years of service, except for Cause; provided , however, that the termination of the Participant’s employment will not be considered a Retirement if the Participant fails to provide the Company or the Subsidiary that employs the Participant with the written notice required by Section 3(j) hereof or fails to comply with the Participant’s obligations during the Notice Period as set forth in Section 3(j) hereof.

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(e) Exercise Following Termination of Employment Subject to Company Policies on Insider Trading. Any exercise of the Option pursuant to Section 4(b) or 4(c) above following termination of the Participant’s employment for any reason other than death shall be subject to, and shall be permitted only to the extent such exercise complies with, the policies of the Company concerning insider trading.

(f) Cancellation of Option and Repayment of Option Gain. Notwithstanding any other provision of this Award Agreement, the Committee may cancel all or any portion of the Option, whether or not vested, and may require the Participant to repay to the Company all or any portion of the Option Gain (as defined herein) that the Participant realizes from any full or partial exercise of the Option occurring within six months before or after the termination of the Participant’s employment with the Company and its Subsidiaries, if (A) the Participant engages in Competitive Activity (as defined herein) within six months following the termination of the Participant’s employment or (B) the Participant fails to provide the Company or the Subsidiary that employs the Participant with the written notice required by Section 3(j) hereof or fails to comply with the Participant’s obligations during the Period Notice as set forth in Section 3(j) hereof. A Participant will be considered to engage in “Competitive Activity” if the Participant (1) enters into a relationship as an employee, officer, partner, member, director, independent contractor, consultant, advisor or agent of, or in any similar relationship with, any corporation, partnership, limited liability company, joint venture or other business entity that engages in any activity which the Committee determines is competitive with a principal business activity of the Company (a “Competitor”), where the Participant will be responsible for providing services which are similar or substantially related to the services that the Participant provided during any of the last three years of the Participant’s employment with the Company and its Subsidiaries or (2) either alone, or in concert with others, acquires or maintains beneficial ownership (within the meaning of Section 13(d) of the Exchange Act) of 5% or more of any class of equity securities of a Competitor. The amount of a Participant’s “Option Gain” realized upon full or partial exercise of an Option is the amount of income included (or to be included) in respect of such exercise on the Form W-2 (or successor form) that the Company or one of its Subsidiaries issues to the Participant for the year in which such exercise occurs. The Company may require the Participant, in connection with any full or partial exercise of an Option, to certify in a manner acceptable to the Company that the Participant has not engaged in Competitive Activity and may decline to give effect to such exercise if the Participant fails so to certify. If the Participant is required to repay any Option Gain to the Company pursuant to this Section 4(f), the Participant shall pay such amount in such manner and on such terms and conditions as the Company may require, and the Company shall be entitled to withhold or set-off against any other amount owed to the Participant by the Company or any of its Subsidiaries (other than any amount owed to the Participant under any retirement plan intended to be qualified under Section 401(a) of the Code) up to any amount sufficient to satisfy any unpaid obligation of the Participant under this Section 4(f).

5. Transfer; Option Exercisable Only by Participant and Permitted Transferees.

The Option may not be transferred, pledged, assigned, or otherwise disposed of, except (i) by will or the laws of descent and distribution, (ii) pursuant to a domestic relations order or (iii) for no consideration, to a member or members of the Participant’s immediate family (as defined below) or to one or more trusts or partnerships established in whole or in part for the benefit of one or more of such immediate family members (the parties identified in clauses (i), (ii), and (iii) being referred to collectively as “Permitted Transferees”). If the Option is transferred to a Permitted Transferee, it shall be further transferable only by will or the laws of descent and distribution or, for no consideration, to another Permitted Transferee of the Participant. The Participant shall promptly notify the Company of any proposed transfer to a Permitted Transferee in advance in writing and shall upon request provide the Company with information concerning the Permitted Transferee’s financial condition and investment experience. No assignment or transfer of the Option, or of the rights represented thereby, whether voluntary or involuntary, by operation of law or otherwise, except as permitted by this Section 5, shall vest in the assignee or transferee any interest or right in the Option, but immediately upon any attempt to assign or transfer the Option the same shall terminate and be of no force or effect. For purposes of this Option Agreement, the Participant’s “immediate family” means any child, stepchild, grandchild, spouse, son-in-law or daughter-in-law and shall include adoptive relationships.

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6. Tax Withholding.

The Company shall have the right, prior to the issuance of shares as set forth in section 3(g) hereof, to require the Participant to remit to the Company an amount sufficient to satisfy the minimum required Federal, state or local tax withholding requirements. The Company may permit the Participant to satisfy, in whole or in part, such obligation to remit taxes, by directing the Company to withhold shares of Common Stock that would otherwise be received by the Participant, pursuant to such rules as the Committee may establish from time to time. The Company shall also have the right to deduct from all cash payments made pursuant to or in connection with the Option the minimum required Federal, state or local taxes required to be withheld with respect to such payments or such lesser amount as determined by the Company in order to assure that it complies with applicable accounting standards.

7. No Restriction on Right to Effect Corporate Changes; No Right to Employment.

Neither the Plan, this Award Agreement nor the existence of the Option shall affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalizations, reorganizations or other changes in the Company’s capital structure or its business, or any merger or consolidation of the Company, or any issue of bonds, debentures, preferred or prior preference stocks ahead of or convertible into, or otherwise affecting the Common Stock or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding, whether of a similar character or otherwise.

In addition, neither this Award Agreement, the grant of the Option nor any action taken hereunder shall be deemed to limit or restrict the right of the Company to terminate the Participant’s employment at any time, for any reason, with or without Cause.

8. Adjustment of and Changes in Shares.

In the event of any merger, consolidation, recapitalization, reclassification, stock split, stock dividend, special cash dividend, split-up, spin-off, or other transaction or change in corporate structure affecting the Common Stock, the Committee shall make equitable adjustments in order to preserve, but not increase, the benefits or potential benefits intended to be made available to participants granted stock options. Any adjustments shall be determined by the Committee, whose determination as to what adjustments shall be made, and the extent thereof, shall be final.

