##### Table of Contents





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 March 31, 2011



| ̈ | 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.

(Debtor-in-possession as of November 8,
2010)

(Exact name of Registrant as specified in its charter)



|                                          |  |                                    
|----------------------------------------- |  | -----------------------------------
|Delaware                                  |  | 13-3621676                         
|(State of incorporation)                  |  | (I.R.S. employeridentification 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 has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post
such files).    Yes   ̈    No   ̈

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definition of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act): (Check one):



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈ |  | Accelerated filer         |  | x
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller reporting company |  |  ̈

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 April 29, 2011, 302,428,811 shares of Common Stock, par value $0.01 per share, (net of 5,587,953 treasury shares) of the
Registrant were outstanding.









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##### Table of Contents

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  March 31, 2011 (unaudited) and December 31, 2010                           |     |  | 3   | 
|                             |  |                                                                                                         
|                             |  | Consolidated Statements of Operations (unaudited)  three months ended March 31, 2011 and 2010           |     |  | 4   | 
|                             |  |                                                                                                         
|                             |  | Consolidated Statements of Stockholders Equity (unaudited)  three months ended March 31, 2011 and 2010 |     |  | 5   | 
|                             |  |                                                                                                         
|                             |  | Consolidated Statements of Cash Flows (unaudited)  three months ended March 31, 2011 and 2010           |     |  | 6   | 
|                             |  |                                                                                                         
|                             |  | Notes to Unaudited Consolidated Financial Statements                                                     |     |  | 7   | 
|                             |  |                                                                                                         
|Item 2.                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                    |     |  | 73  | 
|                             |  |                                                                                                         
|Item 3.                      |  | Quantitative and Qualitative Disclosures About Market Risk                                               |     |  | 121 | 
|                             |  |                                                                                                         
|Item 4.                      |  | Controls and Procedures                                                                                  |     |  | 125 | 
|                             | 
|PART II OTHER INFORMATION    |  |                                                                                                          |     | 
|                             |  |                                                                                                         
|Item 1.                      |  | Legal Proceedings                                                                                        |     |  | 126 | 
|                             |  |                                                                                                         
|Item 1A.                     |  | Risk Factors                                                                                             |     |  | 126 | 
|                             |  |                                                                                                         
|Item 2.                      |  | Unregistered Sales of Equity Securities and Use of Proceeds                                              |     |  | 131 | 
|                             |  |                                                                                                         
|Item 6.                      |  | Exhibits                                                                                                 |     |  | 132 | 
|                             | 
|SIGNATURES                   |  |                                                                                                          | 133 | 
|                             | 
|INDEX TO EXHIBITS            |  |                                                                                                          | 134 | 



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##### Table of Contents

PART 1  FINANCIAL INFORMATION

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

Ambac Financial Group Inc. and Subsidiaries

Debtor-In-Possession

Consolidated Balance Sheets



|                                                                                                                       |  |               |            |   |                  |   |            |  
|---------------------------------------------------------------------------------------------------------------------- |  | ------------- | ---------- | - | ---------------- | - | ---------- | -
|(Dollars in Thousands)                                                                                                 |  | March 31,2011 |            |   | December 31,2010 |  
|                                                                                                                       |  | (unaudited)   |            |   |                  |  
|Assets:                                                                                                                |  |               |            |   |                  |   |            |  
|Investments:                                                                                                           |  |               |            |   |                  |   |            |  
|Fixed income securities, at fair value (amortized cost of $5,695,438 in 2011 and $5,707,727 in 2010)                   |  | $             | 6,083,472  |   |                  | $ | 6,020,895  |  
|Fixed income securities pledged as collateral, at fair value (amortized cost of $104,939 in 2011 and $120,918 in
2010) |  |               | 107,084    |   |                  |   | 123,519    |  
|Short-term investments, at cost (approximates fair value)                                                              |  |               | 792,426    |   |                  |   | 708,797    |  
|Other, at cost (approximates fair value)                                                                               |  |               | 100        |   |                  |   | 100        |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total investments                                                                                                      |  |               | 6,983,082  |   |                  |   | 6,853,311  |  
|                                                                                                                       |  |              
|Cash and cash equivalents                                                                                              |  |               | 7,626      |   |                  |   | 9,497      |  
|Restricted cash                                                                                                        |  |               | 2,500      |   |                  |   | 2,500      |  
|Receivable for securities sold                                                                                         |  |               | 77,449     |   |                  |   | 23,505     |  
|Investment income due and accrued                                                                                      |  |               | 39,715     |   |                  |   | 45,066     |  
|Premium receivables                                                                                                    |  |               | 2,290,920  |   |                  |   | 2,422,596  |  
|Reinsurance recoverable on paid and unpaid losses                                                                      |  |               | 141,311    |   |                  |   | 136,986    |  
|Deferred ceded premium                                                                                                 |  |               | 250,291    |   |                  |   | 264,858    |  
|Subrogation recoverable                                                                                                |  |               | 796,622    |   |                  |   | 714,270    |  
|Deferred acquisition costs                                                                                             |  |               | 247,746    |   |                  |   | 250,649    |  
|Loans                                                                                                                  |  |               | 20,397     |   |                  |   | 20,167     |  
|Derivative assets                                                                                                      |  |               | 300,849    |   |                  |   | 290,299    |  
|Other assets                                                                                                           |  |               | 75,959     |   |                  |   | 82,579     |  
|Variable interest entity assets:                                                                                       |  |               |            |   |                  |   |            |  
|Fixed income securities, at fair value                                                                                 |  |               | 1,929,691  |   |                  |   | 1,904,361  |  
|Restricted cash                                                                                                        |  |               | 2,190      |   |                  |   | 2,098      |  
|Investment income due and accrued                                                                                      |  |               | 1,285      |   |                  |   | 4,065      |  
|Loans (includes $14,029,346 in 2011 and $15,800,918 in 2010 at fair value)                                             |  |               | 14,231,947 |   |                  |   | 16,005,066 |  
|Derivative assets                                                                                                      |  |               |           |   |                  |   | 4,511      |  
|Other assets                                                                                                           |  |               | 10,724     |   |                  |   | 10,729     |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total assets                                                                                                           |  | $             | 27,410,304 |   |                  | $ | 29,047,113 |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Liabilities and Stockholders Deficit:                                                                                 |  |               |            |   |                  |   |            |  
|Liabilities:                                                                                                           |  |               |            |   |                  |   |            |  
|Liabilities subject to compromise                                                                                      |  | $             | 1,708,486  |   |                  | $ | 1,695,231  |  
|Unearned premiums                                                                                                      |  |               | 3,821,726  |   |                  |   | 4,007,886  |  
|Losses and loss expense reserve                                                                                        |  |               | 6,296,761  |   |                  |   | 5,288,655  |  
|Ceded premiums payable                                                                                                 |  |               | 134,248    |   |                  |   | 141,450    |  
|Obligations under investment and payment agreements                                                                    |  |               | 681,396    |   |                  |   | 767,982    |  
|Obligations under investment repurchase agreements                                                                     |  |               | 35,720     |   |                  |   | 37,650     |  
|Current taxes                                                                                                          |  |               | 24,884     |   |                  |   | 22,534     |  
|Long-term debt                                                                                                         |  |               | 210,837    |   |                  |   | 208,260    |  
|Accrued interest payable                                                                                               |  |               | 86,387     |   |                  |   | 61,708     |  
|Derivative liabilities                                                                                                 |  |               | 352,345    |   |                  |   | 348,791    |  
|Other liabilities                                                                                                      |  |               | 117,398    |   |                  |   | 124,748    |  
|Payable for securities purchased                                                                                       |  |               | 76,361     |   |                  |   |           |  
|Variable interest entity liabilities:                                                                                  |  |               |            |   |                  |   |            |  
|Accrued interest payable                                                                                               |  |               | 709        |   |                  |   | 3,425      |  
|Long-term debt (includes $14,516,870 in 2011 and $15,885,711 in 2010 at fair value)                                    |  |               | 14,730,527 |   |                  |   | 16,101,026 |  
|Derivative liabilities                                                                                                 |  |               | 1,214,536  |   |                  |   | 1,580,120  |  
|Other liabilities                                                                                                      |  |               | 11,880     |   |                  |   | 11,875     |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total liabilities                                                                                                      |  |               | 29,504,201 |   |                  |   | 30,401,341 |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Stockholders deficit:                                                                                                 |  |               |            |   |                  |   |            |  
|Ambac Financial Group, Inc.:                                                                                           |  |               |            |   |                  |   |            |  
|Preferred stock                                                                                                        |  |               |           |   |                  |   |           |  
|Common stock                                                                                                           |  |               | 3,080      |   |                  |   | 3,080      |  
|Additional paid-in capital                                                                                             |  |               | 2,187,593  |   |                  |   | 2,187,485  |  
|Accumulated other comprehensive income                                                                                 |  |               | 371,235    |   |                  |   | 291,774    |  
|Accumulated deficit                                                                                                    |  |               | (4,898,771 | ) |                  |   | (4,042,335 | )
|Common stock held in treasury at cost                                                                                  |  |               | (411,419   | ) |                  |   | (448,540   | )
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total Ambac Financial Group, Inc. stockholders deficit                                                                |  |               | (2,748,282 | ) |                  |   | (2,008,536 | )
|Noncontrolling interest                                                                                                |  |               | 654,385    |   |                  |   | 654,308    |  
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total stockholders deficit                                                                                            |  |               | (2,093,897 | ) |                  |   | (1,354,228 | )
|                                                                                                                       |  |               |            |   |                  |   |            |  
|Total liabilities and stockholders deficit                                                                            |  | $             | 27,410,304 |   |                  | $ | 29,047,113 |  
|                                                                                                                       |  |               |            |   |                  |   |            |  

See accompanying Notes to Unaudited Consolidated Financial Statements.



3



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##### Table of Contents

Ambac Financial Group Inc. and Subsidiaries

Debtor-In-Possession

Consolidated Statements of Operations

(Unaudited)



|                                                                                           |  |                             |             |   |      |   |             |  
|------------------------------------------------------------------------------------------ |  | --------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                                           |  | Three Months
EndedMarch 31, |            
|(Dollars in Thousands, Except Share Data)                                                  |  | 2011                        |             |   | 2010 |  
|Revenues:                                                                                  |  |                             |             |   |      |   |             |  
|Financial Guarantee:                                                                       |  |                             |             |   |      |   |             |  
|Net premiums earned                                                                        |  | $                           | 91,799      |   |      | $ | 125,231     |  
|Net investment income                                                                      |  |                             | 71,665      |   |      |   | 117,570     |  
|Other-than-temporary impairment losses:                                                    |  |                             |             |   |      |   |             |  
|Total other-than-temporary impairment losses                                               |  |                             | (1,713      | ) |      |   | (33,468     | )
|Portion of loss recognized in other comprehensive income                                   |  |                             |            |   |      |   | 2,119       |  
|                                                                                           |  |                             |             |   |      |   |             |  
|Net other-than-temporary impairment losses recognized in earnings                          |  |                             | (1,713      | ) |      |   | (31,349     | )
|                                                                                           |  |                             |             |   |      |   |             |  
|Net realized investment (losses) gains                                                     |  |                             | (15         | ) |      |   | 55,139      |  
|Change in fair value of credit derivatives:                                                |  |                             |             |   |      |   |             |  
|Realized gains and other settlements                                                       |  |                             | 5,323       |   |      |   | 9,924       |  
|Unrealized losses                                                                          |  |                             | (14,226     | ) |      |   | (177,063    | )
|                                                                                           |  |                             |             |   |      |   |             |  
|Net change in fair value of credit derivatives                                             |  |                             | (8,903      | ) |      |   | (167,139    | )
|Other income (loss)                                                                        |  |                             | 28,303      |   |      |   | (55,903     | )
|Loss on variable interest entities                                                         |  |                             | (6,125      | ) |      |   | (492,704    | )
|Financial Services:                                                                        |  |                             |             |   |      |   |             |  
|Investment income                                                                          |  |                             | 4,726       |   |      |   | 9,268       |  
|Derivative products                                                                        |  |                             | 21,004      |   |      |   | (58,227     | )
|Net realized investment gains                                                              |  |                             | 2,465       |   |      |   | 1,410       |  
|Net mark-to-market losses on non-trading derivative contracts                              |  |                             |            |   |      |   | (2,739      | )
|Corporate and Other:                                                                       |  |                             |             |   |      |   |             |  
|Other income                                                                               |  |                             | 77          |   |      |   | 304         |  
|                                                                                           |  |                             |             |   |      |   |             |  
|Total revenues                                                                             |  |                             | 203,283     |   |      |   | (499,139    | )
|                                                                                           |  |                             |             |   |      |   |             |  
|Expenses:                                                                                  |  |                             |             |   |      |   |             |  
|Financial Guarantee:                                                                       |  |                             |             |   |      |   |             |  
|Losses and loss expenses                                                                   |  |                             | 919,647     |   |      |   | 89,152      |  
|Underwriting and operating expenses                                                        |  |                             | 42,376      |   |      |   | 50,496      |  
|Interest expense                                                                           |  |                             | 28,069      |   |      |   |            |  
|Financial Services:                                                                        |  |                             |             |   |      |   |             |  
|Interest from investment and payment agreements                                            |  |                             | 2,191       |   |      |   | 5,434       |  
|Other expenses                                                                             |  |                             | 2,614       |   |      |   | 3,627       |  
|Corporate and Other:                                                                       |  |                             |             |   |      |   |             |  
|Interest                                                                                   |  |                             |            |   |      |   | 30,159      |  
|Other expenses                                                                             |  |                             | 477         |   |      |   | 11,948      |  
|                                                                                           |  |                             |             |   |      |   |             |  
|Total expenses                                                                             |  |                             | 995,374     |   |      |   | 190,816     |  
|                                                                                           |  |                             |             |   |      |   |             |  
|Pre-tax loss from continuing operations before reorganization items                        |  |                             | (792,091    | ) |      |   | (689,955    | )
|Reorganization items                                                                       |  |                             | 24,805      |   |      |   |            |  
|                                                                                           |  |                             |             |   |      |   |             |  
|Pre-tax loss from continuing operations                                                    |  |                             | (816,896    | ) |      |   | (689,955    | )
|Provision for income taxes                                                                 |  |                             | 2,350       |   |      |   | 107         |  
|                                                                                           |  |                             |             |   |      |   |             |  
|Net loss                                                                                   |  |                             | ($819,246   | ) |      |   | ($690,062   | )
|Less: net income (loss) attributable to the noncontrolling interest                        |  |                             | 33          |   |      |   | (11         | )
|                                                                                           |  |                             |             |   |      |   |             |  
|Net loss attributable to Ambac Financial Group, Inc.                                       |  |                             | ($819,279   | ) |      |   | ($690,051   | )
|                                                                                           |  |                             |             |   |      |   |             |  
|Net loss per share attributable to Ambac Financial Group, Inc. common shareholders         |  |                             | ($2.71      | ) |      |   | ($2.39      | )
|Net loss per diluted share attributable to Ambac Financial Group, Inc. common shareholders |  |                             | ($2.71      | ) |      |   | ($2.39      | )
|Weighted-average number of common shares outstanding:                                      |  |                             |             |   |      |   |             |  
|Basic                                                                                      |  |                             | 302,355,243 |   |      |   | 288,244,846 |  
|Diluted                                                                                    |  |                             | 302,355,243 |   |      |   | 288,244,846 |  

See accompanying
Notes to Unaudited Consolidated Financial Statements.



4



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##### Table of Contents

Ambac Financial Group Inc. and Subsidiaries

Debtor-In-Possession

Consolidated Statements of Stockholders Equity

(Unaudited)



|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|------------------------------------------------------------------------------ |  | ----- | ------------------ | - | -------------------------- | ----------------------------------- | --------- | --------------------------- | -------------- | -- | ----------- | ----------- |  | -- | -------------- | - |  | ----------------------------------- | - |  | ---------------------- | - | ----- |  |  | - | --------- |  |  | - | -------- | - |  | - | ------- | -
|                                                                               |  | Total |                    |   | Comprehensive(Loss) Income |                                     |           | Ambac Financial Group, Inc. |                |    |             |            
|                                                                               |  |       | AccumulatedDeficit |   |                            | AccumulatedOtherComprehensiveIncome |           |                             | PreferredStock |    |             | CommonStock |  |    | Paid-inCapital |   |  | CommonStock Held inTreasury, atCost |   |  | NoncontrollingInterest |  
|Balance at January 1, 2011                                                     |  | $     | (1,354,228         | ) |                            |                                     |           |                             |                | $  | (4,042,335  | )           |  | $  | 291,774        |   |  | $                                   |  |  |                        | $ | 3,080 |  |  | $ | 2,187,485 |  |  | $ | (448,540 | ) |  | $ | 654,308 |  
|Comprehensive loss:                                                            |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Net (loss) income                                                              |  |       | (819,246           | ) |                            | $                                   | (819,246  | )                           |                |    | (819,279    | )           |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   | 33      |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Other comprehensive loss:                                                      |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Unrealized gains on securities, net of deferred income taxes of $0             |  |       | 74,410             |   |                            |                                     | 74,410    |                             |                |    |             |             |  |    | 74,410         |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Gain on foreign currency translation, net of deferred income taxes of $0       |  |       | 4,384              |   |                            |                                     | 4,384     |                             |                |    |             |             |  |    | 4,340          |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   | 44      |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Other comprehensive gain                                                       |  |       | 78,794             |   |                            |                                     | 78,794    |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                       |  | $     | (740,452           | ) |                            | $                                   | (740,452  | )                           |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Amortization of postretirement benefit, net of tax                             |  |       | 711                |   |                            |                                     |           |                             |                |    |             |             |  |    | 711            |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Stock-based compensation                                                       |  |       | (37,049            | ) |                            |                                     |           |                             |                |    | (37,157     | )           |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   | 108       |  |  |   |          |   |  |   |         |  
|Cost of shares acquired                                                        |  |       | (35                | ) |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   | (35      | ) |  |   |         |  
|Shares issued under equity plans                                               |  |       | 37,156             |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   | 37,156   |   |  |   |         |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Balance at March 31, 2011                                                      |  | $     | (2,093,897         | ) |                            |                                     |           |                             |                | $  | (4,898,771  | )           |  | $  | 371,325        |   |  | $                                   |  |  |                        | $ | 3,080 |  |  | $ | 2,187,593 |  |  | $ | (411,419 | ) |  | $ | 654,385 |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |               
|Balance at January 1, 2010                                                     |  |       | ($1,633,645        | ) |                            |                                     |           |                             |                | ($ | 3,878,015   | )           |  | ($ | 24,827         | ) |  | $                                   |  |  |                        | $ | 2,944 |  |  | $ | 2,172,656 |  |  | $ | (560,543 | ) |  | $ | 654,140 |  
|Comprehensive loss:                                                            |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Net loss                                                                       |  |       | (690,062           | ) |                            |                                     | ($690,062 | )                           |                |    | (690,051    | )           |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   | (11     | )
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Other comprehensive loss:                                                      |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Unrealized gains on securities, net of deferred income taxes of $118,366       |  |       | 170,478            |   |                            |                                     | 170,478   |                             |                |    |             |             |  |    | 170,478        |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Loss on derivative hedges, net of deferred income taxes of ($404)              |  |       | (752               | ) |                            |                                     | (752      | )                           |                |    |             |             |  |    | (752           | ) |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Loss on foreign currency translation, net of deferred income taxes of ($4,345) |  |       | (28,104            | ) |                            |                                     | (28,104   | )                           |                |    |             |             |  |    | (28,035        | ) |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   | (69     | )
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Other comprehensive gain                                                       |  |       | 141,622            |   |                            |                                     | 141,622   |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Total comprehensive loss                                                       |  |       | ($548,440          | ) |                            |                                     | ($548,440 | )                           |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Adjustment to initially apply ASC 2009-17                                      |  |       | 705,046            |   |                            |                                     |           |                             |                |    | 702,042     |             |  |    | 3,004          |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Dividends declared  subsidiary shares to non-controlling interest             |  |       | (816               | ) |                            |                                     |           |                             |                |    | (816        | )           |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Amortization of postretirement benefit, net of tax                             |  |       | (208               | ) |                            |                                     |           |                             |                |    |             |             |  |    | (208           | ) |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Stock-based compensation                                                       |  |       | (104,323           | ) |                            |                                     |           |                             |                |    | (105,914    | )           |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   | 1,591     |  |  |   |          |   |  |   |         |  
|Cost of shares acquired                                                        |  |       | (313               | ) |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   | (313     | ) |  |   |         |  
|Shares issued under equity plans                                               |  |       | 105,914            |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   | 105,914  |   |  |   |         |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  
|Balance at March 31, 2010                                                      |  |       | ($1,476,785        | ) |                            |                                     |           |                             |                |    | ($3,972,754 | )           |  | $  | 119,660        |   |  | $                                   |  |  |                        | $ | 2,944 |  |  | $ | 2,174,247 |  |  | $ | (454,942 | ) |  | $ | 654,060 |  
|                                                                               |  |       |                    |   |                            |                                     |           |                             |                |    |             |             |  |    |                |   |  |                                     |   |  |                        |   |       |  |  |   |           |  |  |   |          |   |  |   |         |  

See accompanying Notes to Unaudited Consolidated Financial Statements.