9. Change in Control.

(a) Committee Discretion to Take Certain Actions. The Committee, in its sole discretion, may at any time prior to, coincident with or after the time of a Change in Control (as defined herein):

(i) provide for the acceleration of any vesting conditions relating to the exercise of the Option or that the Option may be exercised in full on or before a date fixed by the Committee;

(ii) provide for the purchase of the Option, upon the Participant’s request, for an amount of cash equal to the amount, as determined by the Committee in its sole discretion, which could have been realized upon the exercise of the Option had the Option been currently exercisable;

(iii) make such adjustments to the Option as the Committee deems appropriate to reflect such Change in Control; or

(iv) cause the Option then to be assumed, or new rights substituted therefor, by the surviving corporation in such Change in Control.

Any such actions shall be authorized by the Committee, whose determination as to what actions shall be taken and the extent thereof, shall be final.

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(b) Definitions. For purposes hereof, a “Change in Control” shall be deemed to occur on the date on which one of the following events occurs:

(i) the acquisition by any Person of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of the Common Stock then outstanding, but shall not include any such acquisition by:

(A) the Company;

(B) any Subsidiary of the Company;

(C) any employee benefit plan of the Company or of any Subsidiary of the Company;

(D) any Person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan;

(E) any Person who as of January 31, 1996 was the beneficial owner of 15% or more of the shares of Common stock outstanding on such date unless and until such Person, together with all affiliates and associates of such Person, becomes the beneficial owner of 25% or more of the shares of Common stock then outstanding whereupon a Change in Control shall be deemed to have occurred; or

(F) any Person who becomes the beneficial owner of 20% or more, or, with respect to a Person described in clause (E) above, 25% or more, of the shares of Common Stock then outstanding as a result of a reduction in the number of shares of Common Stock outstanding due to the repurchase of shares of Common Stock by the Company unless and until such Person, after becoming aware that such Person has become the beneficial owner of 20% or more, or 25% or more, as the case may be, of the then outstanding shares of Common Stock, acquires beneficial ownership of additional shares of Common Stock representing 1% or more of the shares of Common Stock then outstanding, whereupon a Change in Control shall be deemed to have occurred; or

(ii) individuals who, as of July 30, 1997, constitute the Board, and subsequently elected members of the Board whose election is approved or recommended by at least a majority of such current members or their successors whose election was so approved or recommended (other than any subsequently elected members whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board), cease for any reason to constitute at least a majority of such Board; or

(iii) approval by the stockholders of the Company of (A) a merger or consolidation of the Company with any other corporation, (B) the issuance of voting securities of the Company in connection with a merger or consolidation of the Company (or any Subsidiary) pursuant to applicable stock exchange requirements, or (C) sale or disposition of all or substantially all of the assets of the Company or the acquisition of assets of another corporation (each, a “Business Combination”), unless, in each case, immediately following such Business Combination, all or substantially all of the individuals and entities who were the beneficial owners of the Common Stock outstanding immediately prior to such Business Combination beneficially own, directly or indirectly, more than 70% of the then outstanding shares of Common Stock and 70% of the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company’s assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the Common Stock.

As used herein, “Person” means any individual, firm, corporation, partnership or other entity.

10. Preemption of Applicable Laws and Regulations.

Anything herein to the contrary notwithstanding, if, at any time specified herein for the issuance of shares of Common Stock to the Participant, any law, regulation or requirement of any governmental authority having jurisdiction shall require either the Company or the Participant to take any action in connection with the shares then to be issued, the issuance of such shares shall be deferred until such action shall have been taken.

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11. Committee Decisions Final.

Any dispute or disagreement which shall arise under, or as a result of, or pursuant to, or in connection with, this Award Agreement or the Option shall be determined by the Committee, and any such determination or any other determination by the Committee under or pursuant to this Award Agreement and any interpretation by the Committee of the terms of the Option shall be final and binding on all persons affected thereby.

12. Amendments.

The Committee shall have the power to alter or amend the terms of the Option as set forth herein from time to time, in any manner consistent with the provisions of Section 16 of the Plan, and any alteration or amendment of the terms of the Option by the Committee shall, upon adoption, become and be binding on all persons affected thereby without requirement for consent or other action with respect thereto by any such person. The Committee shall give written notice to the Participant of any such alteration or amendment as promptly as practicable after the adoption thereof. The foregoing shall not restrict the ability of the Participant and the Company by mutual consent to alter or amend the terms of the Option in any manner which is consistent with the Plan and approved by the Committee. In addition, the terms of the Option may be amended or supplemented by any employment, management retention, severance or similar agreement (an “Employment Agreement”) entered into between the Company and the Participant (including any such agreement entered into prior to the Date of Grant) and approved, to the extent such Employment Agreement amends or supplements the terms of the Option, by the Committee.

13. Notice Requirements.

Any notice which either party hereto may be required or permitted to give to the other shall be in writing. Such notice may be delivered to the Company personally or by mail, postage prepaid, addressed as follows: Ambac Financial Group, Inc., One State Street Plaza, New York, New York 10004, attention: Senior Vice President, Chief Administrative Officer and Employment Counsel, or at such other address as the Company, by notice to the Participant, may designate in writing from time to time, and to the Participant at the Participant’s address as shown on the records of the Company or at such other address as the Participant, by notice to the Company, may designate in writing from time to time.

14. Governing Law.

The terms and conditions stated herein are to be governed by, and construed in accordance with, the laws of the State of Delaware.

15. Entire Agreement; Headings.

This Award Agreement (which includes Annex A) and the other related documents expressly referred to herein (including, if applicable, any Employment Agreement) set forth the entire agreement and understanding between the parties hereto and supersede all prior agreements and understandings relating to the subject matter hereof. In the event of a discrepancy or inconsistency in the number of shares of common stock covered by the Option, the Date of Grant, the vesting schedule, the Exercise Price or any other term in this Award Agreement and the resolutions of the Committee authorizing the grant of the Option covered hereby, such resolutions shall control and the Company shall have the right, in its sole discretion, to replace the Award Agreement or any portion thereof (including any portion of Annex A) with a correct version. The headings of Sections and subsections herein are included solely for convenience of reference and shall not affect the meaning of any of the provisions of this Award Agreement.

AMBAC FINANCIAL GROUP, INC.

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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 officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - -15(e) and 15d – 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

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

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

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

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

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

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

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

By:	/s/ Robert J. Genader
	Robert J. Genader
	Chairman, President and Chief Executive Officer

Date: November 9, 2007

EX-31.2

EXHIBIT 31.2

Ambac Financial Group, Inc.

Certifications

I, Sean T. Leonard, 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 officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - -15(e) and 15d – 15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

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

b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

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

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

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

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

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

By:	/s/ Sean T. Leonard
	Sean T. Leonard
	Senior Vice President and Chief Financial Officer

Date: November 9, 2007

EX-32.1

EXHIBIT 32.1

Certification of CEO Pursuant to

18 U.S.C. Section 1350,

as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Ambac Financial Group, Inc. (the “Company”) for the period ended September 30, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Robert J. Genader, as Chief Executive Officer of the Company, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

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

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

/s/ Robert J. Genader
Name:	Robert J. Genader
Title:	Chairman, President and Chief Executive Officer
Date:	November 9, 2007

EX-32.2

EXHIBIT 32.2

Certification of CFO Pursuant to

18 U.S.C. Section 1350,

as Adopted Pursuant to

Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of Ambac Financial Group, Inc. (the “Company”) for the period ended September 30, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Sean T. Leonard, as Chief Financial Officer of the Company, hereby certifies, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of his knowledge:

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

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

/s/ Sean T. Leonard
Name:	Sean T. Leonard
Title:	Senior Vice President and Chief Financial Officer
Date:	November 9, 2007

EX-99.07

EXHIBIT 99.07

AMBAC ASSURANCE CORPORATION AND SUBSIDIARIES

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

Consolidated Unaudited Financial Statements

As of September 30, 2007 and December 31, 2006

and for the Three and Nine Months Ended September 30, 2007 and 2006

Ambac Assurance Corporation and Subsidiaries

Consolidated Balance Sheets

September 30, 2007 and December 31, 2006

(Dollars in Thousands Except Share Data)

	September 30, 2007		December 31, 2006
	(unaudited)
Assets
Investments:
Fixed income securities, at fair value (amortized cost of $10,217,122 in 2007 and $9,669,972 in 2006)	$	10,376,705	$	9,877,920
Short-term investments, at cost (approximates fair value)		470,878		232,179
Other (cost of $12,876 in 2007 and $12,845 in 2006)		13,699		13,397
Total investments		10,861,282		10,123,496
Cash		25,382		23,595
Securities purchased under agreements to resell		—		95,000
Receivable for securities sold		1,781		2,382
Investment income due and accrued		123,267		131,538
Reinsurance recoverable on paid and unpaid losses		10,406		3,921
Prepaid reinsurance		332,373		315,498
Deferred taxes		10,500		—
Deferred acquisition costs		277,619		252,115
Derivative assets		1,000,094		1,018,886
Loans		277,422		11,291
Other assets		103,209		83,841
Total assets	$	13,023,335	$	12,061,563
Liabilities And Stockholder’s Equity
Liabilities:
Unearned premiums	$	3,134,972	$	3,048,039
Loss and loss expense reserve		284,128		220,074
Ceded reinsurance balances payable		24,402		20,080
Obligations under payment agreements		248,180		248,415
Long-term debt		280,690		—
Deferred income taxes		—		208,053
Current income taxes		46,353		61,342
Payable for securities purchased		30,852		95,973
Derivative liabilities		1,738,979		920,399
Other liabilities		293,936		246,882
Total liabilities		6,082,492		5,069,257
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 September 30, 2007 and December 31, 2006		82,000		82,000
Additional paid-in capital		1,550,164		1,508,828
Accumulated other comprehensive income		113,811		141,927
Retained earnings		5,194,868		5,259,551
Total stockholder’s equity		6,940,843		6,992,306
Total liabilities and stockholder’s equity	$	13,023,335	$	12,061,563

See accompanying Notes to Consolidated Unaudited Financial Statements.

1

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

For The Three and Nine Months Ended September 30, 2007 and 2006

(Dollars in Thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2007			2006			2007			2006
Revenues:
Financial Guarantee:
Gross premiums written	$	289,355		$	215,577		$	805,515		$	749,561
Ceded premiums written		(35,095	)		(29,350	)		(93,016	)		(78,340	)
Net premiums written	$	254,260		$	186,227		$	712,499		$	671,221
Net premiums earned	$	197,595		$	202,454		$	643,499		$	610,950
Other credit enhancement fees		19,319			15,395			50,864			42,419
Net premiums earned and other credit enhancement fees		216,914			217,849			694,363			653,369
Net investment income		115,850			107,154			341,115			313,328
Net realized investment gains		3,965			1,329			5,286			2,842
Net mark-to-market (losses) gains on credit derivative contracts		(743,379	)		2,572			(805,370	)		9,906
Other income		1,303			1,005			6,496			32,463
Financial Services:
Investment income		3,009			3,013			9,032			9,117
Derivative products		(11,350	)		3,555			(2,467	)		18,949
Total revenues		(413,688	)		336,477			248,455			1,039,974
Expenses:
Financial Guarantee:
Loss and loss expenses		19,082			(2,543	)		47,600			10,406
Underwriting and operating expenses		34,576			30,186			104,390			99,909
Financial Services:
Interest on payment agreements		2,490			2,387			7,501			6,796
Derivative products		1,314			1,366			4,033			4,562
Total expenses		57,462			31,396			163,524			121,673
Income before income taxes		(471,150	)		305,081			84,931			918,301
Provision for income taxes		(137,761	)		82,835			6,964			251,906
Net income	$	(333,389	)	$	222,246		$	77,967		$	666,395

See accompanying Notes to Consolidated Unaudited Financial Statements.