5



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##### Table of Contents

Ambac Financial Group Inc. and Subsidiaries

Debtor-In-Possession

Consolidated Statements of Cash Flows

(Unaudited)



|                                                                                          |  |                             |           |   |      |   |            |  
|----------------------------------------------------------------------------------------- |  | --------------------------- | --------- | - | ---- | - | ---------- | -
|                                                                                          |  | Three Months EndedMarch 31, |          
|(Dollars in Thousands)                                                                    |  | 2011                        |           |   | 2010 |  
|Cash flows from operating activities:                                                     |  |                             |           |   |      |   |            |  
|Net loss attributable to common shareholders                                              |  |                             | ($819,279 | ) |      |   | ($690,051  | )
|Noncontrolling interest in subsidiaries earnings                                         |  |                             | 33        |   |      |   | (11        | )
|                                                                                          |  |                             |           |   |      |   |            |  
|Net loss                                                                                  |  |                             | ($819,246 | ) |      |   | ($690,062  | )
|Adjustments to reconcile net loss to net cash provided by operating activities:           |  |                             |           |   |      |   |            |  
|Depreciation and amortization                                                             |  |                             | 780       |   |      |   | 746        |  
|Amortization of bond premium and discount                                                 |  |                             | (35,439   | ) |      |   | (56,596    | )
|Reorganization items                                                                      |  |                             | 24,805    |   |      |   |           |  
|Share-based compensation                                                                  |  |                             | 108       |   |      |   | 1,591      |  
|Current income taxes                                                                      |  |                             | 2,350     |   |      |   | 443,944    |  
|Deferred acquisition costs                                                                |  |                             | 2,903     |   |      |   | 6,299      |  
|Unearned premiums, net                                                                    |  |                             | (171,593  | ) |      |   | (655,020   | )
|Loss and loss expense, net                                                                |  |                             | 921,429   |   |      |   | (77,859    | )
|Ceded premiums payable                                                                    |  |                             | (7,202    | ) |      |   | (68,096    | )
|Investment income due and accrued                                                         |  |                             | 5,351     |   |      |   | 26,487     |  
|Premium receivables                                                                       |  |                             | 131,676   |   |      |   | 776,612    |  
|Accrued interest payable                                                                  |  |                             | 24,679    |   |      |   | (55        | )
|Net mark-to-market losses                                                                 |  |                             | 14,226    |   |      |   | 179,802    |  
|Net realized investment gains                                                             |  |                             | (2,450    | ) |      |   | (56,549    | )
|Other-than-temporary impairment charges                                                   |  |                             | 1,713     |   |      |   | 31,349     |  
|Variable interest entity activities                                                       |  |                             | 6,125     |   |      |   | 492,704    |  
|Other, net                                                                                |  |                             | (17,400   | ) |      |   | 71,801     |  
|                                                                                          |  |                             |           |   |      |   |            |  
|Net cash provided by operating activities                                                 |  |                             | 82,815    |   |      |   | 427,098    |  
|                                                                                          |  |                             |           |   |      |   |            |  
|Cash flows from investing activities:                                                     |  |                             |           |   |      |   |            |  
|Proceeds from sales of bonds                                                              |  |                             | 93,191    |   |      |   | 1,129,824  |  
|Proceeds from matured bonds                                                               |  |                             | 202,806   |   |      |   | 243,137    |  
|Purchases of bonds                                                                        |  |                             | (205,418  | ) |      |   | (135,770   | )
|Change in short-term investments                                                          |  |                             | (83,629   | ) |      |   | (1,640,578 | )
|Loans, net                                                                                |  |                             | (230      | ) |      |   | 9,321      |  
|Change in swap collateral receivable                                                      |  |                             | (104      | ) |      |   | (2,984     | )
|Other, net                                                                                |  |                             | 787       |   |      |   | 3,454      |  
|                                                                                          |  |                             |           |   |      |   |            |  
|Net cash provided by (used in) investing activities                                       |  |                             | 7,403     |   |      |   | (393,596   | )
|                                                                                          |  |                             |           |   |      |   |            |  
|Cash flows from financing activities:                                                     |  |                             |           |   |      |   |            |  
|Dividends paid  subsidiary shares to noncontrolling interest                             |  |                             |          |   |      |   | (816       | )
|Proceeds from issuance of investment and payment agreements                               |  |                             | 24        |   |      |   | 1,184      |  
|Payments for investment and payment draws                                                 |  |                             | (89,673   | ) |      |   | (31,145    | )
|Net cash collateral paid/received                                                         |  |                             | (2,440    | ) |      |   | 4          |  
|                                                                                          |  |                             |           |   |      |   |            |  
|Net cash used in financing activities                                                     |  |                             | (92,089   | ) |      |   | (30,773    | )
|                                                                                          |  |                             |           |   |      |   |            |  
|Net cash flow                                                                             |  |                             | (1,871    | ) |      |   | 2,729      |  
|Cash and cash equivalents at January 1                                                    |  |                             | 9,497     |   |      |   | 112,079    |  
|                                                                                          |  |                             |           |   |      |   |            |  
|Cash and cash equivalents at March 31                                                     |  | $                           | 7,626     |   |      | $ | 114,808    |  
|                                                                                          |  |                             |           |   |      |   |            |  
|Supplemental disclosure of cash flow information:                                         |  |                             |           |   |      |   |            |  
|Cash paid during the year for:                                                            |  |                             |           |   |      |   |            |  
|Income taxes                                                                              |  | $                           |          |   |      | $ |           |  
|Interest expense on long-term debt                                                        |  | $                           |          |   |      | $ | 101,016    |  
|Interest on investment agreements                                                         |  | $                           | 3,656     |   |      | $ | 7,947      |  
|Cash receipts and payments related to reorganization items:                               |  |                             |           |   |      |   |            |  
|Professional fees paid for services rendered in connection with the Chapter 11 proceeding |  | $                           | 5,457     |   |      | $ |           |  

Supplemental disclosure of noncash
financing activities:

In March 2011, surplus notes with a par value of $3,000 were issued in connection with the
commutation of financial guarantee transactions.

See accompanying Notes to Unaudited Consolidated Financial Statements.



6



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------

(1) Background and Basis of Presentation

Ambac Financial Group, Inc.
(Ambac or the Company), headquartered in New York City, is a holding company incorporated in the state of Delaware. Ambac was incorporated on April 29, 1991. On November 8, 2010, Ambac filed a voluntary petition for
relief (the Bankruptcy Filing) under Chapter 11 of the United States Bankruptcy Code (Bankruptcy Code) in the United States Bankruptcy Court for the Southern District of New York (Bankruptcy Court). Ambac will
continue to operate in the ordinary course of business as debtor-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and the orders of the Bankruptcy Court.
Ambacs common stock trades on the over-the-counter market under the symbol ABKFQ.

Ambac Assurance Corporation
(Ambac Assurance) is Ambacs principal operating subsidiary, which provided financial guarantees and financial services to clients in both the public and private sectors around the world. In March 2010, Ambac Assurance
established a segregated account pursuant to Wisc. Stat. §611.24(2) (the Segregated Account) to segregate certain segments of Ambac Assurances liabilities. OCI commenced rehabilitation proceedings with respect to the
Segregated Account (the Segregated Account Rehabilitation Proceedings) in order to permit the OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account pursuant to the provisions of the
Wisconsin Insurers Rehabilitation and Liquidation Act. The rehabilitator of the Segregated Account is Theodore Nickel, the Commissioner of Insurance of the State of Wisconsin.

The deterioration of Ambac Assurances financial condition resulting from losses in its insured portfolio has made it impossible for it to write new business, which will negatively impact
Ambacs future operations and financial results. Ambac Assurances ability to pay dividends and, as a result, Ambacs liquidity have been significantly restricted by the deterioration of Ambac Assurances financial condition, by
the rehabilitation of the Segregated Account and by the terms of a settlement agreement entered into in 2010 with counterparties of CDO of ABS transactions, which is described in more detail in Ambacs Annual Report on Form 10-K for the year
ended December 31, 2010 (the 2010 Form 10-K).

Ambacs principal business strategy is to reorganize its
capital structure and financial obligations through the bankruptcy process and to increase the residual value of its financial guarantee business by mitigating losses on poorly performing transactions (including through the pursuit of recoveries in
respect of paid claims, commutations of policies and repurchases of surplus notes issued in respect of claims) and maximizing the return on its investment portfolio. The execution of such strategy with respect to policies allocated to the Segregated
Account will be subject to the authority of the rehabilitator of the Segregated Account to control the management of the Segregated Account. In exercising such authority, the rehabilitator will act for the benefit of policyholders, and will not take
into account the interests of Ambac. Similarly, by operation of the contracts executed in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the rehabilitator retains rights to oversee and approve certain
actions taken in respect of Ambac Assurance. This oversight by the rehabilitator could impair Ambacs ability to execute the foregoing strategy. As a result of uncertainties associated with the aforementioned factors, management has concluded
that there is substantial doubt about the ability of the Company to continue as a going concern. The Companys financial statements as of March 31, 2011 and December 31, 2010 and for the periods ended March 31, 2011 and 2010 are
prepared assuming the Company continues as a going concern and do not include any adjustment that might result from its inability to continue as a going concern.

Ambacs liquidity and solvency are largely dependent on its current cash and investments of $58,584 at March 31, 2011 (excluding $2,500 of restricted cash), dividends from Ambac Assurance, and
on the residual value of Ambac Assurance. It is highly unlikely that Ambac Assurance will be able to



7



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



make dividend payments to Ambac for the foreseeable future. The principal uses of liquidity will be the payment of operating expenses, professional advisory fees incurred in connection with the
bankruptcy and expenses related to pending litigation.

While management believes that Ambac will have sufficient liquidity to
satisfy its needs until it emerges from the bankruptcy proceeding, no guarantee can be given that it will be able to pay all such expenses. If its liquidity runs out prior to emergence from bankruptcy, a liquidation of Ambac pursuant to Chapter 7 of
the Bankruptcy Code will occur. While the Companys net operating losses (NOLs) could be used to offset income of Ambac Assurance realized prior to a completion of a liquidation (and/or by Ambac in the event that a transaction
allocating NOLs to Ambac is completed), the NOLs would not be available following the liquidation or sale of Ambacs assets. As a result, in the event of a Chapter 7 liquidation, the Company is likely to be unable to utilize a substantial
portion of its NOLs.

Chapter 11 Reorganization

As required by the Bankruptcy Code, the United States Trustee appointed the Official Committee of Unsecured Creditors
(Creditors Committee). The Creditors Committee and its legal representatives have a right to be heard on all matters that come before the Bankruptcy Court with respect to the Company. There can be no assurance that the
Creditors Committee will support the Companys positions on matters to be presented to the Bankruptcy Court, including any plan of reorganization. Disagreements between the Company and the Creditors Committee could prolong the court
proceedings, negatively impact the Companys ability to operate, and delay the Companys emergence from bankruptcy.

Ambac will seek to propose a reorganization plan (the Reorganization Plan) as a debtor-in-possession, contingent upon the
outcome of negotiations among Ambac, the Creditors Committee, Ambac Assurance, and Office of the Commissioner of Insurance of the State of Wisconsin (OCI); such reorganization plan may or may not be supported by the Creditors
Committee. There is significant uncertainty as to how holders of Ambacs securities will be treated under the Reorganization Plan. It is likely, however, that Ambacs debt holders and creditors will receive all of the equity in the
reorganized company.

Ambac has and will continue to file various documents with, and provide certain information to, the
Bankruptcy Court, including statements of financial affairs, schedules of assets and liabilities and monthly operating reports in forms prescribed by federal bankruptcy law. While these documents and information accurately provide then-current
information required under federal bankruptcy law, they are nonetheless unconsolidated, unaudited and are prepared in a format different from that used in Ambacs US GAAP basis consolidated financial statements filed under the securities
laws. Accordingly, Ambac believes that the substance and format do not allow meaningful comparison with its publicly-disclosed US GAAP basis consolidated financial statements. Moreover, the materials filed with the Bankruptcy Court are not
prepared for the purpose of providing a basis for an investment decision relating to Ambacs securities, or for comparison with other financial information filed with the SEC.

Shortly after the Petition Date, Ambac began notifying current or potential creditors of the Bankruptcy Filing. Subject to certain
exceptions under the Bankruptcy Code, the Bankruptcy Filing automatically enjoined, or stayed, the continuation of any judicial or administrative proceedings or other actions against Ambac. Thus, for example, most creditor actions to obtain
possession of property from Ambac, or to create, perfect or enforce any lien against the property of Ambac, or to collect on monies owed or otherwise exercise rights or remedies to a claim arising prior to the Petition Date are enjoined unless and
until the Bankruptcy Court lifts the automatic stay. Vendors are being paid for goods furnished and services provided after the Petition Date in the ordinary course of business.



8



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



In order to successfully emerge from bankruptcy, Ambac will need to propose and obtain
confirmation by the Bankruptcy Court of a plan of reorganization that satisfies the requirements of the Bankruptcy Code. A plan of reorganization would, among other things, resolve Ambacs obligations arising prior to the Petition Date, set
forth the revised capital structure of a newly reorganized Ambac and provide for corporate governance subsequent to emergence from bankruptcy. As described above, a plan of reorganization may also resolve the issues with respect to the allocation of
value and expenses as between Ambac and Ambac Assurance which are the subject of negotiations among Ambac, Ambac Assurance, the Creditors Committee and OCI.

Ambac currently has the exclusive right to file a plan of reorganization and, if we did so, 60 additional days to obtain necessary acceptances of the plan. Ambac filed and received Bankruptcy Court
approval to extend its exclusive rights to file a plan of reorganization and obtain necessary acceptances of the plan to and including July 6, 2011 and September 6, 2011, respectively. Further extensions are subject to approval by the
Bankruptcy Court. If Ambacs exclusivity period lapses, any party in interest would be able to file a plan of reorganization for Ambac. In addition to being approved by holders of impaired claims and equity interests, a plan of reorganization
must satisfy certain requirements of the Bankruptcy Code and must be approved, or confirmed by the Bankruptcy Court in order to become effective.

A plan of reorganization will be deemed accepted by holders of claims against and equity interests in Ambac if (1) at least one-half in number and two-thirds in dollar amount of claims actually
voting in each impaired class of claims have voted to accept the plan and (2) at least two-thirds in amount of equity interests actually voting in each impaired class of equity interests has voted to accept the plan. Under certain circumstances
set forth in Section 1129(b) of the Bankruptcy Code, however, the Bankruptcy Court may confirm a plan even if such plan has not been accepted by all impaired classes of claims and equity interests. A class of claims or equity interests that
does not receive or retain any property under the plan on account of such claims or interests is deemed to have voted to reject the plan. The precise requirements and evidentiary showing for confirming a plan, notwithstanding its rejection by one or
more impaired classes of claims or equity interests, depends upon a number of factors, including, without limitation, the status and seniority of the claims or equity interests in the rejecting class (i.e., secured claims or unsecured claims,
subordinate or senior claims, preferred or common stock). Generally, with respect to common stock interests, a plan may be crammed down even if the stockholders receive no recovery if the proponent of the plan demonstrates that
(1) no class junior to the common stock is receiving or retaining property under the plan and (2) no class of claims or interests senior to the common stock is being paid more than in full.

A significant consideration for any restructuring or reorganization is the impact, if any, on Ambacs estimated $7,200,000 net
operating loss tax carry forward. Ambac considers the NOLs to be a valuable asset. However, Ambacs ability to use the NOLs could be substantially limited if there were an ownership change as defined under Section 382 of the
Internal Revenue Code of 1986, as amended. In general, an ownership change would occur if shareholders owning 5% or more of Ambacs stock increased their percentage ownership (by value) in Ambac to 50% or more, as measured over a rolling three
year period beginning with the last ownership change. These provisions can be triggered by new issuances of stock, merger and acquisition activity or normal market trading. On February 2, 2010, Ambac entered into a Tax Benefit Preservation Plan
to reduce the risk of an ownership change resulting from the trading of Ambacs stock.

Segregated Account

Pursuant to the Plan of Operation for the Segregated Account, Ambac Assurance has allocated to the Segregated Account
(1) certain policies insuring or relating to credit default swaps; (2) residential mortgage-backed securities (RMBS) policies; (3) certain Student Loan Policies; and (4) other policies insuring obligations with
substantial projected impairments or relating to transactions which have



9



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



contractual triggers based upon Ambac Assurances financial condition or the commencement of rehabilitation, which triggers are potentially damaging (collectively, the Segregated
Account Policies). The policies described in (4) above include (a) certain types of securitizations, including commercial asset-backed transactions, consumer asset-backed transactions and other types of structured transactions;
(b) the policies relating to Las Vegas Monorail Company; (c) policies relating to debt securities purchased by, and the debt securities issued by, Juneau Investments, LLC and Aleutian Investments, LLC, which are both finance companies
owned by Ambac Assurance; (d) policies relating to leveraged lease transactions; and (e) policies relating to interest rate, basis, and/or currency swap or other swap transactions. Claims on Segregated Account Policies remain subject to a
payment moratorium until the Segregated Account Rehabilitation Plan (as defined below) becomes effective. Insurance claims presented during the moratorium of $1,768,706 for policies allocated to the Segregated Account have not yet been paid. Net par
exposure as of March 31, 2011 for policies allocated to the Segregated Account is $42,004,626. Ambac Assurance also allocated the following to the Segregated Account: (i) all remediation claims, defenses, offsets, and/or credits (except
with respect to recoveries arising from remediation efforts or reimbursement or collection rights), if any, in respect of the Segregated Account Policies, (ii) Ambac Assurances disputed contingent liability under the recently settled
long-term lease with One State Street, LLC (OSS), and its contingent liability (as guarantor), if any, under the recently terminated Ambac Assurance UK Limited (Ambac UK) lease with British Land, (iii) Ambac
Assurances limited liability interests in Ambac Credit Products, LLC (ACP), Ambac Conduit Funding LLC, Aleutian Investments, LLC (Aleutian) and Juneau Investments, LLC (Juneau) and (iv) all of Ambac
Assurances liabilities as reinsurer under reinsurance agreements (except for reinsurance assumed from Everspan). Effective November 7, 2010, the Plan of Operation for the Segregated Account was amended for the purpose of allocating to the
Segregated Account (i) any and all liabilities (including contingent liabilities) it has or may have, now or in the future, to Ambac, or any successor to Ambac, in regard to, or respecting, tax refunds and/or the July 18, 1991 Tax Sharing
Agreement, as amended (other than any liability to Ambac pertaining to any possible misallocation of up to $38,486 of tax refunds received by Ambac Assurance in September 2009 and February 2010), (ii) any and all liabilities (including
contingent liabilities) it has or may have, now or in the future, to the IRS and/or the United States Department of the Treasury (the U.S. Treasury) in regard to, or in respect of, taxes imposed under the Internal Revenue Code of 1986,
as amended (the Federal Taxes), for taxable periods ending on or prior to December 31, 2009 and, (iii) to the extent not described in clause (ii), any and all liabilities (including contingent liabilities) Ambac Assurance has
or may have, now or in the future, to the IRS and/or the U.S. Treasury in regard to, or respect of, any Federal Tax refunds that were received prior to November 7, 2010 by Ambac Assurance, Ambac or their affiliates (each of clauses (i),
(ii) and (iii), the Allocated Disputed Contingent Liabilities). In addition, on November 8, 2010, the rehabilitation court issued an order for temporary supplemental injunctive relief (the State Court Injunction)
enjoining Ambac, any successor-in-interest, any state court receiver of Ambac, all persons purporting to be creditors of Ambac, the IRS and all other federal and state governmental entities from commencing or prosecuting any actions, claims,
lawsuits or other formal legal proceedings relating to the Allocated Disputed Contingent Liabilities.