2

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Stockholder’s Equity

(Unaudited)

For The Nine Months Ended September 30, 2007 and 2006

(Dollars in Thousands)

	2007						2006
Retained Earnings:
Balance at January 1	$	5,259,551					$	4,509,653
Net income		77,967		$	77,967			666,395		$	666,395
Dividends declared - common stock		(142,650	)					(102,000	)
Balance at September 30	$	5,194,868					$	5,074,048
Accumulated Other Comprehensive (Loss) Income:
Balance at January 1	$	141,927					$	136,897
Unrealized (losses) gains on securities, ($48,151) and $3,477, pre-tax, in 2007 and 2006, respectively(1)					(31,298	)					2,259
Foreign currency translation gain					3,182						5,086
Other comprehensive loss		(28,116	)		(28,116	)		7,345			7,345
Comprehensive income				$	49,851					$	673,740
Balance at September 30	$	113,811					$	144,242
Preferred Stock:
Balance at January 1 and September 30	$	—					$	—
Common Stock:
Balance at January 1 and September 30	$	82,000					$	82,000
Additional Paid-in Capital:
Balance at January 1	$	1,508,828					$	1,453,060
Capital issuance costs		(2,882	)					(2,636	)
Employee benefit plans		35,799						15,129
Excess tax benefit related to share-based compensation		8,419						10,212
Balance at September 30	$	1,550,164					$	1,475,765
Total Stockholder’s Equity at September 30	$	6,940,843					$	6,776,055
(1) Disclosure of reclassification amount:
Unrealized holding (losses) gains arising during period	$	(28,883	)				$	2,795
Less: reclassification adjustment for net securities gains included in net income		2,415						536
Net unrealized (losses) gains on securities	$	(31,298	)				$	2,259

See accompanying Notes to Consolidated Unaudited Financial Statements.

3

Ambac Assurance Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

For The Nine Months Ended September 30, 2007 and 2006

(Dollars in Thousands)

	Nine Months Ended September 30,
	2007			2006
Cash flows from operating activities:
Net income	$	77,967		$	666,395
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization		2,010			2,075
Amortization of bond premium and discount		19,231			18,601
Share based compensation		30,684			17,626
Current income taxes		(14,989	)		26,380
Deferred income taxes		(203,416	)		(2,768	)
Deferred acquisition costs		(19,056	)		(15,254	)
Unearned premiums, net		70,058			65,056
Loss and loss expenses		57,569			(26,087	)
Ceded reinsurance balances payable		4,322			(6,783	)
Change in trading account assets		—			(85,000	)
Net mark-to-market losses (gains)		805,370			(9,906	)
Net realized investment gains		(5,286	)		(2,842	)
Other, net		5,580			53,793
Net cash provided by operating activities		830,044			701,286
Cash flows from investing activities:
Proceeds from sales of bonds		176,833			527,216
Proceeds from maturities of bonds		441,415			296,613
Purchases of bonds		(1,239,280	)		(1,706,404	)
Change in short-term investments		(238,699	)		230,166
Loans		(266,131	)		(5,029	)
Securities purchased under agreements to resell		95,000			63,000
Other, net		1,042			1,186
Net cash used in investing activities		(1,029,820	)		(593,252	)
Cash flows from financing activities:
Dividends paid		(142,650	)		(102,000	)
Capital issuance costs		(2,882	)		(2,636	)
Proceeds from issuance of long-term debt		280,690			-
Payment agreements		(235	)		(200	)
Net cash collateral received		58,221			(695	)
Excess tax benefit related to share-based compensation		8,419			10,212
Net cash provided by (used in) financing activities		201,563			(95,319	)
Net cash flow		1,787			12,715
Cash at January 1		23,595			20,469
Cash at September 30	$	25,382		$	33,184
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Income taxes	$	196,997		$	197,971
Interest on payment agreements	$	7,016		$	5,996

See accompanying Notes to Consolidated Unaudited Financial Statements.

4

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(Dollars in thousands)

(1) Background and Basis of Presentation

Ambac Assurance and subsidiaries, headquartered in New York City, provides financial guarantee products and other financial services to clients in both the public and private sectors around the world. Ambac Assurance Corporation, a leading guarantor of public finance and structured finance obligations, has earned triple-A financial strength ratings, the highest ratings available from Moody’s Investors Service, Inc., Standard & Poor’s Ratings Services, and Fitch, Inc. Financial guarantee insurance provides an unconditional and irrevocable guarantee that protects the holder of a fixed income obligation against non-payment of principal and interest when due. Essentially, Ambac Assurance makes payment if the obligor responsible for making payments fails to do so. A bond guaranteed by Ambac Assurance receives triple-A ratings, typically resulting in lower financing costs for the issuer and the guarantee generally makes the issue more marketable, both in the primary and secondary markets. Ambac Assurance’s financial strength ratings are an essential part of Ambac Assurance’s ability to provide credit enhancement and any reduction in these ratings could have a materially adverse affect on Ambac Assurance’s ability to compete in the financial guarantee business. Ambac Assurance provides financial guarantees for bond issues and other forms of debt financing. As an alternative to financial guarantee insurance, credit protection relating to a particular pool of assets, security or issuer can be provided through a credit derivative. Ambac provides credit protection in the global markets in credit derivative form. Ambac Assurance is a wholly owned subsidiary of Ambac Financial Group, Inc, 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. As of September 30, 2007, Ambac Assurance’s net guarantees in force (principal and interest) were $891,998,629.

The accompanying consolidated unaudited interim financial statements have been prepared on the basis of U.S. generally accepted accounting principles (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities. Actual results could differ from those estimates. The results of operations for the nine months ended September 30, 2007 may not be indicative of the results that may be expected for the full year ending December 31, 2007. 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, 2006 and 2005, and for each of the years in the three-year period ended December 31, 2006, which was filed with the Securities and Exchange Commission on March 1, 2007 as Exhibit 99.01 to Ambac Financial Group Inc.’s Form 10-K, (ii) the unaudited consolidated financial statements of Ambac Assurance and subsidiaries as of March 31, 2007, which was filed with the SEC on May 10, 2007 as Exhibit 99.03 to Ambac Financial Group’s 10-Q for the quarterly period ended March 31, 2007 and (iii) the unaudited consolidated financial statements of Ambac Assurance and subsidiaries as of June 30, 2007, which was filed with the SEC on August 9, 2007 as Exhibit 99.05 to Ambac Financial Group’s 10-Q for the quarterly period ended June 30, 2007.

5

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

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

Gross premiums are received either upfront (typical of public finance obligations), or in installments (typical of structured finance obligations). Up-front insurance premiums written are received for an entire bond issue, which may contain several maturities; and are recorded as unearned premiums. The premium is allocated to each bond maturity proportionately based on total principal amount guaranteed and is recognized as premiums on a straight-line basis over the term of each maturity. Installment insurance premiums written are recognized as premiums earned over each installment period, typically one year or less, on a straight-line basis. Premium earnings under both the upfront and installment revenue recognition methods are in proportion to the principal amount guaranteed and result in higher premium earnings during periods where guaranteed principal is higher. When an issue insured by Ambac Assurance has been refunded or called, the remaining unrecognized premium (net of refunding credits, if any) is recognized at that time.

Premiums ceded to reinsurers reduce the amount of premiums earned by Ambac from its financial guarantee insurance policies. For both up-front and installment premiums, ceded premiums written are primarily recognized in earnings in proportion to and at the same time the related gross premium revenue is recognized. Prepaid reinsurance represents the portion of premiums ceded to reinsurers relating to unearned premiums ceded under reinsurance contracts. As discussed in footnote 9, the accounting for premiums earned is subject to change.

(3) Loss and Loss Expenses

The loss reserve policy for financial guarantee insurance discussed in this footnote relates only to Ambac Assurance’s non-derivative insurance business. The policy for derivative contracts is discussed in Note (4) “Derivative Contracts”. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the non-derivative financial guarantee portfolio as of the reporting date. The evaluation process for determining the level of

6

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

reserves is subject to certain estimates and judgments. In most instances, claim payments are forecasted in advance of issuer default as a result of active surveillance of the insured book of business and observation of deterioration in the obligor’s credit standing. Based upon Ambac Assurance’s experience, claim payments become probable and estimable once the issuer’s credit profile has migrated to certain impaired credit levels. The trustee, on behalf of the insured party, named beneficiary, or custodian has the right to make a claim under Ambac Assurance’s financial guarantee insurance policy at the first scheduled debt service date of the defaulted obligation. As discussed in the last paragraph of this Note, the accounting for credit loss reserves is subject to change.

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

The active credit reserve is established through a process that begins with estimates of probable losses inherent in the adversely classified credit portfolio. These estimates are based upon: (i) Ambac Assurance’s internal system of credit ratings, which are analogous to the risk ratings of the major rating agencies; (ii) internally developed historical default information (taking into consideration ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) the net par outstanding on the adversely classified credit. The loss severities and default information are based on rating agency information and are specific to each bond type and are established and approved by Ambac Assurance’s Portfolio Risk Management Committee. The Portfolio Risk Management Committee is comprised of senior risk management professionals and other senior management of Ambac Assurance. For certain adversely classified credit exposures, Ambac Assurance’s additional monitoring and loss remediation efforts may provide information relevant to the estimate of the active credit reserve. Additional remediation activities applied to adversely classified credits can include

7

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

various actions by Ambac Assurance. The most common actions include obtaining detailed appraisal information on collateral, more frequent meetings with the issuer’s or servicer’s management to review operations, financial condition and financial forecasts and more frequent analysis of the issuer’s financial statements. In estimating the active credit reserve Ambac Assurance uses relevant credit-specific information obtained from its remediation efforts to supplement the statistical approach discussed above. Senior management meets at least quarterly with the Surveillance Group to review the status of their work to determine the adequacy of Ambac Assurance’s loss reserves and make any necessary adjustments. Active credit reserves were $166,734 and $172,644 at September 30, 2007 and December 31, 2006, respectively. The active credit reserves at September 30, 2007 and December 31, 2006 were comprised of 48 credits with net par of $1,859,994 and 55 credits with net par outstanding of $3,830,759, respectively. Included in the calculation of active credit reserves at September 30, 2007 and December 31, 2006 was the consideration of $13,222 and $6,859, respectively, of reinsurance which would be due to Ambac Assurance from reinsurers, upon default of the insured obligation.

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

Case basis credit reserves were $117,394 and $47,430 at September 30, 2007 and December 31, 2006, respectively. The discount rate applied to case basis credit reserves was 4.50% at September 30, 2007 and December 31, 2006. The case basis credit reserves at September 30, 2007 and December 31, 2006 were comprised of 10 and 7 credits, respectively, with net par outstanding of $822,054 and $668,440, respectively. Additionally, we have reinsurance recoverables on case basis credit reserves of $10,295 and $4,972 at September 30, 2007 and December 31, 2006, respectively.

Ambac Assurance provides information on the classification of its loss reserve between active credit reserve and case basis credit reserve for the purpose of disclosing the components of the total reserve that relate to exposures that have not yet defaulted and those that have defaulted. The total reserve (active credit and case basis) was $284,128 and $220,074 at September 30, 2007 and December 31, 2006, respectively. Due to the relatively small number and large size of certain insured obligations comprising the active and case basis credit reserves, improvements or further deterioration in any one credit may significantly

8

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

impact our loss provision in a given period. The provision for losses and loss expenses in the accompanying Consolidated Statements of Operations represents the expense recorded to bring the total reserve to a level determined by management to be adequate for losses inherent in the non-derivative financial guarantee insurance portfolio. Ambac Assurance’s management believes that the reserves for losses and loss expenses are adequate to cover the ultimate net cost of claims, but the reserves are based on estimates and there can be no assurance that the ultimate liability for losses will not exceed such estimates.