On October 8,
2010, the rehabilitator filed a plan of rehabilitation for the Segregated Account (the Segregated Account Rehabilitation Plan) in the Dane County Circuit Court in Wisconsin (the Rehabilitation Court). The Rehabilitation Court
confirmed the Segregated Account Rehabilitation Plan on January 24, 2011. The effective date of the Segregated Account Rehabilitation Plan will be determined by the rehabilitator. Under the confirmed Segregated Account Rehabilitation Plan,
holders of permitted policy claims will receive 25% of their permitted claims in cash and 75% in Segregated Account Surplus Notes, and delivery of such cash and Segregated Account Surplus Notes will constitute satisfaction under the Segregated
Account Rehabilitation Plan in full of the Segregated Accounts obligations in respect of each claim. The policyholders will not have the option to reject the surplus notes as consideration for settling claim liabilities. The Segregated Account
Rehabilitation Plan also makes permanent the injunctions issued by the Rehabilitation Court on March 24, 2010.

Policy
obligations not transferred to the Segregated Account remain in the General Account, and such policies in the General Account are not subject to and, therefore, will not be directly impacted by the Segregated Account Rehabilitation Plan. Ambac
Assurance is not, itself, in rehabilitation proceedings.



10



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The issuance of surplus notes by both Ambac Assurance and the Segregated Account as
contemplated by the rehabilitation plan could subject Ambac Assurance to the risk of deconsolidation from Ambac for tax purposes or having to recognize significant cancellation of indebtedness income (CODI). Deconsolidation or the
recognition of substantial CODI would likely have a material adverse effect on the financial condition of Ambac Assurance and the Segregated Account. As such, the rehabilitator is considering substantial amendments to the rehabilitation plan and/or
the initiation of rehabilitation proceedings with respect to Ambac Assurance. Such amendments to the rehabilitation plan (and, presumably, any rehabilitation plan with respect to Ambac Assurance) could include the elimination of the issuance of
surplus notes by the Segregated Account and/or the imposition of transfer restrictions on any surplus notes issued by the Segregated Account. Any such amendments to the rehabilitation plan could adversely affect the interests of Ambac security
holders and holders of securities insured by Ambac Assurance as such amendments could reduce the likelihood of consummation of an agreement between Ambac and Ambac Assurance with respect to the ongoing term sheet negotiations. The parties
failure to consummate such a transaction increases the likelihood that Ambacs bankruptcy case will convert to a Chapter 7 liquidation proceeding, with attendant adverse consequences to Ambac security holders and holders of securities insured
by Ambac Assurance (including, without limitation, the loss of NOLs).

In March 2011, the Segregated Account issued Segregated
Account Surplus Notes with a par value of $3,000 in connection with the commutation of insurance policies allocated to the Segregated Account. At March 31, 2011, these Segregated Account Surplus Notes are reported in long-term debt on the
consolidated balance sheet with a carrying value of $655 based on an imputed interest rate of 30.9% at the date of issuance and have a scheduled maturity of June 7, 2020.Interest on the Segregated Account Surplus Notes is payable
annually in June at the rate of 5.1% on the unpaid principal balance outstanding. All payments of principal and interest on the Segregated Account Surplus Notes are subject to the prior approval of the OCI. If the OCI does not approve the payment of
interest on the Segregated Account Surplus Notes, such interest will accrue and compound annually until paid. The Segregated Account Surplus Notes were issued pursuant to a fiscal agency agreement entered into with The Bank of New York Mellon, as
fiscal agent.

On March 1, 2011, Ambac, Ambac Assurance, the Segregated Account of Ambac Assurance Corporation and One
State Street LLC (OSS) entered into a settlement agreement (the Settlement Agreement) to terminate the Companys existing headquarters office lease with OSS (the Existing Lease) and agree to settle all claims
among the parties relating to the Existing Lease. On March 1, 2011, Ambac Assurance also entered into a new lease (the New AAC Lease) with OSS for an initial term commencing on the Effective Date (as defined below) through
December 31, 2015. The New AAC Lease provides for the rental of a reduced amount of space at the Companys current location, One State Street Plaza. The Settlement Agreement also provides that OSS will have an allowed general unsecured
claim in Ambacs bankruptcy case for the amount that the Company would owe OSS under the U.S. Bankruptcy Code upon rejection of the existing lease, which amount will be determined on the Effective Date but will not exceed $14.3 million (the
AFG Payment). The AFG Payment will be made by the Company in the same form as payment is made to the Companys other creditors. The Settlement Agreement further provides that the Segregated Account will issue junior surplus notes to
OSS. Junior surplus are subordinate to Segregate Account Surplus Notes. The amount of the junior surplus notes will be determined on the Effective Date and will equal: (i) the net present value, using a 7% discount rate (NPV), of
certain amounts owed under the Existing Lease; minus (ii) the NPV of amounts owed under the New AAC Lease; minus (iii) 83.33% of the value of any distribution received by OSS from the Companys bankruptcy estate; minus (iv) the
NPV of amounts paid for any extension of term of the New AAC Lease. The Effective Date will occur on the date on which certain conditions have been satisfied, so long as such events occur prior to June 30, 2011, including, without limitation,
approval of the Settlement Agreement by (i) the rehabilitator for the Segregated Account, (ii) the Wisconsin rehabilitation court, (iii) the bankruptcy court in the Companys bankruptcy, (iv) OCI and (v) OSSs
mortgage holder.

Reclassifications:

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



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



(2) Debtor in Possession Financial Information

Liabilities Subject to Compromise

As required by ASC Topic 852, the amount of the Liabilities subject to compromise represents our estimate of known or potential pre-petition and post-petition claims to be addressed in connection with the
Bankruptcy Filing. Such claims are subject to future adjustments. Adjustments may result from, among other things, negotiations with creditors, rejection of executory contracts and unexpired leases and orders of the Bankruptcy Court. The Liabilities
subject to compromise in the Consolidated Balance Sheet consists of the following at March 31, 2011:



|                                                |  |                |           |  |                   |   |           | 
|----------------------------------------------- |  | -------------- | --------- |  | ----------------- | - | --------- | 
|                                                |  | March 31, 2011 |           |  | December 31, 2010 |  
|Accrued interest payable                        |  | $              | 68,091    |  |                   | $ | 68,091    | 
|Other                                           |  |                | 18,206    |  |                   |   | 4,951     | 
|Senior unsecured notes                          |  |                | 1,222,189 |  |                   |   | 1,222,189 | 
|Directly-issued Subordinated capital securities |  |                | 400,000   |  |                   |   | 400,000   | 
|                                                |  |                |           |  |                   |   |           | 
|Consolidated liabilities subject to compromise  |  |                | 1,708,486 |  |                   |   | 1,695.231 | 
|Payable to non-debtor subsidiaries              |  |                | 1,652     |  |                   |   | 1,657     | 
|                                                |  |                |           |  |                   |   |           | 
|Debtors Liabilities subject to compromise      |  | $              | 1,710,138 |  |                   | $ | 1,696,888 | 
|                                                |  |                |           |  |                   |   |           | 

Reorganization Items

Professional advisory fees and other costs directly associated with our reorganization are reported separately as reorganization items pursuant to ASC Topic 852. Reorganization items also include
adjustments to reflect the carrying value of certain pre-petition liabilities at their estimated allowable claim amounts. The reorganization items in the Consolidated Statement of Operations for the three months ended March 31, 2011 consisted
of the following items:



|                           |  |   |        | 
|-------------------------- |  | - | ------ | 
|U.S. Trustee fees          |  | $ | 5      | 
|Professional fees          |  |   | 10,498 | 
|Lease settlement           |  |   | 14,302 | 
|                           |  |   |        | 
|Total reorganization items |  | $ | 24,805 | 
|                           |  |   |        | 

Refer to Note 1 to the Unaudited Consolidated Financial Statements for further discussion of the office
lease settlement.

(3) Net income per Share

ASC Paragraph 260-10-65-2 of ASC Topic 260, Earnings Per Share, effective for fiscal years beginning after December 15, 2008, clarified that unvested share-based payment awards that contain
nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method. Ambac had participating securities consisting of
nonvested common stock with the same voting and dividend rights as our common stock. These shares of common stock all vested in January 2010. Basic net income per share is computed by dividing net income available to common stockholders by the
weighted-average number of common shares outstanding. Ambac was in a net loss position; consequently, no income or loss was allocated to participating securities during the three months ended March 31, 2010.

Common shares outstanding includes common stock issued less treasury shares plus restricted stock units for which no future service is
required as a condition to the delivery of the underlying



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



common stock. Diluted net income per share is computed by dividing net income attributable to common stockholders by the weighted-average number of common shares outstanding plus all dilutive
potential common shares outstanding during the period. All dilutive potential common shares outstanding consider common stock deliverable pursuant to stock options, nonvested restricted stock units, nonvested common shares, and stock purchase
contracts. There were no dilutive effects for the three months ended March 31, 2011 and 2010. The following table presents securities outstanding that could potentially dilute basic EPS in the future that were not included in the computation of
diluted EPS because they were antidilutive for the periods ended March 31, 2011 and 2010:



|                           |  |                |           |  |                |  |            | 
|-------------------------- |  | -------------- | --------- |  | -------------- |  | ---------- | 
|                           |  | March 31, 2011 |           |  | March 31, 2010 | 
|Stock options              |  |                | 1,786,031 |  |                |  | 2,973,685  | 
|Restricted stock and units |  |                | 469,896   |  |                |  | 2,423,464  | 
|Stock purchase contracts   |  |                |          |  |                |  | 37,037,000 | 

In March 2008, Ambac
issued 5,000,000 Corporate Units. Each Corporate Unit had a stated amount of $50 and initially consisted of (a) a Purchase Contract on Ambac common stock issued by Ambac and (b) a 5% beneficial ownership interest in $1,000 principal amount
of 9.50% Senior Notes due 2021, to be held by the Collateral Agent to secure the performance of the Holders obligations under the Purchase Contract.

As discussed in Note 1, on November 8, 2010, Ambac filed a petition for relief under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court. Pursuant to the Purchase Contract Agreement the filing
of the bankruptcy case constituted a termination event. As a result, the Purchase Contracts were terminated and the Corporate Units thereafter represented the rights of the Holders to receive their applicable ownership interests in the $250,000,000
Senior Notes. On November 16, 2010, Ambac filed a motion seeking an order approving the termination of the Purchase Contracts and the release of the Senior Notes. On November 30, 2010, the Bankruptcy Court approved the motion.
Consequently, at March 31, 2011, no Purchase Contracts are outstanding.



13



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



(4) Special Purposes Entities, Including Variable Interest Entities

Ambac has engaged in transactions with special purpose entities, including VIEs, in various capacities. Ambac has provided financial
guarantees, including credit derivative contracts for various debt obligations issued by various entities, including VIEs. Ambac has also sponsored two special purpose entities that issued medium-term notes to fund the purchase of certain financial
assets. Finally, Ambac is an investor in collateralized debt obligations, mortgage-backed and other asset-backed securities issued by VIEs and its ownership interest is generally insignificant to the VIE and/or Ambac does not have rights that direct
the activities that are most significant to such VIE.

Financial Guarantees:

Ambac has provided 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 debt obligations guaranteed by Ambac
Assurance), the structure allows the transaction to experience defaults among the securitized assets before a default is experienced on the debt 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. Generally, upon deterioration in the performance of a transaction or upon an event of default as specified in the transaction legal documents, Ambac will obtain
certain loss remediation rights. These rights enable Ambac to direct the activities of the entity that most significantly impact the entitys economic performance.

We determined that Ambac generally has the obligation to absorb the VIEs expected losses given that we have issued financial guarantees supporting the liabilities (and in certain cases assets) of a
VIE. We also determined for certain transactions that experienced the aforementioned performance deterioration, that we had the power, through voting rights or similar rights, to direct the activities of certain VIEs that most significantly impact
the VIEs economic performance because: a) certain triggers had been breached in these transactions resulting in Ambac having the ability to exercise certain loss remediation activities, or b) due to the passive nature of the VIEs
activities, Ambacs contingent loss remediation rights upon a breach of certain triggers in the future is considered to be the power to direct the activities that most significantly impact the VIEs economic performance.

Ambac Sponsored VIEs:

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 special purpose entities are legal entities that are demonstrably distinct from Ambac. Ambac, its affiliates or its agents cannot unilaterally dissolve these entities. The permitted activities of these entities are limited to
those outlined below. As a result of the adoptions of both ASU-2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of Financial Assets and ASU 2009-17,Consolidations (Topic 810): Improvements to Financial Reporting by
Enterprise Involved with Variable Interest Entities on January 1, 2010, Ambac was required to consolidate these VIEs on January 1, 2010.



14



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



As a result of the Rehabilitation Proceedings of the Segregated Account on March 24, 2010, Ambac was required to deconsolidate these entities because Ambacs policies issued to these
entities have been allocated to the Segregated Account. The consolidation of these entities did not have any effects on Ambacs beginning retained earnings as these entities were accounted for at fair value before initial consolidation. Prior
to 2010 and upon deconsolidation, Ambac has elected to account for its equity interest in these entities at fair value under the fair value option in accordance with ASC Topic 825, Financial Instruments. We believe that the fair value of the
investments in these entities provides for greater transparency for recording profit or loss as compared to the equity method under ASC Topic 323, Investments  Equity Method in Joint Ventures. At March 31, 2011 and
December 31, 2010 the fair value of these entities is $19,005 and $17,909, respectively and is reported within Other Assets within the Consolidated Balance Sheets. The change in fair value of these entities for the three months ended
March 31, 2011 and March 31, 2010 is $1,096 and ($1,917), respectively. For the three months ended March 31, 2011 income from these entities is included within Financial Guarantee: Other income (loss) on the Consolidated Statement of
Operations. For the three months ended March 31, 2010, while the entities were consolidated, income was included in Financial Guarantee: Loss on variable interest entities on the Consolidated Statements of Operations.

As of March 31, 2011 there have been 15 individual transactions with these entities, of which 5 are outstanding. Total principal
amount of debt outstanding was $571,136 at March 31, 2011. In each case, Ambac sold assets to these entities. The assets are composed of asset-backed securities and utility obligations with a weighted average rating of BBB+ and weighted average
life of 8.9 years at March 31, 2011. The purchase by these entities is financed through the issuance of medium-term notes (MTNs), which are cross-collateralized by the purchased assets. The MTNs have the same expected weighted
average life as the purchased assets. Derivative contracts (interest rate swaps) are used within the entities for economic hedging purposes only. Hedges are established at the time MTNs are issued to purchase financial assets. The activities of
these entities are contractually limited to purchasing assets from Ambac, issuing MTNs to fund such purchase, executing derivative hedges and obtaining financial guarantee policies with respect to indebtedness incurred. As of March 31, 2011
Ambac Assurance had financial guarantee insurance policies issued for all assets, MTNs and derivative contracts owned and outstanding by the entities.

Insurance premiums paid to Ambac Assurance by these entities are earned in a manner consistent with other insurance policies, over the risk period. Additionally, any losses incurred on such insurance
policies are 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.

There were no assets sold to these entities during the three months ended March 31, 2011 and 2010,
respectively. Ambac Assurance earned premiums for issuing the financial guarantee policies on the assets, MTNs and derivative contracts of $235 and $721 for the three months ended March 31, 2011 and 2010, respectively. Ambac paid claims to
these entities of $0 and $24,411 for the three months ended March 31, 2011 and 2010, respectively, under these financial guarantee contracts. Ambac also earned fees for providing other services amounting to $11 and $23 for the three months
ended March 31, 2011 and 2010, respectively.

Derivative contracts are provided by Ambac Financial Services to these
entities. Consistent with other non-hedging derivatives, Ambac Financial Services accounts for these contracts on a trade date basis at fair value. Ambac Financial Services paid $131, and received $1,149, for the three months ended March 31,
2011 and 2010, respectively, under these derivative contracts.



15



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



Consolidation of VIEs:

Except for consolidations resulting from the adoption of ASU 2009-17 on January 1, 2010, upon initial consolidation of a VIE, we
recognize a gain or loss in earnings for the difference between: a) the fair value of the consideration paid, the fair value of any non-controlling interests and the reported amount of any previously held interests and b) the net amount as measured
on a fair value basis, of the assets and liabilities consolidated. Upon deconsolidation of a VIE, we recognize a gain or loss for the difference between: a) the fair value of any consideration received, the fair value of any retained non-controlling
investment in the VIE and the carrying amount of any non-controlling interest in the VIE and b) the carrying amount of the VIEs assets and liabilities. Gains or losses from consolidation and deconsolidation that are reported in earnings are
reported within Financial Guarantee: Loss on variable interest entities.

Upon the adoption of ASU 2009-17, Ambac generally
measured the assets and liabilities of newly consolidated VIEs at fair value, as the carrying amount transition method was not practical. The carrying amount transition method (whereby assets, liabilities, and non-controlling interests of the VIE
are recorded in amounts that would have been carried in the consolidated financial statements if ASU 2009-17 had been effective when Ambac first met the conditions to be the primary beneficiary) was used for one VIE. Ambac has elected to account for
the assets and liabilities of the VIEs which were consolidated at fair value under the fair value option in accordance with ASC Topic 825, Financial Instrumentsin subsequent periods. The fair value option is elected to allow for consistency
in the measurement attributes of assets and liabilities of these VIEs. For VIEs where the assets, liabilities, and non-controlling interests were measured at initial consolidation under the carrying amount transition method, balances continue to be
measured and reported based on other applicable GAAP guidance.