Our liabilities for credit losses are based in part on the short-duration accounting guidance in SFAS 60, “Accounting and Reporting by Insurance Enterprises.” The trustee (on behalf of the insured party), named beneficiary or custodian has a right to a claim payment under the financial guarantee insurance policy at the date of the first scheduled debt service payment of a defaulted security in the amount equal to the payment shortfall. We believe a loss event occurs for financial guarantee insurance products at the time the issuers’ financial condition deteriorates to an impaired credit status rather than at the time the insured party has a right to a claim payment. Because of this belief and the ambiguities discussed below in the application of SFAS 60 to the financial guarantee industry, Ambac Assurance does not believe that SFAS 60 alone provides sufficient guidance. As a result, Ambac Assurance supplements the guidance in SFAS 60 with the guidance in SFAS 5, “Accounting for Contingencies,” which calls for a loss to be accrued if it is probable that a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. Ambac Assurance also relies by analogy on EITF Issue 85-20, “Recognition of Fees for Guaranteeing a Loan,” which states that a guarantor should perform an ongoing assessment of the probability of loss to determine if a liability (and a loss) should be recognized under SFAS 5.

In management’s view, the accounting guidance noted above does not comprehensively address the attributes of financial guarantee insurance contracts, primarily due to the fact that SFAS 60 was developed prior to the maturity of the financial guarantee industry. Financial guarantee contracts have elements of long-duration insurance contracts in that they are generally irrevocable and extend over a period of time that may be 30 years or more but are considered and reported for regulatory purposes as property and casualty insurance, normally considered short-duration contracts. The short-duration and long-duration classifications have different methods of accounting for premium revenue, deferred acquisition costs and contract liability recognition.

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

9

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

In January and February of 2005, the Securities and Exchange Commission staff discussed with the financial guarantee industry participants differences in loss reserve recognition practices among those participants. In September 2005, the Financial Accounting Standards Board (“FASB”) added a project to its agenda to consider the accounting by financial guarantee insurers for claims liability recognition, premium recognition and deferred acquisition costs. The proposed guidance was issued on April 18, 2007 and the final guidance is expected to be issued in the first quarter of 2008.

(4) Derivative Contracts

SFAS 133 “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS 138, SFAS 149 and SFAS 155, establishes accounting and reporting standards for derivative instruments. All derivatives, whether designated for hedging relationships or not, are required to be recorded on the Consolidated Balance Sheets at fair value. When available, quotes from independent market sources are obtained for market value. However, when quotes are not available, Ambac Assurance uses internally developed valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves and tax-exempt interest ratios. The valuation results from these models could differ materially from amounts that would actually be realized in the market. In accordance with the Emerging Issues Task Force (EITF) Issue 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities” (EITF 02-3), recognition of a trading profit or loss at inception of a derivative transaction is prohibited unless fair value of that derivative is obtained from a quoted market price, supported by comparison to other observable market transactions, or based upon a valuation technique incorporating observable market data. Ambac Assurance defers trade date gains or losses on derivative transactions where the fair value is not determined based upon observable market transactions and market data. The deferral is recognized in income when the market data becomes observable or over the life of the transaction. The fair value includes an adjustment for counterparty credit risk and other adjustments, as appropriate, to reflect liquidity and ongoing servicing costs.

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

Derivative Contracts Classified as Held for Trading Purposes:

Financial Guarantee Credit Derivatives:

Ambac Assurance, through its subsidiary Ambac Credit Products, enters into credit derivative transactions with various financial institutions. Management views these credit derivative transactions as an extension of its financial guarantee business, under which Ambac Assurance intends to hold its position for the entire term of the related contract. These credit

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Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

derivative contracts are accounted for at fair value since they do not qualify for the financial guarantee scope exception under SFAS 133, as amended. Changes in fair value are recorded in the Consolidated Statement of Operations. The fee component is reflected in “Other Credit Enhancement Fees”, and the mark-to-market gains or losses associated with fair value changes are reflected in “Net Mark-to-Market (Losses) Gains on Credit Derivative Contracts”.

During the third quarter of 2007, a net mark-to-market loss of $743,379 was recorded across the entire credit derivative portfolio, with the largest declines related to collateralized debt obligations of asset-backed securitizations (“CDO of ABS”) containing sub-prime mortgage-backed securities as collateral, including CDOs containing other CDO of ABS securities as collateral (“CDO of CDO”). Unrealized losses of CDO of ABS comprised approximately 71% of the total unrealized losses for the three months ended September 30, 2007. The remainder of the mark is attributed primarily to CDOs of corporate assets, both loans and bonds.

Financial Services Derivative Products:

Ambac Assurance, through its subsidiary Ambac Financial Services, provides interest rate and currency swaps to states, municipalities and their authorities, asset-backed issuers and other entities in connection with their financings. Ambac Capital Services enters into total return swaps with professional counterparties. Total return swaps are primarily referenced to fixed income obligations, which meet Ambac Assurance’s financial guarantee credit underwriting criteria. These contracts are recorded on trade date at fair value. Changes in fair value are recorded as a component of “Derivative Product” revenue in the accompanying Consolidated Statements of Operations.

(5) Income Taxes

On January 1, 2007, Ambac Assurance adopted the provisions of FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes”, an interpretation of SFAS 109, which provides a framework to determine the appropriate level of tax reserves for uncertain tax positions. FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, measurement classification, interest and penalties, accounting in interim periods, disclosure and transition. Ambac Assurance’s liability for unrecognized tax benefits was not impacted as a result of the adoption of FIN 48.

Ambac Financial Group files a consolidated Federal income tax return with its subsidiaries. Ambac Financial Group and its subsidiaries also file separate or combined income tax returns in various states, local and foreign jurisdictions.

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Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

The following are the major jurisdictions in which Ambac Assurance and its affiliates operate and the earliest tax years subject to examination:

Jurisdiction	Tax Year
United States	2001
New York State	2005
New York City	2000
United Kingdom	2005

As of September 30, 2007 and December 31, 2006, the liability for unrecognized tax benefits is approximately $56,460 and $54,100, respectively. Included in these balances at September 30, 2007 and December 31, 2006 are $32,660 and $30,300, respectively, of unrecognized tax benefits that, if recognized, would affect the effective tax rate. Over the next 12 months, Ambac Assurance estimates it may decrease federal tax reserves related to the unrecognized tax benefits by approximately $11,200 for issues that may no longer warrant a tax reserve after an expected settlement for the years 2001 through 2004.

Ambac Assurance accrues interest and penalties related to unrecognized tax benefits in the provision for income taxes. During the three and nine months ended September 30, 2007 Ambac Assurance recognized interest of approximately $950 and $2,360 , respectively, compared to $500 and $900 in the three and nine months ended September 30, 2006, respectively. Ambac Assurance had approximately $4,560 and $2,200 for the payment of interest accrued at September 30, 2007 and December 31, 2006, respectively.

(6) Special Purpose and Variable Interest Entities

Ambac Financial Group has involvement with special purpose entities, including VIEs, in the following ways. First, Ambac Assurance is a provider of financial guarantee insurance for various debt obligations issued by VIEs. Second, Ambac Financial Group has sponsored two special purpose entities that issue 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”). Lastly, Ambac Assurance is an investor in asset-backed securities issued by VIEs, and, in one transaction, has a beneficial interest in a VIE that purchases fixed rate municipal bonds with proceeds from the issuance of floating rate short term beneficial interests as discussed in detail below.

Financial Guarantees:

Ambac Assurance provides financial guarantees in respect of assets held or debt obligations of special purpose entities, including VIEs. Ambac’ Assurances primary variable interest exists through this financial guarantee insurance or credit derivative contract. The transaction structure provides certain financial protection to Ambac Assurance. This financial

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Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

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

As of September 30, 2007, Ambac Assurance is the primary beneficiary and therefore consolidated a VIE under one transaction as a result of providing a financial guaranty. The VIE is a bankruptcy remote special purpose financing entity created by the issuer of debt securities to facilitate the sale of notes guaranteed by Ambac Assurance. Ambac Assurance is not primarily liable for the debt obligations of the VIE. Ambac Assurance would only be required to make payments on these debt obligations in the event that the issuer defaults on any principal or interest due. Additionally, Ambac Assurance’s creditors do not have rights with regard to the assets of the VIE.

Proceeds from the note issuance of the VIE were used to extend loans to universities in the United Kingdom. The financial reports of this VIE are prepared by an outside trustee and are not available within the time constraints Ambac Assurance requires to ensure the financial accuracy of the operating results. As such, the financial results of the VIE are consolidated on a one quarter lag. Total long-term debt outstanding under this note issuance was $280,690 with a maturity date of December 7, 2047 and a fixed rate of interest of 5.32% at September 30, 2007. Ambac Assurance is subject to potential consolidation of an additional $743,000 of assets and liabilities in connection with future utilization of the VIE.

The following table provides supplemental information about the combined assets and liabilities associated with the VIE discussed above. The assets and liabilities of the VIE are consolidated into the respective Balance Sheet captions.

	At September 30, 2007		At December 31, 2006
Assets:
Cash	$	1,334	$	—
Investment income due and accrued		1,830		—
Loans		265,741		—
Other assets		12,984		—
Total assets	$	281,889		—
Liabilities:
Accrued interest payable	$	1,199	$	—
Long-term debt		280,690		—
Total liabilities		281,889		—
Stockholders’ equity:		—		—
Total liabilities and stockholders’ equity	$	281,889	$	—

13

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

Qualified Special Purpose Entities:

A subsidiary of Ambac Financial Group has transferred financial assets to two special purpose entities. The business purpose of these entities is to provide certain financial guarantee clients with funding for their debt obligations. These entities meet the characteristics of QSPEs in accordance with SFAS 140, “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. 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 September 30, 2007, there have been 15 individual transactions processed through the QSPEs of which 10 are outstanding. In each case, a subsidiary of Ambac Financial Group sold fixed income debt obligations to the QSPEs. These transactions are true sales based upon the bankruptcy remote nature of the QSPEs and the absence of any agreement or obligation for Ambac Financial Group to repurchase or redeem assets of the QSPEs. Additionally, Ambac Financial Group’s creditors do not have any rights with regards to the assets of the QSPEs. The purchase by the QSPEs is financed through the issuance of MTNs, which are collateralized by the purchased assets. Derivative contracts (interest rate and currency swaps) may be used for hedging purposes only. Derivative hedges are established at the time MTNs are issued to purchase financial assets. The activities of the QSPEs are contractually limited to purchasing assets from Ambac Financial Group, issuing MTNs to fund such purchase, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. Ambac Assurance may issue a financial guarantee insurance policy on the assets sold, the MTNs issued and/or the related derivative contracts. As of September 30, 2007, Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the QSPEs.

14

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

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 nine months ended September 30, 2007 and the year ended December 31, 2006 were $0 and $450,000, respectively. No gains or losses were recognized on the sales in either period. As of September 30, 2007, the estimated fair value of financial assets, MTN liabilities and derivative hedge liabilities of the QSPEs was $1,985,274, $1,995,897 and $21,097, respectively. When market quotes are not available, fair values are based on internal valuation models, which utilize current market information. The valuation results from these models could differ materially from amounts that would actually be realized in the market. Ambac Assurance received gross premiums for issuing financial guarantee policies on the assets, MTNs and derivative contracts of $4,665 and $3,774 for the nine months ended September 30, 2007 and 2006, respectively. Ambac Financial Group also received fees for providing other services amounting to $179 and $200 for the nine months ended September 30, 2007 and 2006, respectively.

VIE Beneficial Interest:

Ambac Assurance owns a beneficial interest in a special purpose entity that meets the definition of a VIE. This entity has issued floating rate beneficial interests to investors and invested the proceeds in fixed rate municipal debt securities. These beneficial interests are directly secured by the related municipal debt securities. Ambac Assurance is the primary beneficiary of this entity as a result of its beneficial interest. The fixed rate municipal debt securities, which are reported as “Investments in fixed income securities, at fair value” on the Consolidated Balance Sheets, were $255,952 and $258,976 as of September 30, 2007 and December 31, 2006, respectively. The beneficial interests issued to third parties, reported as “Obligations under investment and payment agreements” on the Consolidated Balance Sheets, were $248,180 and $248,415 as of September 30, 2007 and December 31, 2006, respectively. Under the terms of these beneficial interests, the investors have the contractual right to redeem their investment at any time, with five business days notice. As of September 30, 2007 and December 31, 2006, the interest rates on these beneficial interests ranged from 3.54% to 4.06% and from 2.95% to 4.01%, respectively.