Impact of ASU 2009-17 and ASU 2009-16

As a result of adopting ASU 2009-17, a cumulative effect gain adjustment of $705,046 was recorded as a net increase
to total equity as of January 1, 2010, which includes changes to the opening balance of retained earnings and accumulated other comprehensive loss, net of taxes as Ambac was required to consolidate 83 additional VIEs. The types of entities that
Ambac was required to consolidate included: (i) RMBS securitization trusts as a result of financial guarantee insurance policies on the senior debt of such trusts; (ii) collateralized debt obligation trusts as a result of credit derivative
contracts issued to investors of the debt of such trust; (iii) international and other asset-backed securitizations as a result of insurance policies guarantying the debt of such financing entities; and (iv) other transactions, including
the Ambac sponsored special purpose entities, Juneau and Aleutian. The net impact of consolidating these VIEs on Ambacs balance sheet at adoption of ASU 2009-17 and ASU 2009-16 was as follows:



| |  |  | Ambac was required to recognize the assets and liabilities of the VIE. The aggregate amount of the VIE assets and liabilities recorded upon adoption
were generally recognized at fair value as described above.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For a financial guarantee policy issued to a consolidated VIE, Ambac does not reflect the financial guarantee insurance policy in accordance with the
related insurance accounting rules under ASC Topic 944, Financial ServicesInsurance. The financial guarantee policy would be eliminated upon consolidation. Consequently, Ambac eliminated insurance assets (premium receivables,
reinsurance recoverables, deferred ceded premium, subrogation recoverable and deferred acquisition costs) and insurance liabilities (unearned premiums, loss and loss expense reserves and ceded premiums payable) from the Consolidated Balance Sheet.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For VIEs consolidated as a result of Ambacs credit derivative transactions, the consolidation results in offsetting increases to assets and
liabilities with no transition effect. The credit derivative liabilities remained on Ambacs consolidated financial statements and were not eliminated upon the consolidation of the VIE because Ambacs credit derivative contracts are
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



| | not entered into directly with the VIE, but rather entered into with third parties, typically the holders of the notes issued by the VIEs.
| | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For investment securities owned by Ambac that are debt instruments issued by the VIE, the investment securities balance is eliminated upon
consolidation.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------

The impact of the above items upon adoption of ASU 2009-17 and ASU 2009-16 on
January 1, 2010 is summarized below:



|                                                    |  |   |             |  
|--------------------------------------------------- |  | - | ----------- | -
|Addition of VIE assets                              |  | $ | 23,112,303  |  
|Addition of VIE liabilities                         |  |   | (22,798,176 | )
|                                                    |  |   |             |  
|Net VIE assets added upon adoption                  |  |   | 314,127     |  
|                                                    |  |   |             |  
|Elimination of insurance assets                     |  |   | (833,716    | )
|Elimination of insurance liabilities                |  |   | 1,269,477   |  
|                                                    |  |   |             |  
|Net insurance liabilities eliminated upon adoption  |  |   | 435,761     |  
|                                                    |  |   |             |  
|Elimination of intercompany invested assets         |  |   | (44,842     | )
|                                                    |  |   |             |  
|Net decrease of Shareholders deficit upon adoption |  | $ | 705,046     |  
|                                                    |  |   |             |  

As a result of the establishment of the Segregated Account and the rehabilitation proceedings with respect
to the Segregated Account, including the terms of the management agreement which permit OCI to terminate the agreement with Ambac at any point in time, Ambac no longer has the unilateral power to direct the activities of the VIEs that most
significantly impact the entitys economic performance for those insurance policies that were allocated to the Segregated Account. Accordingly, Ambac deconsolidated 49 VIEs, including 43 RMBS securitization trusts and certain other entities
including the Ambac sponsored VIEs, Juneau and Aluetian, effective March 24, 2010. Juneau and Aleutian are related parties of Ambac. While the RMBS securitization and other trusts are not related parties of Ambac, the company continues to
provide financial guarantee policies on the senior debt or assets of such trusts upon deconsolidation. The effect of this deconsolidation was to reverse a significant portion of the transition adjustment to adopt ASU 2009-17 on January 1, 2010
and to deconsolidate one additional VIE which was consolidated as of December 31, 2009, effectively re-establishing insurance accounting for such transactions. Financial Guarantee: Loss on variable interest entities included losses of $8,422
and $495,077 for the three month periods ended March 31, 2011 and 2010, respectively, related to VIEs that were no longer consolidated as of the end the respective periods. The losses on these VIEs is primarily a result of deconsolidation,
including for 2010 the deconsolidation of transactions allocated to the Segregated Account as discussed above, as the carrying value of the re-established net insurance liabilities exceeded the net liabilities of the VIEs which were carried at fair
value in consolidation.

As of March 31, 2011, consolidated VIE assets and liabilities relating to 18 consolidated
entities were $16,175,837 and $15,957,652, respectively. As of December 31, 2010, consolidated VIE assets and liabilities relating to 19 consolidated entities were $17,930,829 and $17,696,445, respectively. Ambac is not primarily liable for the
debt obligations issued by the VIEs. Ambac would only be required to make payments on these debt obligations in the event that the issuer of such debt obligations defaults on any principal or interest due. Additionally, Ambacs creditors do not
have rights with regard to the assets of the VIEs. Ambac evaluates the net income statement effects and earnings per share effects to determine attributions between Ambac and non-controlling interests as a result of consolidating a VIE. Ambac has
determined that the net changes in fair value of most consolidated VIE assets and liabilities are attributable to Ambac due to Ambacs interest through financial guarantee premium and loss payments with the VIE.

The financial reports of certain VIEs 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 certain VIEs are consolidated on a time lag that is no longer than 90 days.



17



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The table below provides the fair value of fixed income securities, by asset-type, held
by consolidated VIEs as of March 31, 2011 and December 31, 2010:



|                                                               |  |                |           |  |                   |   |           | 
|-------------------------------------------------------------- |  | -------------- | --------- |  | ----------------- | - | --------- | 
|                                                               |  | March 31, 2011 |           |  | December 31, 2010 |  
|Investments:                                                   |  |                |           |  |                   |   |           | 
|Corporate obligations                                          |  | $              | 1,929,691 |  |                   | $ | 1,904,361 | 
|                                                               |  |                |           |  |                   |   |           | 
|Total Variable interest entity assets: Fixed income securities |  | $              | 1,929,691 |  |                   | $ | 1,904,361 | 
|                                                               |  |                |           |  |                   |   |           | 

The following table provides supplemental information about the loans held as assets and long-term debt
associated with the VIEs for which the fair value option has been elected as of March 31, 2011 and December 31, 2010:



|                   |  |                      |            |  |                          |   |            | 
|------------------ |  | -------------------- | ---------- |  | ------------------------ | - | ---------- | 
|                   |  | Estimated 
fairvalue |            |  | Unpaid 
principalbalance |  
|March 31, 2011:    |  |                      |            |  |                          |   |            | 
|Loans              |  | $                    | 14,029,346 |  |                          | $ | 14,451,581 | 
|Long-term debt     |  | $                    | 14,516,870 |  |                          | $ | 15,898,389 | 
|                   |  |                     
|December 31, 2010: |  |                      |            |  |                          |   |            | 
|Loans              |  | $                    | 15,800,918 |  |                          | $ | 16,750,029 | 
|Long-term debt     |  | $                    | 15,885,711 |  |                          | $ | 18,156,968 | 

Variable
Interests in Non-Consolidated VIEs

The following table displays the carrying amount of the assets, liabilities and
maximum exposure to loss of Ambacs variable interests in non-consolidated VIEs resulting from financial guarantee and credit derivative contracts by major underlying asset classes, considering the consolidation guidance for each period, as of
March 31, 2011:



|                                |  |                                          |             |  |                    |   |           |                         |  |   |                          |  |  |   |         | 
|------------------------------- |  | ---------------------------------------- | ----------- |  | ------------------ | - | --------- | ----------------------- |  | - | ------------------------ |  |  | - | ------- | 
|                                |  | Carrying Value of Assets and Liabilities |            
|                                |  | MaximumExposure
ToLoss(1)                |             |  | InsuranceAssets(2) |   |           | InsuranceLiabilities(3) |  |   | DerivativeLiabilities(4) | 
|March 31, 2011:                 |  |                                          |             |  |                    |   |           |                         |  |   |                          |  |  |   |         | 
|Global Structured Finance:      |  |                                          |             |  |                    |   |           |                         |  |   |                          |  |  |   |         | 
|Collateralized debt obligations |  | $                                        | 19,209,590  |  |                    | $ | 21,691    |                         |  | $ | 110,286                  |  |  | $ | 180,158 | 
|Mortgage-backed  residential   |  |                                          | 34,322,796  |  |                    |   | 1,046,998 |                         |  |   | 4,917,212                |  |  |   |        | 
|Mortgage-backed  commercial    |  |                                          | 943,434     |  |                    |   |          |                         |  |   |                         |  |  |   | 6,752   | 
|Other consumer asset-backed     |  |                                          | 12,236,113  |  |                    |   | 167,227   |                         |  |   | 1,122,189                |  |  |   | 22,561  | 
|Other commercial asset-backed   |  |                                          | 18,401,353  |  |                    |   | 668,517   |                         |  |   | 661,489                  |  |  |   | 5,639   | 
|Other                           |  |                                          | 7,901,500   |  |                    |   | 121,003   |                         |  |   | 549,253                  |  |  |   | 2,500   | 
|                                |  |                                          |             |  |                    |   |           |                         |  |   |                          |  |  |   |         | 
|Total Global Structured Finance |  |                                          | 93,014,786  |  |                    |   | 2,025,436 |                         |  |   | 7,360,429                |  |  |   | 217,610 | 
|Global Public Finance           |  |                                          | 41,596,432  |  |                    |   | 633,641   |                         |  |   | 758,414                  |  |  |   | 11,208  | 
|                                |  |                                          |             |  |                    |   |           |                         |  |   |                          |  |  |   |         | 
|Total                           |  | $                                        | 134,611,218 |  |                    | $ | 2,659,077 |                         |  | $ | 8,118,843                |  |  | $ | 228,818 | 
|                                |  |                                          |             |  |                    |   |           |                         |  |   |                          |  |  |   |         | 



|(1) | Maximum exposure to loss represents the gross maximum future payments of principal and interest on insured obligations and credit derivative contracts. Ambacs
maximum exposure to loss does not include the benefit of any financial instruments (such as reinsurance or hedge contracts) that Ambac may utilize to mitigate the risks associated with these variable interests.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



|(2) | Insurance assets represents the amount recorded in Premium receivables and Subrogation recoverable for financial guarantee contracts on
Ambacs Consolidated Balance Sheets.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Insurance liabilities represents the amount recorded in Losses and loss expense reserve and Unearned premiums for financial guarantee contracts
on Ambacs Consolidated Balance Sheets.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Derivative liabilities represents the fair value recognized on credit derivative contracts on Ambacs Consolidated Balance Sheets.
|--- | ----------------------------------------------------------------------------------------------------------------------------------

(5) Net Premiums Earned

Gross premiums are received either upfront (typical of public finance obligations) or in installments (typical of structured finance
obligations). For premiums received upfront, an unearned premium revenue (UPR) liability is established, which is initially recorded as the cash amount received. For installment premium transactions, a premium receivable asset and
offsetting UPR liability is initially established in an amount equal to: (i) the present value of future contractual premiums due (the contractual method) or, (ii) if the underlying insured obligation is a homogenous pool of
assets which are contractually prepayable (the expected method), the present value of premiums to be collected over the expected life of the transaction. An appropriate risk-free rate corresponding to the weighted average life of each
policy and exposure currency is used to discount the future premiums contractually due or expected to be collected. For example, U.S. dollar exposures are discounted using U.S. Treasury rates while exposures denominated in a foreign currency are
discounted using the appropriate risk-free rate for the respective currency. The weighted average risk-free rate and weighted average period of future premiums used to estimate the premium receivable at March 31, 2011 and December 31, 2010
is 3.4% and 3.1%, and 10.8 years and 10.4 years, respectively. Insured obligations consisting of homogeneous pools for which Ambac uses expected future premiums to estimate the premium receivable and UPR include residential mortgage-backed
securities and consumer auto loans. As prepayment assumptions change for homogenous pool transactions, or if there is an actual prepayment for a contractual method installment transaction, the related premium receivable and UPR are
adjusted in equal and offsetting amounts with no immediate effect on earnings using new premium cash flows and the then current risk free rate.

Generally, the priority for the payment of financial guarantee premiums to Ambac, as required by the bond indentures of the insured obligations, is very senior in the waterfall. Additionally, in
connection with the allocation of certain liabilities to the Segregated Account, trustees are required under the Rehabilitation Plan to continue to pay installment premiums, notwithstanding the claims moratorium. As such, Ambac has not historically
written off any meaningful amount of uncollectible premiums. In evaluating the credit quality of the premiums receivable, management evaluates the internal ratings of the transactions underlying the premiums receivable. As of March 31, 2011 and
December 31, 2010, approximately 31% and 29% of the premiums receivable related to transactions with non-investment grade internal ratings, comprised mainly of non-investment grade MBS and student loan transactions, which comprised 10% and 11%,
and 9% and 11% of the total premiums receivable at March 31, 2011 and December 31, 2010, respectively.

For both
upfront and installment premium policies, premium revenues are earned over the life of the financial guarantee contract in proportion to the insured principal amount outstanding at each reporting date (referred to as the level-yield method). For
installment paying policies, the premium receivable discount, equating to the difference between the undiscounted future installment premiums and the present value of future installment premiums, is accreted as premiums earned in proportion to the
premium receivable balance at each reporting date. Because the premium receivable discount and UPR are being accreted into income using different rates, the total premiums earned as a percentage of insured principal is higher in the earlier years
and lower in the later years for an installment premium transaction as compared to an upfront premium transaction.



19



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



Below is the premium receivable roll-forward for the period ended March 31, 2011
and December 31, 2010:



|                                                                                        |  |               |           |   |                  |   |           |  
|--------------------------------------------------------------------------------------- |  | ------------- | --------- | - | ---------------- | - | --------- | -
|                                                                                        |  | March 31,2011 |           |   | December 31,2010 |  
|Premium receivable at December 31, 2009                                                 |  |               |           |   |                  | $ | 3,718,158 |  
|Impact of adoption of ASU 2009-17(1)                                                    |  |               |           |   |                  |   | (670,997  | )
|                                                                                        |  |               |           |   |                  |   |           |  
|Premium receivable at January 1, 2011 and 2010                                          |  | $             | 2,422,596 |   |                  |   | 3,047,161 |  
|Premium payments received                                                               |  |               | (51,927   | ) |                  |   | (266,028  | )
|Adjustments for changes in expected life of homogeneous pools or contractual cash flows |  |               | (178,842  | ) |                  |   | (577,626  | )
|Accretion of premium receivable discount                                                |  |               | 18,820    |   |                  |   | 84,567    |  
|Deconsolidation of certain VIEs(1)                                                      |  |               | 60,735    |   |                  |   | 173,511   |  
|Other adjustments (including foreign exchange)                                          |  |               | 19,538    |   |                  |   | (38,989   | )
|                                                                                        |  |               |           |   |                  |   |           |  
|Premium receivable at March 31, 2011 and December 31, 2010                              |  | $             | 2,290,920 |   |                  | $ | 2,422,596 |  
|                                                                                        |  |               |           |   |                  |   |           |  



|(1) | Refer to Note 4 to the Unaudited Consolidated Financial Statements for discussion of the consolidation standard.
|--- | ----------------------------------------------------------------------------------------------------------------

Similar to gross premiums, premiums ceded to reinsurers are paid either upfront or in installments. For premiums paid upfront, a deferred
ceded premium asset is established which is initially recorded as the cash amount paid. For installment premiums, a ceded installment premiums payable liability and offsetting deferred ceded premium asset are initially established in an amount equal
to: i) the present value of future contractual premiums due or, ii) if the underlying insured obligation is a homogenous pool of assets which are contractually prepayable, the present value of premiums to be paid over the life of the transaction. An
appropriate risk-free rate corresponding to the weighted average life of each policy and exposure currency is used to discount the future premiums contractually due or expected to be collected. 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 as the related gross premium
revenue is recognized. For premiums paid to reinsurers on an installment basis, Ambac records the present value of future ceding commissions as an offset to ceded premiums payable, using the same assumptions noted above for installment premiums. The
ceding commission revenue associated with the ceding premiums payable is deferred (as an offset to deferred acquisition cost) and recognized in income in proportion to ceded premiums.



20



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The table below summarizes the future gross undiscounted premiums expected to be
collected, and future expected premiums earned, net of reinsurance at March 31, 2011:



|                     |  |                                           |           |  |                                                          |   |           | 
|-------------------- |  | ----------------------------------------- | --------- |  | -------------------------------------------------------- | - | --------- | 
|                     |  | Futurepremiumsexpected 
tobe collected(1) |           |  | Futurepremiumsexpected to
beearned, net ofreinsurance(1) |  
|Three months ended:  |  |                                           |           |  |                                                          |   |           | 
|June 30, 2011        |  | $                                         | 48,023    |  |                                                          | $ | 75,391    | 
|September 30, 2011   |  |                                           | 49,632    |  |                                                          |   | 73,714    | 
|December 31, 2011    |  |                                           | 50,520    |  |                                                          |   | 71,868    | 
|                     |  |                                          
|Twelve months ended: |  |                                           |           |  |                                                          |   |           | 
|December 31, 2012    |  |                                           | 188,594   |  |                                                          |   | 267,940   | 
|December 31, 2013    |  |                                           | 177,716   |  |                                                          |   | 242,552   | 
|December 31, 2014    |  |                                           | 172,438   |  |                                                          |   | 225,498   | 
|December 31, 2015    |  |                                           | 164,144   |  |                                                          |   | 210,967   | 
|                     |  |                                          
|Five years ended:    |  |                                           |           |  |                                                          |   |           | 
|December 31, 2020    |  |                                           | 745,045   |  |                                                          |   | 894,274   | 
|December 31, 2025    |  |                                           | 628,320   |  |                                                          |   | 654,771   | 
|December 31, 2030    |  |                                           | 509,801   |  |                                                          |   | 458,029   | 
|December 31, 2035    |  |                                           | 337,297   |  |                                                          |   | 264,938   | 
|December 31, 2040    |  |                                           | 118,766   |  |                                                          |   | 94,732    | 
|December 31, 2045    |  |                                           | 32,176    |  |                                                          |   | 27,340    | 
|December 31, 2050    |  |                                           | 7,590     |  |                                                          |   | 8,133     | 
|December 31, 2055    |  |                                           | 557       |  |                                                          |   | 1,288     | 
|                     |  |                                           |           |  |                                                          |   |           | 
|Total                |  | $                                         | 3,230,619 |  |                                                          | $ | 3,571,435 | 
|                     |  |                                           |           |  |                                                          |   |           | 



|(1) | The future premiums expected to be collected and future premiums expected to be earned, net of reinsurance disclosed in the above table relate to the discounted premium
receivable asset and unearned premium liability recorded on Ambacs balance sheet. The use of contractual lives for many bond types which do not have homogeneous pools of underlying collateral is required in the calculation of the premium
receivable as described above, which results in a higher premium receivable balance than if expected lives were considered. If installment paying policies are retired early as a result of rate step-ups or other early retirement provision incentives
for the issuer, premiums reflected in the premium receivable asset and amounts reported in the above table for such policies may not be collected in the future.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

When a bond issue insured by Ambac Assurance has been retired, including those retirements due to refunding or calls, any remaining UPR is recognized at that time to the extent the financial guarantee
contract is legally extinguished. For installment premium paying transactions, we offset the recognition of any remaining UPR by the reduction of the related premium receivable to zero (as it will not be collected as a result of the retirement),
which may cause negative accelerated premium revenue. Accelerated premium revenue for retired obligations for the three months ended March 31, 2011 and 2010 was ($70) and $12,138, respectively. Certain obligations insured by Ambac have been
legally defeased whereby government securities are purchased by the issuer with the proceeds of a new bond issuance, or less frequently with other funds of the issuer, and held in escrow (a pre-refunding). The principal and interest received from
the escrowed securities are then used to retire the Ambac-insured obligations at a future date either to their maturity date or a specified call date. Ambac has evaluated the provisions in certain financial guarantee insurance policies issued on
legally defeased obligations and determined those policies have not been legally extinguished and, therefore, premium revenue recognition has not been accelerated.



21



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The table below shows premiums written on a gross and net basis for the three month
periods ended March 31, 2011 and 2010:



|                       |  |                             |         |   |      |   |          |  
|---------------------- |  | --------------------------- | ------- | - | ---- | - | -------- | -
|                       |  | Three Months
EndedMarch 31, |        
|                       |  | 2011                        |         |   | 2010 |  
|Revenues:              |  |                             |         |   |      |   |          |  
|Financial Guarantee:   |  |                             |         |   |      |   |          |  
|Gross premiums written |  | ($                          | 160,211 | ) |      | $ | (149,400 | )
|Ceded premiums written |  |                             | 9,218   |   |      |   | 18,616   |  
|                       |  |                             |         |   |      |   |          |  
|Net premiums written   |  | ($                          | 150,993 | ) |      | $ | (130,784 | )
|                       |  |                             |         |   |      |   |          |  

(6) Losses and Loss Expenses

Ambacs financial guarantee insurance policies generally pay scheduled interest and principal if the issuer of the insured obligation fails to meet its obligation. The loss and loss expense reserve
(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 Derivative Contracts
below. A loss reserve is recorded on the balance sheet on a policy-by-policy basis for the excess of: (a) the present value of expected net cash outflows to be paid under an insurance contract (i.e., the expected loss) over (b) the UPR for
that contract. To the extent (a) is less than (b), no loss reserve is recorded. Changes to the loss reserve in subsequent periods are recorded as a loss and loss expense on the income statement. Expected losses 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 expected losses is subject to certain estimates and judgments based on our assumptions regarding
the probability of default and expected severity of credits, including,our active surveillance of the insured book of business and observation of deterioration in the obligors credit standing.

Ambacs loss reserves are based on managements on-going review of the non-derivative financial guarantee credit portfolio.
Active surveillance of the insured portfolio enables Ambacs surveillance group to track credit migration of insured obligations from period to period and update internal classifications and credit ratings for each transaction. Non-adversely
classified credits are assigned a Class I or Survey List (SL) rating while adversely classified credits are assigned a rating of Class IA through Class V. The criteria for an exposure to be assigned an adversely classified credit rating
includes the deterioration of an issuers financial condition, underperformance of the underlying collateral (for collateral dependent transactions such as mortgage-backed securitizations), poor performance by 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 loss mitigation efforts could cause an increase in the delinquency and potential default of the underlying
obligation. Similarly, loss severities increase when a servicer does not effectively handle loss mitigation activities such as (i) the advancing of delinquent principal and interest and of default related expenses which are deemed to be
recoverable by the servicer, (ii) pursuit of loan charge-offs which maximize cash flows from the mortgage loan pool, and (iii) foreclosure and real estate owned disposition strategies and timelines. As a consequence of the Segregated
Account Rehabilitation Proceedings, the rehabilitator retains operational control and decision-making authority with respect to all matters related to the Segregated Account, including surveillance, remediation and loss mitigation. Similarly, by
virtue of the contracts executed between Ambac Assurance and the Segregated Account in connection with the



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



establishment, and subsequent rehabilitation, of the Segregated Account, the rehabilitator retains the discretion to oversee and approve certain actions taken by Ambac Assurance in respect of
assets and liabilities which remain in Ambac Assurance. As such, the following discussion of Ambacs risk management practices is qualified by reference to the rehabilitators exercise of its discretion to alter or eliminate any of these
risk management practices.

All credits are assigned risk classifications by the Surveillance Group using the following
guidelines:

CLASS I  Fully Performing  Meets Ambac Criteria with Remote Probability of Claim

Credits that demonstrate adequate security and structural protection with a strong capacity to pay interest, repay
principal and perform as underwritten. Factors supporting debt service payment and performance are considered unlikely to change and any such change would not have a negative impact upon the fundamental credit quality.

SURVEY LIST (SL)  Investigation of Specific Condition or Weakness Underway

Credits that require additional analysis to determine if adverse classification is warranted. These credits may lack information or
demonstrate a weakness but further deterioration is not expected.

CLASS IA  Potential Problem with Risks to
be Dimensioned

Credits that are fully current and monetary default or claims-payment are not anticipated. The
payors or issuers financial condition may be deteriorating or the credits may lack adequate collateral. A structured financing may also evidence weakness in its fundamental credit quality as evidenced by its under-performance relative to
its modeled projections at underwriting, issues related to the servicers ability to perform, or questions about the structural integrity of the transaction. While these credits may still retain an investment grade rating, they usually have
experienced or are vulnerable to a ratings downgrade. Further investigation is required to dimension and correct any deficiencies. A complete legal review of documents may be required. An action plan should be developed with triggers for future
classification changes upward or downward.

CLASS II  Substandard Requiring Intervention

Credits whose fundamental credit quality has deteriorated to the point that timely payment of debt service may be
jeopardized by adversely developing trends of a financial, economic, structural, managerial or political nature. No claim payment is currently foreseen but the probability of loss or claim payment over the life of the transaction is now existent
(10% or greater probability). Class II credits may be borderline or below investment grade (BBB- to B). Prompt and sustained action must be taken to execute a comprehensive loss mitigation plan and correct deficiencies.

CLASS III  Doubtful with Clear Potential for Loss

Credits whose fundamental credit quality has deteriorated to the point that timely payment of debt service has been or will be jeopardized
by adverse trends of a financial, economic, structural, managerial or political nature which, in the absence of positive change or corrective action, are likely to result in a loss. The probability of monetary default or claims paying over the life
of the transaction is 50% or greater. Full exercise of all available remedial actions is required to avert or minimize losses. Class III credits will generally be rated below investment grade (B to CCC).



23



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



CLASS IV  Imminent Default or Defaulted

Monetary default or claims payment has occurred or is expected imminently. Class IV credits are generally rated D.

CLASS V  Fully Reserved

The credit has defaulted and payments have occurred. The claim payments are scheduled and known, reserves have been established to fully cover such claims, and no claim volatility is expected.

The population of credits evaluated in Ambacs loss reserve process are: i) all adversely classified credits (Class IA through V)
and ii) non-adversely classified credits (Class I and SL) which had an internal Ambac rating downgrade since the transactions inception. One of two approaches is then utilized to estimate expected losses to ultimately determine if a loss
reserve should be established. The first approach is a statistical expected loss approach, which considers the likelihood of all possible outcomes. The base case statistical expected loss is the product of: (i) the net par
outstanding on the credit; (ii) internally developed historical default information (taking into consideration internal ratings and average life of an obligation); (iii) internally developed loss severities; and (iv) a discount
factor. The loss severities and default information are based on rating agency information, are specific to each bond type and are established and approved by Ambacs senior risk management professionals and other senior management. For certain
credit exposures, Ambacs additional monitoring and loss remediation efforts may provide information relevant to adjust this estimate of base case statistical expected losses. As such, loss severities used in estimating the
base case statistical expected losses may be adjusted based on the professional judgment of the surveillance analyst monitoring the credit with the approval of senior management. Analysts may accept the base case statistical
expected loss as the best estimate of expected loss or assign multiple probability weighted severities to determine an adjusted statistical expected loss that better reflects a given transactions potential severity.

The second approach entails the use of more precise estimates of expected net cash outflows (future claim payments, net of potential
recoveries, expected to be paid to the holder of the insured financial obligation). Ambacs surveillance group will consider the likelihood of all possible outcomes and develop cash flow scenarios. This approach can include the utilization of
market accepted software tools to develop net claim payment estimates. We have utilized such tools primarily for residential mortgage-backed and student loans exposures. These tools, in conjunction with detailed data of the historical performance of
the collateral pools, assist Ambac in the determination of certain assumptions, such as home price forecast, default and voluntary prepayment rates, which are needed in order to estimate expected future net claim payments. In this approach a
probability-weighted expected loss estimate is developed based on assigning probabilities to multiple net claim payment scenarios and applying an appropriate discount factor. A loss reserve is recorded for the excess, if any, of estimated expected
losses (net cash outflows) using either of these two approaches, over UPR. For certain policies, estimated potential recoveries exceed estimated future claim payments because all or a portion of such recoveries relate to claims previously paid. The
expected net cash inflows for these policies are recorded as a subrogation recoverable asset.

The discount factor applied to
both of the above described approaches is based on a risk-free discount rate corresponding to the remaining expected weighted-average life of the exposure and the exposure currency. The discount factor is updated for the current risk-free rate each
reporting period. The weighted average risk-free rate used to discount the loss reserve was 3.2% and 3.0% at March 31, 2011 and December 31, 2010, respectively.

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. Senior



24



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



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.

The tables below summarize information related to policies currently included in Ambacs loss reserves at March 31,
2011:

Surveillance Categories(at March 31, 2011)



|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|------------------------------------------------------------------------------ |  | ---- | --------- | - | -- | - | --------- | -- |  | - | --------- | - |  | -- | ---------- | - | - | - | ---------- | ----- |  | - | --- | - |  | - | ---------- | -
|                                                                               |  | I/SL |           |   | IA |   |           | II |  |   | III       |   |  | IV |            |   | V |   |            | Total | 
|Number of policies                                                             |  |      | 29        |   |    |   | 15        |    |  |   | 34        |   |  |    | 129        |   |   |   | 143        |       |  |   | 1   |   |  |   | 351        |  
|Remaining weighted-average contract period (in years)                          |  |      | 5         |   |    |   | 9         |    |  |   | 18        |   |  |    | 19         |   |   |   | 10         |       |  |   | 10  |   |  |   | 14         |  
|Gross insured contractual payments outstanding:                                |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Principal                                                                      |  | $    | 1,691,112 |   |    | $ | 840,812   |    |  | $ | 2,615,767 |   |  | $  | 14,934,700 |   |   | $ | 15,131,035 |       |  | $ | 47  |   |  | $ | 35,213,473 |  
|Interest                                                                       |  |      | 486,091   |   |    |   | 183,080   |    |  |   | 2,199,585 |   |  |    | 10,669,267 |   |   |   | 4,225,120  |       |  |   | 27  |   |  |   | 17,763,170 |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Total                                                                          |  | $    | 2,177,203 |   |    | $ | 1,023,892 |    |  | $ | 4,815,352 |   |  | $  | 25,603,967 |   |   | $ | 19,356,155 |       |  | $ | 74  |   |  | $ | 52,976,643 |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross undiscounted claim liability                                             |  | $    | 29,753    |   |    | $ | 77,477    |    |  | $ | 234,660   |   |  | $  | 4,072,420  |   |   | $ | 7,942,257  |       |  | $ | 75  |   |  | $ | 12,356,642 |  
|Discount, gross claim liability                                                |  |      | (2,257    | ) |    |   | (15,381   | )  |  |   | (37,568   | ) |  |    | (1,450,385 | ) |   |   | (1,410,480 | )     |  |   | (20 | ) |  |   | (2,916,091 | )
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross discounted claim liability before all subrogation and before reinsurance |  | $    | 27,496    |   |    | $ | 62,096    |    |  | $ | 197,092   |   |  | $  | 2,622,035  |   |   | $ | 6,531,777  |       |  | $ | 55  |   |  | $ | 9,440,551  |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Less:                                                                          |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross RMBS subrogation(1)                                                      |  |      |          |   |    |   |          |    |  |   |          |   |  |    |           |   |   |   | (2,592,281 | )     |  |   |    |   |  |   | (2,592,281 | )
|Discount, RMBS subrogation                                                     |  |      |          |   |    |   |          |    |  |   |          |   |  |    |           |   |   |   | 93,472     |       |  |   |    |   |  |   | 93,472     |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Discounted RMBS subrogation, before reinsurance                                |  |      |          |   |    |   |          |    |  |   |          |   |  |    |           |   |   |   | (2,498,809 | )     |  |   |    |   |  |   | (2,498,809 | )
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Less:                                                                          |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross other subrogation(2)                                                     |  |      |          |   |    |   | (49       | )  |  |   | (335      | ) |  |    | (269,556   | ) |   |   | (880,049   | )     |  |   |    |   |  |   | (1,149,989 | )
|Discount, other subrogation                                                    |  |      |          |   |    |   | 23        |    |  |   | 111       |   |  |    | 87,137     |   |   |   | 130,911    |       |  |   |    |   |  |   | 218,182    |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Discounted other subrogation, before reinsurance                               |  |      |          |   |    |   | (26       | )  |  |   | (224      | ) |  |    | (182,419   | ) |   |   | (749,138   | )     |  |   |    |   |  |   | (931,807   | )
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross discounted claim liability, net of all subrogation, before reinsurance   |  |      | 27,496    |   |    |   | 62,070    |    |  |   | 196,868   |   |  |    | 2,439,616  |   |   |   | 3,283,830  |       |  |   | 55  |   |  |   | 6,009,935  |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Less: Unearned premium reserves                                                |  |      | (10,803   | ) |    |   | (12,171   | )  |  |   | (126,806  | ) |  |    | (271,881   | ) |   |   | (188,692   | )     |  |   |    |   |  |   | (610,353   | )
|Plus: Loss adjustment expenses reserves                                        |  |      |          |   |    |   |          |    |  |   |          |   |  |    |            |   |   |   | 91,294     |       |  |   |    |   |  |   | 91,294     |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Discounted claim liability reported on Balance Sheet, before reinsurance(3)    |  |      | 16,693    |   |    |   | 49,899    |    |  |   | 70,062    |   |  |    | 2,167,735  |   |   |   | 3,186,432  |       |  |   | 55  |   |  |   | 5,490,876  |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Reinsurance recoverable reported on Balance Sheet                              |  |      | 1,473     |   |    |   | 36        |    |  |   | 4,216     |   |  |    | 113,835    |   |   |   | 21,751     |       |  |   |    |   |  |   | 141,311    |  
|                                                                               |  |      |           |   |    |   |           |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  



|    |  |                                                                                                                                                                                                                                                              |  |  |  | 
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  |  |  | 
|(1) |  | RMBS subrogation represents Ambacs estimate of subrogation recoveries from RMBS transaction sponsors forrepresentations and warranty breaches. Please see
Representation and Warranty Breaches by RMBS TransactionSponsors below for detailed discussion. |  |  |  | 
|(2) |  | Other subrogation represents subrogation other than subrogation as defined in (1) above.                                                                                                                                                                     |  |  |  | 
|(3) |  | Claim liability reported is included in the Consolidated Balance Sheets as follows:                                                                                                                                                                          |  |  |  | 



25



---

##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



| |  |                                                                                      |  |   |           |   |  |  |  | 
| |  | ------------------------------------------------------------------------------------ |  | - | --------- | - |  |  |  | 
| |  | Loss and loss expense reserve (net of potential remediation subrogation of $985,218) |  | $ | 6,296,761 |   |  |  |  | 
| |  | Subrogation recoverable (includes gross potential remediation of $1,513,591)         |  |   | (796,622  | ) |  |  |  | 
| |  | Other assets (within)                                                                |  |   | (9,260    | ) |  |  |  | 
| |  |                                                                                      |  |   |           |   |  |  |  | 
| |  |                                                                                      |  | $ | 5,490,879 |   |  |  |  | 
| |  |                                                                                      |  |   |           |   |  |  |  | 

Surveillance Categories(at December 31, 2010)



|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|------------------------------------------------------------------------------ |  | ---- | --------- | - | -- | - | ------- | -- |  | - | --------- | - |  | -- | ---------- | - | - | - | ---------- | ----- |  | - | --- | - |  | - | ---------- | -
|                                                                               |  | I/SL |           |   | IA |   |         | II |  |   | III       |   |  | IV |            |   | V |   |            | Total | 
|Number of policies                                                             |  |      | 24        |   |    |   | 4       |    |  |   | 34        |   |  |    | 118        |   |   |   | 127        |       |  |   | 1   |   |  |   | 308        |  
|Remaining weighted-average contract period (in years)                          |  |      | 5         |   |    |   | 9       |    |  |   | 17        |   |  |    | 19         |   |   |   | 9          |       |  |   | 10  |   |  |   | 14         |  
|Gross insured contractual payments outstanding:                                |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Principal                                                                      |  | $    | 1,831,525 |   |    | $ | 198,460 |    |  | $ | 2,620,973 |   |  | $  | 17,723,814 |   |   | $ | 13,766,322 |       |  | $ | 47  |   |  | $ | 36,141,141 |  
|Interest                                                                       |  |      | 392,486   |   |    |   | 58,317  |    |  |   | 1,983,875 |   |  |    | 10,609,295 |   |   |   | 3,327,242  |       |  |   | 27  |   |  |   | 16,371,242 |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Total                                                                          |  | $    | 2,224,011 |   |    | $ | 256,777 |    |  | $ | 4,604,848 |   |  | $  | 28,333,109 |   |   | $ | 17,093,564 |       |  | $ | 74  |   |  | $ | 52,512,383 |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross undiscounted claim liability                                             |  | $    | 19,664    |   |    | $ | 9,952   |    |  | $ | 62,469    |   |  | $  | 4,195,891  |   |   | $ | 7,197,833  |       |  | $ | 75  |   |  | $ | 11,485,884 |  
|Discount, gross claim liability                                                |  |      | (925      | ) |    |   | (4,700  | )  |  |   | 13,974    |   |  |    | (1,517,671 | ) |   |   | (1,234,704 | )     |  |   | (20 | ) |  |   | (2,744,046 | )
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross discounted claim liability before all subrogation and before reinsurance |  | $    | 18,739    |   |    | $ | 5,252   |    |  | $ | 76,443    |   |  | $  | 2,678,220  |   |   | $ | 5,963,129  |       |  | $ | 55  |   |  | $ | 8,741,838  |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Less:                                                                          |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross RMBS subrogation(1)                                                      |  |      |          |   |    |   |        |    |  |   |          |   |  |    |           |   |   |   | (2,514,477 | )     |  |   |    |   |  |   | (2,514,477 | )
|Discount, RMBS subrogation                                                     |  |      |          |   |    |   |        |    |  |   |          |   |  |    |           |   |   |   | 97,371     |       |  |   |    |   |  |   | 97,371     |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Discounted RMBS subrogation, before reinsurance                                |  |      |          |   |    |   |        |    |  |   |          |   |  |    |           |   |   |   | (2,417,106 | )     |  |   |    |   |  |   | (2,417,106 | )
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Less:                                                                          |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross other subrogation(2)                                                     |  |      |          |   |    |   |        |    |  |   | (11       | ) |  |    | (629,022   | ) |   |   | (1,033,055 | )     |  |   |    |   |  |   | (1,662,088 | )
|Discount, other subrogation                                                    |  |      |          |   |    |   |        |    |  |   |          |   |  |    | 207,811    |   |   |   | 89,166     |       |  |   |    |   |  |   | 296,977    |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Discounted other subrogation, before reinsurance                               |  |      |          |   |    |   |        |    |  |   | (11       | ) |  |    | (421,211   | ) |   |   | (943,889   | )     |  |   |    |   |  |   | (1,365,111 | )
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Gross discounted claim liability, net of all subrogation, before reinsurance   |  |      | 18,739    |   |    |   | 5,252   |    |  |   | 76,432    |   |  |    | 2,257,009  |   |   |   | 2,602,134  |       |  |   | 55  |   |  |   | 4,959,621  |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Less: Unearned premium reserves                                                |  |      | (9,095    | ) |    |   | (3,959  | )  |  |   | (49,782   | ) |  |    | (289,408   | ) |   |   | (149,235   | )     |  |   |    |   |  |   | (501,479   | )
|Plus: Loss adjustment expenses reserves                                        |  |      |          |   |    |   |        |    |  |   |          |   |  |    | 9,762      |   |   |   | 85,495     |       |  |   |    |   |  |   | 95,257     |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Discounted claim liability reported on Balance Sheet, before reinsurance(3)    |  |      | 9,644     |   |    |   | 1,293   |    |  |   | 26,650    |   |  |    | 1,977,363  |   |   |   | 2,538,394  |       |  |   | 55  |   |  |   | 4,553,399  |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  
|Reinsurance recoverable reported on Balance Sheet                              |  |      | 542       |   |    |   | 8       |    |  |   | 1,588     |   |  |    | 107,920    |   |   |   | 26,928     |       |  |   |    |   |  |   | 136,986    |  
|                                                                               |  |      |           |   |    |   |         |    |  |   |           |   |  |    |            |   |   |   |            |       |  |   |     |   |  |   |            |  



|    |  |                                                                                                                                                                                                                                                              |  |  |  | 
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  |  |  | 
|(1) |  | RMBS subrogation represents Ambacs estimate of subrogation recoveries from RMBS transaction sponsors forrepresentations and warranty breaches. Please see
Representation and Warranty Breaches by RMBS TransactionSponsors below for detailed discussion. |  |  |  | 
|(2) |  | Other subrogation represents subrogation other than subrogation as defined in (1) above.                                                                                                                                                                     |  |  |  | 



26



---

##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



|    |  |                                                                                      |  |   |           |   |  |  |  | 
|--- |  | ------------------------------------------------------------------------------------ |  | - | --------- | - |  |  |  | 
|(3) |  | Claim liability reported is included in the Consolidated Balance Sheets as follows:  |  |   |           |   |  | 
|    |  | Loss and loss expense reserve (net of potential remediation subrogation of $714,679) |  | $ | 5,288,655 |   |  |  |  | 
|    |  | Subrogation recoverable (includes gross potential remediation of $1,702,427)         |  |   | (714,270  | ) |  |  |  | 
|    |  | Other assets (within)                                                                |  |   | (20,986   | ) |  |  |  | 
|    |  |                                                                                      |  |   |           |   |  |  |  | 
|    |  |                                                                                      |  | $ | 4,553,399 |   |  |  |  | 
|    |  |                                                                                      |  |   |           |   |  |  |  | 

Loss expense reserves were also established for significant surveillance and mitigation expenses
associated with adversely classified credits. Total loss expense reserves, net of reinsurance, were $89,957 and $93,900 at March 31, 2011 and December 31, 2010, respectively. Loss reserves ceded to reinsurers at March 31, 2011 and
December 31, 2010 were $132,079 and $128,993, respectively. Amounts were included in reinsurance recoverable on paid and unpaid losses on the Consolidated Balance Sheet.