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Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

(7) Segment Information

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

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

Intersegment revenues include the premiums earned under those agreements. Ambac Assurance guarantees swap obligations and receives dividends from its Financial Services subsidiaries. Such premiums are determined as if they were premiums to third parties, that is, at current market prices. Financial Guarantee intersegment revenues include dividends of $13,237 in the three and nine months ended September 30, 2007 compared to dividends of $10,600 and $21,600, respectively, from Financial Services, in the three and nine months ended September 30, 2006, respectively.

16

Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

The following tables summarize the financial information by reportable segment as of and for the three and nine months ended September 30, 2007 and 2006:

(Dollars in thousands) Three months ended September 30,	Financial Guarantee			Financial Services			Intersegment Eliminations			Consolidated
2007:
Revenues:
External customers	$	(405,347	)	$	(8,341	)	$	—		$	(413,688	)
Intersegment		13,870			—			(13,870	)		—
Total revenues	$	(391,477	)	$	(8,341	)	$	(13,870	)	$	(413,688	)
Income before income taxes:
External customers	$	(459,005	)		(12,145	)	$	—		$	(471,150	)
Intersegment		14,537			(1,300	)		(13,237	)		—
Total income before income taxes	$	(444,468	)	$	(13,445	)	$	(13,237	)	$	(471,150	)
Total assets	$	11,585,260		$	1,438,075		$	—		$	13,023,335
2006:
Revenues:
External customers	$	329,909		$	6,568		$	—		$	336,477
Intersegment		11,086			—			(11,086	)		—
Total revenues	$	340,995		$	6,568		$	(11,086	)	$	336,477
Income before income taxes:
External customers	$	302,266		$	2,815		$	—		$	305,081
Intersegment		11,760			(1,160	)		(10,600	)		—
Total income before income taxes	$	314,026		$	1,655		$	(10,600	)	$	305,081
Total assets	$	10,362,959		$	1,501,443		$	—		$	11,864,402
(Dollars in thousands) Nine months ended September 30,	Financial Guarantee			Financial Services			Intersegment Eliminations			Consolidated
2007:
Revenues:
External customers	$	241,890		$	6,565		$	—		$	248,455
Intersegment		15,329			—			(15,329	)		—
Total revenues	$	257,219		$	6,565		$	(15,329	)	$	248,455
Income before income taxes:
External customers	$	89,900		$	(4,969	)	$	—		$	84,931
Intersegment		17,330			(4,093	)		(13,237	)		—
Total income before income taxes	$	107,230		$	(9,062	)	$	(13,237	)	$	84,931
Identifiable assets	$	11,585,260		$	1,438,075		$	—		$	13,023,335
2006:
Revenues:
External customers	$	1,011,908		$	28,066		$	—		$	1,039,974
Intersegment		23,500			—			(23,500	)		—
Total revenues	$	1,035,408		$	28,066		$	(23,500	)	$	1,039,974
Income before income taxes:
External customers	$	901,593		$	16,708		$	—		$	918,301
Intersegment		25,522			(3,922	)		(21,600	)		—
Total income before income taxes	$	927,115		$	12,786		$	(21,600	)	$	918,301
Identifiable assets	$	10,362,959		$	1,501,443		$	—		$	11,864,402

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Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated 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 nine months ended September 30, 2007 and 2006:

	Three Months				Nine Months
(Dollars in thousands)	Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees		Gross Premiums Written		Net Premiums Earned and Other Credit Enhancement Fees
2007:
United States	$	212,556	$	164,058	$	614,557	$	527,148
United Kingdom		46,751		18,669		91,794		55,686
Other International		30,048		34,187		99,164		111,529
Total	$	289,355	$	216,914	$	805,515	$	694,363
2006:
United States	$	153,108	$	153,294	$	538,736	$	481,891
United Kingdom		32,541		27,928		106,128		60,033
Other International		29,928		36,627		104,697		111,445
Total	$	215,577	$	217,849	$	749,561	$	653,369

(8) Future Application of Accounting Standards

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In addition, SFAS 157 supersedes certain accounting guidance, which prohibited the recognition of day one gains on certain derivative transactions. With the adoption of SFAS 157, any remaining reserves for day one gains will be reflected as a cumulative effect adjustment to the opening balance of retained earnings. Ambac Assurance is currently evaluating the implications of SFAS 157 on its financial statements.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS 159 permits reporting entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The fair value option may be applied instrument by instrument, is irrevocable and is applied only to entire instruments and not to portions of instruments. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS 159 is effective for fiscal years that begin after November 15, 2007. Ambac Assurance is currently evaluating the implications of SFAS 159 on its financial statements.

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Ambac Assurance Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements (Continued)

(Dollars in thousands)

On April 18, 2007, the FASB issued an Exposure Draft (“ED”) for a proposed SFAS “Accounting for Financial Guarantee Insurance Contracts”, an interpretation of SFAS 60, “Accounting and Reporting by Insurance Enterprises”. The ED clarifies how SFAS 60 applies to financial guarantee insurance contracts issued by insurance enterprises, including the methodology to account for premium revenue and claim liabilities. The comment period for the ED ended on June 18, 2007 and the final Statement is expected to be issued in the first quarter of 2008. The final Statement shall be applied to existing and future financial guarantee insurance contracts. The cumulative effect of initially applying this final Statement will be recorded as an adjustment to the opening balance of retained earnings for that fiscal year.

In April 2007, the FASB issued FASB Staff Position (“FSP”) FIN 39-1, an amendment of FASB Interpretation No. 39. FSP FIN 39-1 permits fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a liability) to be offset against fair value amounts recognized for derivative instruments that are executed with the same counterparty under the same master netting arrangement. The decision to offset fair value amounts constitutes an accounting policy election by the entity. A reporting entity shall not offset fair value amounts recognized for derivative instruments without offsetting fair value amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral. FSP FIN 39-1 is effective for fiscal years beginning after November 15, 2007, with earlier application permitted. An entity must recognize the effect of applying FSP FIN 39-1 retrospectively as a change in accounting principle for all financial statement periods presented, unless it is impracticable to do so. Ambac Assurance is currently evaluating the implications of FSP FIN 39-1 on its financial statements.

19