Below is the loss reserve roll-forward, net of subrogation recoverable and reinsurance for the three months ended March 31, 2011 and the year ended December 31, 2010:



|                                                                                            |  |                                 |           |   |                            |   |           |  
|------------------------------------------------------------------------------------------- |  | ------------------------------- | --------- | - | -------------------------- | - | --------- | -
|                                                                                            |  | Three monthsEnded March 31,2011 |           |   | Year EndedDecember 31,2010 |  
|Loss reserves at December 31, net of subrogation recoverable and reinsurance                |  | $                               | 4,424,450 |   |                            | $ | 3,777,321 |  
|Impact of adopting ASU 2009-17                                                              |  |                                 |          |   |                            |   | (503,887  | )
|                                                                                            |  |                                 |           |   |                            |   |           |  
|Beginning balance of net loss reserves, net of subrogation recoverable and reinsurance      |  |                                 | 4,424,450 |   |                            |   | 3,273,434 |  
|Changes in the loss reserves due to:                                                        |  |                                 |           |   |                            |   |           |  
|Current year:                                                                               |  |                                 |           |   |                            |   |           |  
|Establishment of new loss reserves, gross of subrogation and net of reinsurance             |  |                                 | 249,774   |   |                            |   | 266,913   |  
|Claim (payments) recoveries, net of reinsurance                                             |  |                                 | 195       |   |                            |   | (874      | )
|Establishment of subrogation recoveries, net of reinsurance                                 |  |                                 | (34,252   | ) |                            |   | (342,979  | )
|                                                                                            |  |                                 |           |   |                            |   |           |  
|Total current year                                                                          |  |                                 | 215,717   |   |                            |   | (76,940   | )
|Prior year:                                                                                 |  |                                 |           |   |                            |   |           |  
|Change in previously established loss reserves, gross of subrogation and net of reinsurance |  |                                 | 758,781   |   |                            |   | 822,848   |  
|Change in previously established subrogation recoveries, net of reinsurance                 |  |                                 | (46,765   | ) |                            |   | (26,864   | )
|Claim payments, net of subrogation recoverable and reinsurance                              |  |                                 | 6,676     |   |                            |   | (244,661  | )
|                                                                                            |  |                                 |           |   |                            |   |           |  
|Total prior year                                                                            |  |                                 | 718,692   |   |                            |   | 551,323   |  
|Changes in loss reserves                                                                    |  |                                 | 934,409   |   |                            |   | 474,383   |  
|Deconsolidation of certain VIEs under ASU 2009-17                                           |  |                                 |          |   |                            |   | 676,633   |  
|                                                                                            |  |                                 |           |   |                            |   |           |  
|Ending loss reserves, net of subrogation recoverable and reinsurance                        |  | $                               | 5,358,859 |   |                            | $ | 4,424,450 |  
|                                                                                            |  |                                 |           |   |                            |   |           |  

Representation and Warranty Breaches by RMBS Transaction Sponsors:

In an effort to better understand the unprecedented levels of delinquencies, Ambac or its counsel engaged consultants with significant
mortgage lending experience to review the underwriting documentation for mortgage loans underlying certain insured RMBS transactions. Transactions which have exhibited exceptionally poor performance were chosen for further examination of the
underwriting documentation supporting the underlying loans. Factors which Ambac believes to be indicative of poor performance include (i) increased levels of early payment defaults, (ii) significant number of loan liquidations or
charge-offs and resulting high level of losses, and (iii) rapid elimination of credit protections inherent in the transactions structures. With respect to item (ii), loan liquidations refers to loans for which the servicer has
liquidated the related collateral and the securitization has realized losses on the loan; charge-offs refers to loans which have been written off as uncollectible by the servicer,



27



---

##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



thereby generating no recoveries to the securitization, and may also refer to the unrecovered balance of liquidated loans. In either case, the servicer has taken such actions as it has deemed
viable to recover against the collateral, and the securitization has incurred losses to the extent such actions did not fully repay the borrowers obligations. Generally, the sponsor of the transaction provides representations and warranties
with respect to the securitized loans including the loan characteristics, the absence of fraud or other misconduct in the origination process, including those attesting to the compliance of home loans with the prevailing underwriting policies. Per
the underlying transaction documents, the sponsor of the transaction is contractually obligated to repurchase, cure or substitute any loan that breaches the representations and warranties.

Subsequent to the forensic exercise of examining loan files to ascertain whether the loans conformed to the representations and
warranties, we submit nonconforming loans to the sponsor for repurchase. To effect a repurchase, depending on the transaction, the sponsor is obligated to repurchase the loan at (a) for loans which have not been liquidated or charged off,
either (i) the current unpaid principal balance of the loan, (ii) the current unpaid principal balance plus accrued unpaid interest, or (iii) the current unpaid principal balance plus accrued interest plus unreimbursed servicer
advances/expenses and/or trustee expenses resulting from the breach of representations and warranties that trigger the repurchase, and (b) for a loan that has already been liquidated or charged-off, the amount of the realized loss (which in
certain cases excludes accrued unpaid interest). Notwithstanding the material breaches of representations and warranties, up until the establishment of the Segregated Account and the associated Segregated Account Rehabilitation Proceedings, Ambac
had continued to pay claims submitted under the financial guarantee insurance policies related to these securitizations and will resume paying such claims in accordance with the Rehabilitation Plan after the plan is effective. In cases where loans
are repurchased by a sponsor, the effect is typically to offset current period losses and then to increase the over-collateralization of the securitization, depending on the extent of loan repurchases and the structure of the securitization.
Specifically, the repurchase price is paid by the sponsor to the securitization trust which holds the loan. The cash becomes an asset of the trust, replacing the loan that was repurchased by the sponsor. On a monthly basis the cash received related
to loan repurchases by the sponsor is aggregated with cash collections from the underlying mortgages and applied in accordance with the trust indenture payment waterfall. This payment waterfall typically includes principal and interest payments to
the note holders, various expenses of the trust and reimbursements to Ambac, as financial guarantor, for claim payments made in previous months. Notwithstanding the reimbursement of previous monthly claim payments, to the extent there continues to
be insufficient cash in the waterfall in the current month to make scheduled principal and interest payments to the note holders, Ambac is required to make additional claim payments to cover this shortfall.

Ambacs estimate of subrogation recoveries includes two components: (1) estimated dollar amounts of loans with material
breaches of representations and warranties based on an extrapolation of the breach rate identified in a random sample of loans taken from the entire population of loans in a securitization (random sample approach); and (2) dollar
amount of actual loans with identified material breaches of representations and warranties discovered from samples of impaired loans in a securitization (adverse sample approach). We do not include estimates of damages in our estimate of
subrogation recoveries under either approach. The amount the sponsors believe to be their liability for these breaches is not known; however, certain large financial institutions who have served as sponsors for certain transactions that Ambac has
insured have disclosed that they have established reserves related to claims by financial guarantors and others for breaches of representations and warranties in RMBS transactions.

The random sample approach to estimate subrogation recoveries was based on obtaining a statistically valid random sample for all the
original loans in the pool. First, a breach rate was computed by dividing (i) the loans identified in the sample as having breached representations and warranties by (ii) the total sample size. Second, an extrapolation to the
entire loan pool was performed by multiplying the breach rate by the sum of (a) the current unpaid loan pool balance (CULPB) plus



28



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



(b) realized losses resulting from loan liquidations or charge-offs to date, to compute an estimated repurchase obligation. The CULPB includes principal only on non-charged-off and
non-liquidated loans, and the realized losses include principal, interest and unreimbursed servicer advances and/or trustee expenses on charged-off and liquidated loans. As a result, the CULPB and realized loss components, which are used in
extrapolating the estimated repurchase obligation, do not precisely correspond to each sponsors contractual repurchase obligation as defined in the transaction documents. Nonetheless, the CULPB and realized loss components are provided through
trustee reports we receive in the normal course of our surveillance of these transactions and is the best information we have available to estimate the sponsors repurchase obligation under the random sample approach. Third, a realization
factor (which incorporates Ambacs views about the uncertainties surrounding the litigation process and/or settlement negotiation) was then applied to the estimated repurchase obligation to compute the undiscounted subrogation recovery. The
realization factor was developed from a range of realization factors using Ambacs own assumptions about the likelihood of outcomes based on all the information available to it including (i) discussions with external legal counsel and
their views on ultimate settlement, (ii) recent experience with loan put back negotiations where the existence of a material breach was debated and negotiated at the loan level, and (iii) the pervasiveness of the breach rates. Finally, a
discount factor was applied to the undiscounted subrogation recovery to compute the estimated subrogation recovery.

Due to
the nature of the sampling methodology used, the subrogation recovery estimate Ambac has recorded based on the above-described random sample approach includes all breached loans which Ambac believes the sponsor is contractually required to
repurchase, including extrapolation to a loan pool which includes loans which have not defaulted, and, in fact, may not default in the future (i.e., performing loans). In theory, a loan that continues to perform in accordance with its terms through
repayment should have little or no effect on Ambacs anticipated claim payments, regardless of whether or not the sponsor repurchases the loan. In other words, since there will be sufficient cash flows to service the notes in either situation
(i.e., whether cash is received from a sponsor loan repurchase or whether cash is received from the underlying performing loan), there should be no claim payment under Ambacs insurance policy in respect of such loans. Nonetheless, Ambac may
have recorded a subrogation recovery for certain performing loans because it believes the breaches of representations and warranties are so pervasive that a court would deem it impractical to have the sponsor re-underwrite every loan in a given
transaction and repurchase only individual loans that have breached. Rather, Ambac believes there is precedent for the utilization of a statistical sampling and extrapolation methodology across a population to prove liability and damages where it
would be impractical to make a determination on an individual loan basis. A recent court ruling in a similar suit unrelated to Ambac, but in the same jurisdiction in which Ambac has filed its litigation to date, supports the view that a sampling
methodology is permissible. Ambac believes a court would likely award damages based on a reasonable methodology, such as our random sample approach, which damages would be either remitted directly to Ambac, placed in the securitization trust, or
otherwise held under an arrangement for the benefit of the securitization trust; however, Ambac believes that under such an approach individual loans would not be repurchased from the trust. In either case, Ambac believes those damages would
compensate Ambac for past and future claim payments. Consequently, since the sponsor is contractually obligated to repurchase those loans which breach representations and warranties regardless of whether they are current or defaulted, Ambac believes
the appropriate measure in estimating subrogation recoveries is to apply the breach rate to both performing and defaulted loans.

The adverse sample approach to estimate subrogation recoveries was based on a sample taken from those loans in the pool that were impaired, meaning loans greater than 90 days past due, charged-off, in
foreclosure, REO or bankruptcy. The estimated subrogation recovery under this approach represents 100% of the original principal balance of those specific loans identified as having not met the underwriting criteria or otherwise breaching
representations and warranties (i.e., the adverse loans), multiplied by a discount factor using the same assumptions used for the discount factor in the random sample approach. For transactions subject to the adverse sample approach, given
Ambacs limitations in developing a statistically valid random sample and its belief that the subrogation estimate under this



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



approach is inherently conservative (for reasons discussed below), Ambac did not attempt to develop probability-weighted alternative cash flow scenarios as it believes such results would not be
meaningful. The three primary differences between this adverse sample approach and the random sample approach, discussed in the previous paragraphs, are as follows:



| | (i) | There is no extrapolation to the CULPB and realized losses under the adverse sample approach. At March 31, 2011, the adverse sample approach is being used for 16
transactions that are with the same sponsor, who has limited our access to the underlying loan files and, therefore, a statistically valid random sample from the entire loan pool cannot be selected. This is in contrast to the transactions subject to
the random sample approach where Ambacs access to individual loan files has not been limited and the Company, therefore, has been able to develop a statistically valid representative sample.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ii) | The adverse sample approach is based on the original principal balance rather than the principal balance at the time of default and liquidation or charge-off.
Furthermore, it does not include other components of the sponsors contractual repurchase obligation where the sponsor is also obligated to repay accrued interest, servicer advances and/or trustee expenses. The adverse sample approach relies on
individual loan level data where all of the components of the sponsors buyback obligation have not been specifically provided by the sponsor, or the sponsors buyback obligation is not easily estimable. For example, home equity lines of
credit (HELOCs) are revolving loans whose principal balances may be higher or lower at the time of default and liquidation or charge-off than at the time of origination. However, given the limited information available to Ambac in estimating such
principal balances at the time of liquidation or charge-off, the original principal balance was used in calculating subrogation recoveries. Another example is closed-end second lien RMBS where the interest due on a particular loan will be a function
of the length of time of delinquency prior to liquidation or charge-off, and cannot be readily estimated. Incremental costs, including fees and servicer advances for such items as property taxes and maintenance, are likewise not readily estimatable.
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | Unlike the random sample approach, for the adverse sample approach Ambac did not apply a realization factor to the estimated repurchase obligation for the adverse loans
related to uncertainties surrounding settlement negotiation or litigation processes given that the adverse loans selected represent only approximately 39% of the value of the impaired population of loans, only approximately 5% of the value of the
original loans in the pool, and the breach rate in the sample was pervasive. In other words, because the adverse loans selected represent only a fraction of the population of impaired loans and a very small proportion of the original loans in the
pools, Ambac believes there is an ample population of additional impaired loans where breaches of representations and warranties exist that could potentially replace any adverse loans it already identified that might be successfully challenged in
negotiations or litigation.
| | ----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



Ambac has updated its estimated subrogation recoveries to $2,498,808.9 ($2,472,105.7,
net of reinsurance) at March 31, 2011 from $2,417,106.2 ($2,391,335.7, net of reinsurance) at December 31, 2010. The balance of subrogation recoveries and the related claim liabilities at March 31, 2011 and December 31, 2010 are
as follows:



|                |  |                |    |     |                                                   |   |             |                          |  |   |                                                  |   |  |   |            |  
|--------------- |  | -------------- | -- | --- | ------------------------------------------------- | - | ----------- | ------------------------ |  | - | ------------------------------------------------ | - |  | - | ---------- | -
|                |  | March 31, 2011 |   
|Method          |  | Count          |    |     | Gross claim liabilitybefore subrogationrecoveries |   |             | Subrogationrecoveries(1) |  |   | Gross claim liabilityafter subrogationrecoveries |  
|Adverse samples |  |                | 16 | (2) |                                                   | $ | 1,750,540.8 |                          |  | $ | (776,052.7                                       | ) |  | $ | 974,488.1  |  
|Random samples  |  |                | 12 | (3) |                                                   |   | 1,105,936.6 |                          |  |   | (1,722,756.3                                     | ) |  |   | (616,819.6 | )
|                |  |                |    |     |                                                   |   |             |                          |  |   |                                                  |   |  |   |            |  
|Totals          |  |                | 28 |     |                                                   | $ | 2,856,477.4 |                          |  | $ | (2,498,809.0                                     | ) |  | $ | 357,668.5  |  
|                |  |                |    |     |                                                   |   |             |                          |  |   |                                                  |   |  |   |            |  



|                |  |                   |    |     |                                                   |   |             |                          |  |   |                                                  |   |  |   |            |  
|--------------- |  | ----------------- | -- | --- | ------------------------------------------------- | - | ----------- | ------------------------ |  | - | ------------------------------------------------ | - |  | - | ---------- | -
|                |  | December 31, 2010 |   
|Method          |  | Count             |    |     | Gross claim liabilitybefore subrogationrecoveries |   |             | Subrogationrecoveries(1) |  |   | Gross claim liabilityafter subrogationrecoveries |  
|Adverse samples |  |                   | 15 | (2) |                                                   | $ | 1,644,488.3 |                          |  | $ | (719,448.1                                       | ) |  | $ | 925,040.2  |  
|Random samples  |  |                   | 12 | (3) |                                                   |   | 1,010,703.7 |                          |  |   | (1,697,658.1                                     | ) |  |   | (686,954.2 | )
|                |  |                   |    |     |                                                   |   |             |                          |  |   |                                                  |   |  |   |            |  
|Totals          |  |                   | 27 |     |                                                   | $ | 2,655,192.0 |                          |  | $ | (2,417,106.2                                     | ) |  | $ | 238,086.0  |  
|                |  |                   |    |     |                                                   |   |             |                          |  |   |                                                  |   |  |   |            |  



|(1) | The amount of recorded subrogation recoveries related to each securitization is limited to ever-to-date paid losses plus the present value of projected future paid
losses for each policy. To the extent significant losses have been paid but not yet recovered, the recorded amount of subrogation recoveries may exceed the projected future paid losses for a given policy. The net cash inflow for these policies is
recorded as a Subrogation recoverable asset. For those transactions where the subrogation recovery is less than projected future paid losses, the net cash outflow for these policies is recorded as a Loss and loss expense
reserve liability. Of the $2,498,809 of subrogation recoveries recorded at March 31, 2011, $1,513,591 was included in Subrogation recoverable and $985,218 was included in Loss and loss expense reserves. Of the
$2,417,106.2 of subrogation recoveries recorded at December 31, 2010, $1,702,426.6 was included in Subrogation recoverable and $714,679.4 was included in Loss and loss expense reserves.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Of these 16 (15 in 2010) transactions, 10 contractually require the sponsor to repurchase loans at the unpaid principal balance and 6 (5 in 2010) contractually require
the sponsor to repurchase loans at unpaid principal plus accrued interest. However, for reasons discussed above in the description of the adverse sample approach, our estimated subrogation recovery for these transactions may not include all the
components of the sponsors contractual repurchase obligation.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Of these 12 transactions, 3 contractually require the sponsor to repurchase loans at unpaid principal plus accrued interest and 9 contractually require the sponsor to
repurchase loans at unpaid principal plus accrued interest plus servicer advances/expense and/or trustee expenses. However, for reasons discussed above in the description of the random sample approach, our estimated subrogation recovery for these
transactions may not include all the components of the sponsors contractual repurchase obligation.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

While
the obligation by sponsors to repurchase loans with material breaches is clear, generally the sponsors have not yet honored those obligations. Ambacs approach to resolving these disputes has included negotiating with individual sponsors at the
transaction level and in some cases at the individual loan level and has resulted in the repurchase of some loans. Ambac has utilized the results of the above described loan file examinations to make demands for loan repurchases from sponsors or
their successors and, in certain instances, as a part of the basis for litigation filings. Ambac has initiated and will continue to initiate lawsuits seeking compliance with the repurchase obligations in the securitization documents. Ambac estimates
that it will take approximately three years from the initiation of litigation with the sponsor to ultimate resolution. Based on this estimate as a basis for projecting the future subrogation cash flows, Ambac assumes, on average, approximately three
and a half years to collect recoveries, discounted at a risk-free rate of 2.70%



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



We have performed the above-mentioned, detailed examinations on a variety of
second-lien and first-lien transactions that have experienced exceptionally poor performance. However, the loan file examinations and related estimated recoveries we have reviewed and recorded to date have been limited to only those transactions
whose sponsors (or their successors) are subsidiaries of large financial institutions, all of which carry an investment grade rating from at least one nationally recognized rating agency. A total of seven sponsors represent the 28 transactions which
have been reviewed as of March 31, 2011. While our contractual recourse is generally to the sponsor/subsidiary, rather than to the financial institutional parent, each of these financial institutions has significant financial resources and an
ongoing interest in mortgage finance, and we therefore believe that the financial institution/parent would not seek to disclaim financial responsibility for these obligations if the sponsor/subsidiary is unable to honor its contractual obligations
or pay a judgment that we may obtain in litigation. Additionally, in the case of successor institutions, we are not aware of any provisions that explicitly preclude or limit the successors obligations to honor the obligations of the original
sponsor. In fact, we have witnessed to date, certain successor financial institutions make significant payments to certain claimants to settle breaches of representations and warranties perpetrated by sponsors that have been acquired by such
financial institutions. As a result, we did not make any significant adjustments to our estimated subrogation recoveries with respect to the credit risk of these sponsors or their successors. We believe that focusing our loan remediation efforts on
large financial institutions first will provide the greatest economic benefit to Ambac. Ambac retains the right to review other RMBS transactions for representations and warranties breaches. Since a significant number of other second-lien and
first-lien transactions are also experiencing poor performance, management is considering expanding the scope of this effort.

Below is the rollforward of RMBS subrogation for the period December 31, 2010 through March 31, 2011:



|                                                               |  |               |           |   |           |  |     |               |  |   |           |   |  |  |     | 
|-------------------------------------------------------------- |  | ------------- | --------- | - | --------- |  | --- | ------------- |  | - | --------- | - |  |  | --- | 
|                                                               |  | Random sample |           |   | # ofdeals |  |     | AdverseSample |  |   | # ofdeals |  
|Rollforward:                                                   |  |               |           |   |           |  |     |               |  |   |           |   |  |  |     | 
|Discounted RMBS subrogation (gross of reinsurance) at 12/31/10 |  | $             | 1,697,658 |   |           |  | 12  |               |  | $ | 719,448   |   |  |  | 15  | 
|                                                               |  |               |           |   |           |  |     |               |  |   |           |   |  |  |     | 
|Changes recognized in 2011:                                    |  |               |           |   |           |  |     |               |  |   |           |   |  |  |     | 
|Additional transactions reviewed                               |  |               |          |   |           |  |    |               |  |   | 34,756    |   |  |  | 1   | 
|Additional adverse sample loans reviewed                       |  |               |          |   |           |  | n/a |               |  |   |          |   |  |  | n/a | 
|Loans repurchased by the sponsor                               |  |               | (16,864   | ) |           |  | n/a |               |  |   | (2,834    | ) |  |  | n/a | 
|                                                               |  |               |           |   |           |  |     |               |  |   |           |   |  |  |     | 
|Subtotal of changes recognized in current period               |  |               | (16,864   | ) |           |  | n/a |               |  |   | 31,922    |   |  |  | n/a | 
|                                                               |  |               |           |   |           |  |     |               |  |   |           |   |  |  |     | 
|Changes from re-estimation of opening balance:                 |  |               |           |   |           |  |     |               |  |   |           |   |  |  |     | 
|Change in pre-recovery loss reserves                           |  |               | 41,962    |   |           |  | n/a |               |  |   | 24,683    |   |  |  | n/a | 
|Discounted RMBS subrogation (gross of reinsurance) at 03/31/11 |  | $             | 1,722,756 |   |           |  | 12  |               |  | $ | 776,053   |   |  |  | 16  | 
|                                                               |  |               |           |   |           |  |     |               |  |   |           |   |  |  |     | 

Our ability to recover the RMBS subrogation recoveries is subject to significant uncertainty, including
risks inherent in litigation, collectability of such amounts from counterparties (and/or their respective parents and affiliates), timing of receipt of any such recoveries, regulatory intervention which could impede our ability to take actions
required to realize such recoveries and uncertainty inherent in the assumptions used in estimating such recoveries. Our current estimate considers that we will receive subrogation recoveries of $865,026 and $1,733,197 in 2012 and 2013, respectively
(gross of discounting, reinsurance and credit risk valuation in the amount of $93,742, $26,703 and $5,673, respectively). The amount of these subrogation recoveries is significant and if we are unable to recover any amounts our future available
liquidity to pay claims would be reduced and our stockholders deficit as of March 31, 2011 would increase from $2,093,897 to $4,566,003.



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



(7) Derivative Contracts

ASC Topic 815, Derivatives and Hedging, 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 on a gross basis; assets and liabilities are netted by customer only when a legal right of offset exists. Methodologies
used to determine fair value of derivative contracts, including model inputs and assumptions where applicable, are described further in Note 11, Fair Value Measurements.

The Company has entered into derivative contracts both for trading purposes and to hedge certain economic risks inherent in its financial asset and liability portfolios. The Company also has certain
options to repurchase Ambac Assurances surplus notes at a discount to par value which are required to be accounted for as stand-alone derivatives. VIEs consolidated under ASC Topic 810 entered into derivative contracts to meet specified
purposes within the securitization structure. Changes in fair value of consolidated VIE derivatives are included within Financial Guarantee: Loss on variable interest entities on the Consolidated Statements of Operations. The notional for VIE
derivatives outstanding as of March 31, 2011 and December 31, 2010 are as follows:



|                                               |                |          |           |                   |  |   |           | 
|---------------------------------------------- | -------------- | -------- | --------- | ----------------- |  | - | --------- | 
|Type of VIE derivative                         |                | Notional |          
|                                               | March 31, 2011 |          |           | December 31, 2010 | 
|Interest rate swapsreceive-fixed/pay-variable |                | $        | 1,760,390 |                   |  | $ | 1,711,881 | 
|Interest rate swapspay-fixed/receive-variable |                |          | 5,249,323 |                   |  |   | 6,291,763 | 
|Currency swaps                                 |                |          | 745,860   |                   |  |   | 725,307   | 
|Credit derivatives                             |                |          | 22,058    |                   |  |   | 21,976    | 

Derivatives for
trading include credit derivatives issued as a form of financial guarantee, certain interest rate and currency swaps and futures contracts. Interest rate and currency swaps are also used to manage the risk of changes in fair value or cash flows
caused by variations in interest rates and foreign currency exchange rates.

Ambac determines that the amounts recognized for
the right to reclaim cash collateral or futures margin or the obligation to return cash collateral are not at fair value and are not offset against fair value amounts recognized for derivative instruments executed with the same counterparty under
the same master netting arrangement. The amounts representing the right to reclaim cash collateral and posted margin, recorded in Other assets were $3,385 and $281 as of March 31, 2011 and December 31, 2010, respectively. The
amounts representing the obligation to return cash collateral, recorded in Other liabilities were $0 and $7,005 as of March 31, 2011 and December 31, 2010, respectively. The following tables summarize the location and fair
values of individual derivative instruments reported in the Consolidated Balance Sheet as of March 31, 2011 and December 31, 2010. Amounts are presented gross of the effect of offsetting balances even where a legal right of offset exists:



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|------------------------------------- |  | ---------------------- | ---------------------------- |  | -------------------- | - | ------- | ---------------------- |  |  | ---------------------------- |  |  | - | --------- | 
|Fair Values of Derivative Instruments | 
|                                      |  |                       
|                                      |  | Derivative Asset       |                              |  | Derivative Liability |  
|                                      |  | Balance Sheet Location |                              |  | Fair Value           |   |         | Balance Sheet Location |  |  | Fair value                   | 
|March 31, 2011:                       |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Derivatives held for trading          |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Credit derivatives                    |  |                        | Derivative assets            |  |                      | $ |        |                        |  |  | Derivative liabilities       |  |  | $ | 235,910   | 
|Interest rate swaps                   |  |                        | Derivative assets            |  |                      |   | 395,601 |                        |  |  | Derivative liabilities       |  |  |   | 117,531   | 
|                                      |  |                        | Derivative liabilities       |  |                      |   | 7,395   |                        |  |  | Derivative assets            |  |  |   | 111,477   | 
|Currency swaps                        |  |                        | Derivative assets            |  |                      |   |        |                        |  |  | Derivative liabilities       |  |  |   | 5,848     | 
|Futures contracts                     |  |                        | Derivative assets            |  |                      |   |        |                        |  |  | Derivative liabilities       |  |  |   | 319       | 
|Other contracts                       |  |                        | Derivative assets            |  |                      |   |        |                        |  |  | Derivative liabilities       |  |  |   | 132       | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Total derivatives held for trading    |  |                        |                              |  |                      |   | 402,996 |                        |  |  |                              |  |  |   | 471,217   | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Call options on long-term debt        |  |                        | Derivative assets            |  |                      |   | 16,725  |                        |  |  | Derivative liabilities       |  |  |   |          | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Total derivatives                     |  |                        |                              |  |                      | $ | 419,721 |                        |  |  |                              |  |  | $ | 471,217   | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Variable Interest Entities            |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Credit derivatives                    |  |                        | VIE - Derivative assets      |  |                      | $ |        |                        |  |  | VIE - Derivative liabilities |  |  | $ |          | 
|Currency swaps                        |  |                        | VIE - Derivative liabilities |  |                      |   | 15,235  |                        |  |  | VIE - Derivative liabilities |  |  |   | 106,394   | 
|Interest rate swaps                   |  |                        | VIE - Derivative liabilities |  |                      |   | 4,761   |                        |  |  | VIE - Derivative liabilities |  |  |   | 1,128,138 | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|                                      |  |                        |                              |  |                      | $ | 19,996  |                        |  |  |                              |  |  | $ | 1,234,532 | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|                                      |  |                        |                              | 
|December 31, 2010:                    |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Derivatives held for trading          |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Credit derivatives                    |  |                        | Derivative assets            |  |                      | $ |        |                        |  |  | Derivative liabilities       |  |  | $ | 221,684   | 
|Interest rate swaps                   |  |                        | Derivative assets            |  |                      |   | 408,299 |                        |  |  | Derivative liabilities       |  |  |   | 124,932   | 
|                                      |  |                        | Derivative liabilities       |  |                      |   | 4,756   |                        |  |  | Derivative assets            |  |  |   | 129,185   | 
|Currency swaps                        |  |                        | Derivative assets            |  |                      |   |        |                        |  |  | Derivative liabilities       |  |  |   | 6,699     | 
|Futures contracts                     |  |                        | Derivative assets            |  |                      |   | 11,185  |                        |  |  | Derivative liabilities       |  |  |   |          | 
|Other contracts                       |  |                        | Derivative assets            |  |                      |   |        |                        |  |  | Derivative liabilities       |  |  |   | 232       | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Total derivatives held for trading    |  |                        |                              |  |                      |   | 424,240 |                        |  |  |                              |  |  |   | 482,732   | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Call options on long-term debt        |  |                        | Derivative assets            |  |                      |   |        |                        |  |  | Derivative liabilities       |  |  |   |          | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Total derivatives                     |  |                        |                              |  |                      | $ | 424,240 |                        |  |  |                              |  |  | $ | 482,732   | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Variable Interest Entities            |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|Credit derivatives                    |  |                        | VIE - Derivative assets      |  |                      | $ | 4,511   |                        |  |  | VIE - Derivative liabilities |  |  | $ |          | 
|Currency swaps                        |  |                        | VIE - Derivative liabilities |  |                      |   | 26,577  |                        |  |  | VIE - Derivative liabilities |  |  |   | 105,037   | 
|Interest rate swaps                   |  |                        | VIE - Derivative liabilities |  |                      |   | 2,203   |                        |  |  | VIE - Derivative liabilities |  |  |   | 1,503,863 | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 
|                                      |  |                        |                              |  |                      | $ | 33,291  |                        |  |  |                              |  |  | $ | 1,608,900 | 
|                                      |  |                        |                              |  |                      |   |         |                        |  |  |                              |  |  |   |           | 

Derivative Contracts Classified as Held for Trading Purposes:

Financial Guarantee Credit Derivatives:

Credit derivatives, which are privately negotiated contracts, provide the counterparty with credit protection against the occurrence of a specific event such as a payment default or bankruptcy relating to
an underlying obligation. Upon a credit event, Ambac is generally required to make payments equal to the difference between the scheduled debt service payment and the actual payment made by the issuer. The majority of our credit derivatives are
written on a pay-as-you-go basis. Similar to an insurance policy execution, pay-as-you-go provides that Ambac pays interest shortfalls on the referenced transaction as they are incurred on each scheduled payment date, but only pays
principal shortfalls upon the earlier of



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



(i) the date on which the assets designated to fund the referenced obligation have been disposed of and (ii) the legal final maturity date of the referenced obligation.

In a small number of transactions, Ambac is required to (i) make a payment equal to the difference between the par value and market
value of the underlying obligation or (ii) purchase the underlying obligation at its par value and a loss is realized for the difference between the par and market value of the underlying obligation. There are 18 transactions, which are not
pay-as-you-go, with a combined notional of approximately $1,092,160 and a net liability fair value of $5,726 as of March 31, 2011. These transactions are primarily in the form of CLOs written between 2002 and 2005.

Substantially all of Ambacs credit derivative contracts relate to structured finance transactions. Credit derivatives
issued by Ambac are insured by Ambac Assurance. None of our outstanding credit derivative transactions at March 31, 2011 include ratings based collateral-posting triggers or otherwise require Ambac to post collateral regardless of Ambacs
ratings or the size of the mark to market exposure to Ambac.

Ambac maintains internal credit ratings on its guaranteed
obligations, including credit derivative contracts, solely to indicate managements view of the underlying credit quality of the guaranteed obligations. Independent rating agencies may have assigned different ratings on the credits in
Ambacs portfolio than Ambacs internal ratings. Ambacs BBB internal rating reflects bonds which are of medium grade credit quality with adequate capacity to pay interest and repay principal. Certain protective elements and margins
may weaken under adverse economic conditions and changing circumstances. These bonds are more likely than higher rated bonds to exhibit unreliable protection levels over all cycles. Ambacs below investment grade (BIG) internal
ratings reflect bonds which are of speculative grade credit quality with the adequacy of future margin levels for payment of interest and repayment of principal potentially adversely affected by major ongoing uncertainties or exposure to adverse
conditions.

The following tables summarize the net par outstanding for CDS contracts, by Ambac rating, for each major
category as of March 31, 2011 and December 31, 2010:

March 31, 2011



|                       |  |     |            |  |       |   |           |       |  |   |            | 
|---------------------- |  | --- | ---------- |  | ----- | - | --------- | ----- |  | - | ---------- | 
|Ambac Rating           |  | CLO |            |  | Other |   |           | Total | 
|AAA                    |  | $   | 247,583    |  |       | $ | 2,138,007 |       |  | $ | 2,385,590  | 
|AA                     |  |     | 8,566,193  |  |       |   | 1,026,674 |       |  |   | 9,592,867  | 
|A                      |  |     | 2,580,317  |  |       |   | 2,817,642 |       |  |   | 5,397,959  | 
|BBB                    |  |     | 31,938     |  |       |   | 621,985   |       |  |   | 653,923    | 
|Below investment grade |  |     |           |  |       |   | 242,915   |       |  |   | 242,915    | 
|                       |  |     |            |  |       |   |           |       |  |   |            | 
|                       |  | $   | 11,426,031 |  |       | $ | 6,847,223 |       |  | $ | 18,273,254 | 
|                       |  |     |            |  |       |   |           |       |  |   |            | 

December 31, 2010



|                       |  |     |            |  |       |   |           |       |  |   |            | 
|---------------------- |  | --- | ---------- |  | ----- | - | --------- | ----- |  | - | ---------- | 
|Ambac Rating           |  | CLO |            |  | Other |   |           | Total | 
|AAA                    |  | $   | 282,294    |  |       | $ | 2,209,540 |       |  | $ | 2,491,834  | 
|AA                     |  |     | 8,323,435  |  |       |   | 1,237,993 |       |  |   | 9,561,428  | 
|A                      |  |     | 2,955,030  |  |       |   | 2,851,213 |       |  |   | 5,806,243  | 
|BBB                    |  |     | 31,938     |  |       |   | 627,021   |       |  |   | 658,959    | 
|Below investment grade |  |     |           |  |       |   | 247,890   |       |  |   | 247,890    | 
|                       |  |     |            |  |       |   |           |       |  |   |            | 
|                       |  | $   | 11,592,697 |  |       | $ | 7,173,657 |       |  | $ | 18,766,354 | 
|                       |  |     |            |  |       |   |           |       |  |   |            | 



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The tables below summarize information by major category as of March 31, 2011 and
December 31, 2010:

March 31, 2011



|                                                                   |  |     |            |   |       |   |           |       |  |   |            |  
|------------------------------------------------------------------ |  | --- | ---------- | - | ----- | - | --------- | ----- |  | - | ---------- | -
|                                                                   |  | CLO |            |   | Other |   |           | Total | 
|Number of CDS transactions                                         |  |     | 58         |   |       |   | 26        |       |  |   | 84         |  
|Remaining expected weighted-average life of obligations (in years) |  |     | 3.3        |   |       |   | 4.9       |       |  |   | 3.9        |  
|Gross principal notional outstanding                               |  | $   | 11,426,031 |   |       | $ | 6,847,223 |       |  | $ | 18,273,254 |  
|Net derivative liabilities at fair value                           |  | $   | (70,066    | ) |       | $ | (165,844  | )     |  | $ | (235,910   | )

December 31, 2010



|                                                                   |  |     |            |   |       |   |           |       |  |   |            |  
|------------------------------------------------------------------ |  | --- | ---------- | - | ----- | - | --------- | ----- |  | - | ---------- | -
|                                                                   |  | CLO |            |   | Other |   |           | Total | 
|Number of CDS transactions                                         |  |     | 59         |   |       |   | 30        |       |  |   | 89         |  
|Remaining expected weighted-average life of obligations (in years) |  |     | 3.4        |   |       |   | 4.4       |       |  |   | 3.8        |  
|Gross principal notional outstanding                               |  | $   | 11,592,697 |   |       | $ | 7,173,657 |       |  | $ | 18,766,354 |  
|Net derivative liabilities at fair value                           |  | $   | (70,467    | ) |       | $ | (151,217  | )     |  | $ | (221,684   | )



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The maximum potential amount of future payments under Ambacs credit derivative
contracts written on a pay-as-you-go basis is generally the gross principal notional outstanding amount included in the above table plus future interest payments payable by the derivative reference obligations. For contracts that are not
written with pay-as-you-go terms, the maximum potential future payment is represented by the principal notional only. Since Ambacs credit derivatives typically reference obligations of or assets held by SPEs that meet the definition of a VIE,
the amount of maximum potential future payments for credit derivatives is included in the table in Note 4, Special Purpose Entities Including Variable Interest Entities.

Ambacs credit derivative contracts are accounted for at fair value since they do not qualify for the financial guarantee scope exception under ASC Topic 815. Changes in fair value are recorded in
Net change in fair value of credit derivatives on the Consolidated Statements of Operations. The Realized gains and losses and other settlements component of this income statement line includes (i) premiums received and
accrued on written credit derivative contracts, (ii) premiums paid and accrued on purchased credit derivative contracts, (iii) losses paid and payable on written credit derivative contracts and (iv) paid losses recovered and
recoverable on purchased credit derivative contracts for the appropriate accounting period. Losses paid and payable and losses recovered and recoverable reported in Realized gains and losses and other settlements include those arising
after a credit event that requires a payment under the contract terms or in connection with a negotiated termination of a contract. Paid losses (recoveries) included in realized gains and losses and other settlements were $0 and $(263) for the three
months ended March 31, 2011 and 2010, respectively. Realized gains and losses and other settlements also included credit derivative fees received of $5,323 and $9,661 for the three months ended March 31, 2011 and 2010, respectively. The
Unrealized gains (losses) component of this income statement line includes all other changes in fair value, including reductions in the fair value of liabilities as they are paid or settled. Refer to Note 11 for a detailed description of
the components of our credit derivative contracts fair value.

Although CDS contracts are accounted for at fair value in
accordance with ASC Topic 815, they are surveilled similar to non-derivative financial guarantee contracts. As with financial guarantee insurance policies, Ambacs surveillance group tracks credit migration of CDS contracts reference
obligations from period to period. Adversely classified credits are assigned risk classifications by the surveillance group using the guidelines described above. As of March 31, 2011, there are 3 CDS contracts on Ambacs adversely
classified credit listing, with a net derivative liability value (at fair value) of $22,561 and total notional principal outstanding of $242,915.

Financial Services Derivative Products:

Ambac, through its subsidiary
Ambac Financial Services (AFS), provided interest rate and currency swaps to states, municipalities and their authorities, asset-backed issuers and other entities in connection with their financings. AFS manages its interest rate swaps
business with the goal of being market neutral to changes in benchmark interest rates while retaining some basis risk and excess interest rate sensitivity as an economic hedge against the effects of rising interest rates elsewhere in the Company,
including on Ambacs financial guarantee exposures. Basis risk in the portfolio arises primarily from (i) variability in the ratio of benchmark tax-exempt to taxable interest rates, (ii) potential changes in the counterparty bond
issuers bond-specific variable rates relative to taxable interest rates, and (iii) variability between Treasury and swap rates. The derivative portfolio also includes an unhedged Sterling-denominated exposure to Consumer Price Inflation
in the United Kingdom. As of March 31, 2011 and December 31, 2010 the notional amounts of AFSs trading derivative products are as follows:



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



|                                               |  |                        |           |  |                           |   |           | 
|---------------------------------------------- |  | ---------------------- | --------- |  | ------------------------- | - | --------- | 
|Type of derivative                             |  | NotionalMarch 31, 2011 |           |  | NotionalDecember 31, 2010 |  
|Interest rate swapsreceive-fixed/pay-variable |  | $                      | 1,605,988 |  |                           | $ | 1,798,704 | 
|Interest rate swapspay-fixed/receive-variable |  |                        | 3,929,371 |  |                           |   | 3,802,086 | 
|Interest rate swapsbasis swaps                |  |                        | 231,250   |  |                           |   | 231,250   | 
|Currency swaps                                 |  |                        | 31,364    |  |                           |   | 35,971    | 
|Futures contracts                              |  |                        | 107,500   |  |                           |   | 290,000   | 
|Other contracts                                |  |                        | 144,060   |  |                           |   | 154,045   | 

The following tables
summarize the location and amount of gains and losses of derivative contracts held for trading purposes in the Consolidated Statement of Operations for the three months ended March 31, 2011 and 2010:



|                                                    |  |                                                                             |  |                                                                                                          |        |   |                                                                                                          |   |          |  
|--------------------------------------------------- |  | --------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------- | ------ | - | -------------------------------------------------------------------------------------------------------- | - | -------- | -
|                                                    |  | Location of Gain or (Loss)Recognized in ConsolidatedStatement of Operations |  | Amount of Gain or(Loss) Recognizedin ConsolidatedStatement
ofOperations Threemonths endedMarch 31, 2011 |        |   | Amount of Gain or(Loss) Recognizedin ConsolidatedStatement
ofOperations Threemonths endedMarch 31, 2010 |  
|Financial Guarantee:                                |  |                                                                             |  |                                                                                                          |        |   |                                                                                                          |   |          |  
|Credit derivatives                                  |  | Net change in fair value of credit derivatives                              |  | $                                                                                                        | (8,903 | ) |                                                                                                          | $ | (167,139 | )
|Financial Services derivatives products:            |  |                                                                             |  |                                                                                                          |        |   |                                                                                                          |   |          |  
|Interest rate swaps                                 |  | Derivative products                                                         |  |                                                                                                          | 23,692 |   |                                                                                                          |   | 21,629   |  
|Currency swaps                                      |  | Derivative products                                                         |  |                                                                                                          | (202   | ) |                                                                                                          |   | (72,113  | )
|Futures contracts                                   |  | Derivative products                                                         |  |                                                                                                          | (2,568 | ) |                                                                                                          |   | (8,240   | )
|Other derivatives                                   |  | Derivative products                                                         |  |                                                                                                          | 88     |   |                                                                                                          |   | 474      |  
|                                                    |  |                                                                             |  |                                                                                                          |        |   |                                                                                                          |   |          |  
|Total Financial Services derivative products        |  |                                                                             |  |                                                                                                          | 21,010 |   |                                                                                                          |   | (58,250  | )
|                                                    |  |                                                                             |  |                                                                                                          |        |   |                                                                                                          |   |          |  
|Total derivative contractsheld for trading purposes |  |                                                                             |  | $                                                                                                        | 12,107 |   |                                                                                                          | $ | (225,389 | )
|                                                    |  |                                                                             |  |                                                                                                          |        |   |                                                                                                          |   |          |  

Derivative Contracts used for Non-Trading and Hedging Purposes:

Interest rate and currency swaps have been used to manage specified risks of changes in fair value or cash flows caused by variations in
interest rates and foreign currency exchange rates. These risks exist within the investment agreement business primarily related to differences in coupon interest terms between investment agreement contracts and invested assets that support those
contracts. There were no designated hedges in effect under ASC Topic 815 subsequent to December 31, 2009. Additionally, the remaining derivative contracts that were not designated hedges under ASC Topic 815, but were considered by management to
be for non-trading and hedging purposes, expired during 2010.

Net gains (losses) recognized on such contracts recognized as
part of net mark-to-market gains (losses) on non-trading derivative contracts was $0 and ($3,895) for the three months ended March 31, 2011 and 2010, respectively.

Call Option on Long-Term Debt

Ambac Assurance has certain contractual
options to repurchase its surplus notes at a discount to their par value, and are considered stand-alone derivatives. The surplus notes were issued in connection with a settlement agreement with certain bank counterparties to credit default swaps in
June 2010 and are classified under Long-term debt on the Consolidated Balance Sheet. The amount of surplus notes that may be repurchased under these options is $500,000 at March 31, 2011 and December 31, 2010. The fair value of the options
were $16,725 and $0 as of March 31, 2011 and December 31, 2010, respectively. Gains of $16,725 and $0 from the change in fair value of the call options were recognized within Financial Guarantee: Other income in the Consolidated Statement
of Operations for the three months ended March 31, 2011 and 2010, respectively.



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



Contingent Features in Derivatives Related to Ambac Credit Risk:

Ambacs interest rate swaps and currency swaps with professional swap-dealer counterparties and certain front-end counterparties are
generally executed under standardized derivative documents including collateral support and master netting agreements. Under these agreements, Ambac is required to post collateral in the event net unrealized losses exceed predetermined threshold
levels. Additionally, given that Ambac Assurance is no longer rated by an independent rating agency, counterparties have the right to terminate the swap positions.

As of March 31, 2011 and December 31, 2010, the aggregate fair value of all derivative instruments with contingent features linked to Ambacs own credit risk that are in a net liability
position after considering legal rights of offset was $11,785 and $31,739, respectively, related to which Ambac had posted assets as collateral with a fair value of $107,084 and $123,519, respectively. All such ratings-based contingent features have
been triggered as of March 31, 2011, requiring maximum collateral levels to be posted by Ambac while preserving counterparties rights to terminate the contracts. Assuming all contracts terminated on March 31, 2011, settlement of
collateral balances and net derivative liabilities would result in a net receipt of cash and/or securities by Ambac. If counterparties elect to exercise their right to terminate, the actual termination payment amounts will be determined in
accordance with derivative contract terms, which may result in amounts that differ from market values as reported in Ambacs financial statements.

(8) Income Taxes

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  |  |          | 2005 | 
|New York State |  |          | 2008 | 
|New York City  |  |          | 2000 | 
|United Kingdom |  |          | 2005 | 
|Italy          |  |          | 2006 | 

As of March 31,
2011 and December 31, 2010, the liability for unrecognized tax benefits is approximately $23,100 and $23,050, respectively. Included in these balances at March 31, 2011, and December 31, 2010 are $23,100 and $23,050, respectively, of
unrecognized tax benefits that, if recognized, would affect the effective tax rate.

Ambac accrues interest and penalties
related to unrecognized tax benefits in the provision for income taxes. During the three months ended March 31, 2011 and 2010, Ambac recognized interest of approximately $50 and $50 respectively. Ambac had approximately $15,270 and $15,220 for
the payment of interest accrued at March 31, 2011 and December 31, 2010, respectively.

As a result of the
development of additional losses and the related impact on the Companys cash flows, management believes it is more likely than not that the Company will not generate sufficient taxable income to recover the deferred tax operating asset. As of
March 31, 2011 a full valuation allowance of $2,676,288 has been established against the deferred tax asset. As of December 31, 2010, the company had a valuation allowance of $2,411,107.



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



(9) Investments

ASC Topic 320, Investment  Debt and Equity Securitiesrequires that all debt instruments and certain equity instruments be classified in Ambacs Consolidated Balance Sheets according to
their purpose and, depending on that classification, be carried at either cost or fair market value. Ambacs investment portfolio is accounted for on a trade-date basis and consists primarily of investments in fixed income securities that are
considered available-for-sale as defined by ASC Topic 320. Available-for-sale securities are reported in the financial statements at fair value with unrealized gains and losses, net of deferred taxes, reflected in Accumulated Other Comprehensive
Income in Stockholders Equity and are computed using amortized cost as the basis. Fair value is based primarily on quotes obtained from independent market sources. When quotes are not available, valuation models are used to estimate fair
value. These models include estimates, made by management, which utilize current market information. The quotes received or valuation results from valuation models could differ materially from amounts that would actually be realized in the market.
For purposes of computing amortized cost, premiums and discounts are accounted for using the effective interest method over the remaining term of the securities. For securities that are not structured securities with a large underlying pool of
homogenous loans, such as typical corporate and municipal bonds, premiums and discounts are amortized or accreted over the remaining term of the securities even if they are callable. Premiums and discounts on mortgage-backed and asset-backed
securities are adjusted for the effects of actual and anticipated prepayments on a retrospective basis. Certain short-term investments, such as money market funds, are carried at cost, which approximates fair value. Realized gains and losses on the
sale of investments are determined on the basis of specific identification.

VIE investments in fixed income securities are
carried at fair value under the fair value option in accordance with ASC Topic 825. For additional information about VIE investments, including fair value by asset-type, see Note 4.



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The amortized cost and estimated fair value of investments, excluding VIE investments,
at March 31, 2011 and December 31, 2010 were as follows:



|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|---------------------------------------------- |  | ------------- | --------- |  | --------------------- | - | ------- | ---------------------- |  | - | -------------------- |  |  | --------------------------------------------- | --------- |  |  | - | ----- | 
|                                               |  | AmortizedCost |           |  | Gross UnrealizedGains |   |         | Gross UnrealizedLosses |  |   | Estimated Fair Value |  |  | Non-credit other-than-temporaryImpairments(1) |          
|March 31, 2011
Fixed income securities:        |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|Municipal obligations                          |  | $             | 2,185,683 |  |                       | $ | 51,036  |                        |  | $ | 9,867                |  |  | $                                             | 2,226,852 |  |  | $ |      | 
|Corporate obligations                          |  |               | 943,183   |  |                       |   | 45,141  |                        |  |   | 14,997               |  |  |                                               | 973,327   |  |  |   |      | 
|Foreign obligations                            |  |               | 93,134    |  |                       |   | 4,238   |                        |  |   |                     |  |  |                                               | 97,372    |  |  |   |      | 
|U.S. government obligations                    |  |               | 119,200   |  |                       |   | 2,733   |                        |  |   | 69                   |  |  |                                               | 121,864   |  |  |   |      | 
|U.S. agency obligations                        |  |               | 81,646    |  |                       |   | 5,919   |                        |  |   |                     |  |  |                                               | 87,565    |  |  |   |      | 
|Residential mortgage-backed securities         |  |               | 1,236,361 |  |                       |   | 369,791 |                        |  |   | 43,001               |  |  |                                               | 1,563,151 |  |  |   |      | 
|Collateralized debt obligations                |  |               | 38,237    |  |                       |   | 25      |                        |  |   | 7,633                |  |  |                                               | 30,629    |  |  |   |      | 
|Other asset-backed securities                  |  |               | 997,994   |  |                       |   | 21,929  |                        |  |   | 37,211               |  |  |                                               | 982,712   |  |  |   |      | 
|Short-term                                     |  |               | 792,426   |  |                       |   |        |                        |  |   |                     |  |  |                                               | 792,426   |  |  |   |      | 
|Other                                          |  |               | 100       |  |                       |   |        |                        |  |   |                     |  |  |                                               | 100       |  |  |   |      | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|                                               |  |               | 6,487,964 |  |                       |   | 500,812 |                        |  |   | 112,778              |  |  |                                               | 6,875,998 |  |  |   |      | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|Fixed income securities pledged as collateral: |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|U.S. government obligations                    |  |               | 97,106    |  |                       |   | 1,718   |                        |  |   |                     |  |  |                                               | 98,824    |  |  |   |      | 
|Residential mortgage-backed securities         |  |               | 7,833     |  |                       |   | 427     |                        |  |   |                     |  |  |                                               | 8,260     |  |  |   |      | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|Total collateralized investments               |  |               | 104,939   |  |                       |   | 2,145   |                        |  |   |                     |  |  |                                               | 107,084   |  |  |   |      | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|Total investments                              |  | $             | 6,592,903 |  |                       | $ | 502,957 |                        |  | $ | 112,778              |  |  | $                                             | 6,983,082 |  |  | $ |      | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|                                               |  |               |           |  |                      
|December 31, 2010
Fixed income securities:     |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|Municipal obligations                          |  | $             | 2,161,627 |  |                       | $ | 54,093  |                        |  | $ | 11,614               |  |  | $                                             | 2,204,106 |  |  | $ |      | 
|Corporate obligations                          |  |               | 897,670   |  |                       |   | 44,015  |                        |  |   | 23,777               |  |  |                                               | 917,908   |  |  |   |      | 
|Foreign obligations                            |  |               | 113,127   |  |                       |   | 5,328   |                        |  |   |                     |  |  |                                               | 118,455   |  |  |   |      | 
|U.S. government obligations                    |  |               | 153,609   |  |                       |   | 3,299   |                        |  |   | 35                   |  |  |                                               | 156,873   |  |  |   |      | 
|U.S. agency obligations                        |  |               | 81,696    |  |                       |   | 6,598   |                        |  |   |                     |  |  |                                               | 88,294    |  |  |   |      | 
|Residential mortgage-backed securities         |  |               | 1,239,107 |  |                       |   | 300,302 |                        |  |   | 40,717               |  |  |                                               | 1,498,692 |  |  |   | 1,111 | 
|Collateralized debt obligations                |  |               | 40,997    |  |                       |   | 391     |                        |  |   | 9,132                |  |  |                                               | 32,256    |  |  |   |      | 
|Other asset-backed securities                  |  |               | 1,019,894 |  |                       |   | 28,274  |                        |  |   | 43,857               |  |  |                                               | 1,004,311 |  |  |   |      | 
|Short-term                                     |  |               | 708,797   |  |                       |   |        |                        |  |   |                     |  |  |                                               | 708,797   |  |  |   |      | 
|Other                                          |  |               | 100       |  |                       |   |        |                        |  |   |                     |  |  |                                               | 100       |  |  |   |      | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|                                               |  |               | 6,416,624 |  |                       |   | 442,300 |                        |  |   | 129,132              |  |  |                                               | 6,729,792 |  |  |   | 1,111 | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|Fixed income securities pledged as collateral: |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|U.S. government obligations                    |  |               | 113,232   |  |                       |   | 2,170   |                        |  |   |                     |  |  |                                               | 115,402   |  |  |   |      | 
|Residential mortgage-backed securities         |  |               | 7,686     |  |                       |   | 431     |                        |  |   |                     |  |  |                                               | 8,117     |  |  |   |      | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|Total collateralized investments               |  |               | 120,918   |  |                       |   | 2,601   |                        |  |   |                     |  |  |                                               | 123,519   |  |  |   |      | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 
|Total investments                              |  | $             | 6,537,542 |  |                       | $ | 444,901 |                        |  | $ | 129,132              |  |  | $                                             | 6,853,311 |  |  | $ | 1,111 | 
|                                               |  |               |           |  |                       |   |         |                        |  |   |                      |  |  |                                               |           |  |  |   |       | 



|(1) | Represents the amount of non-credit other-than-temporary impairment losses remaining in accumulated other comprehensive loss on securities that also had a credit
impairment. These losses are included in gross unrealized losses as of March 31, 2011 and December 31, 2010.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Foreign obligations at March 31, 2011 and December 31, 2010 consist primarily of government issued securities which are denominated in Pounds Sterling and held by Ambac Assurance UK, Limited.



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The amortized cost and estimated fair value of investments, excluding VIE investments,
at March 31, 2011, by contractual maturity, were as follows:



|                                       |  |               |           |  |                     |   |           | 
|-------------------------------------- |  | ------------- | --------- |  | ------------------- | - | --------- | 
|                                       |  | AmortizedCost |           |  | EstimatedFair Value |  
|Due in one year or less                |  | $             | 889,352   |  |                     | $ | 891,721   | 
|Due after one year through five years  |  |               | 748,371   |  |                     |   | 777,447   | 
|Due after five years through ten years |  |               | 892,007   |  |                     |   | 920,185   | 
|Due after ten years                    |  |               | 1,782,748 |  |                     |   | 1,808,977 | 
|                                       |  |               |           |  |                     |   |           | 
|                                       |  |               | 4,312,478 |  |                     |   | 4,398,330 | 
|Residential mortgage-backed securities |  |               | 1,244,194 |  |                     |   | 1,571,411 | 
|Collateralized debt obligations        |  |               | 38,237    |  |                     |   | 30,629    | 
|Other asset-backed securities          |  |               | 997,994   |  |                     |   | 982,712   | 
|                                       |  |               |           |  |                     |   |           | 
|                                       |  | $             | 6,592,903 |  |                     | $ | 6,983,082 | 
|                                       |  |               |           |  |                     |   |           | 

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

Unrealized Losses:

The following table shows gross unrealized losses and fair values of Ambacs investments, aggregated by investment category and
length of time that the individual securities have been in a continuous unrealized loss position, at March 31, 2011 and December 31, 2010:



|                                       |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 
|-------------------------------------- |  | ------------------- | ------- |  | ------------------- | - | ------ | ---------- |  | - | ------------------- |  |  | ---------- | ------- |  | ------------------- | - | --------- |  |  | - | ------- | 
|                                       |  | Less Than 12 Months |         |  | 12 Months or More   |   |        | Total      | 
|                                       |  | Fair Value          |         |  | GrossUnrealizedLoss |   |        | Fair Value |  |   | GrossUnrealizedLoss |  |  | Fair Value |         |  | GrossUnrealizedLoss |  
|March 31, 2011:                        |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 
|Fixed income securities:               |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 
|Municipal obligations.                 |  | $                   | 296,204 |  |                     | $ | 7,440  |            |  | $ | 35,863              |  |  | $          | 2,427   |  |                     | $ | 332,067   |  |  | $ | 9,867   | 
|Corporate obligations                  |  |                     | 65,438  |  |                     |   | 1,441  |            |  |   | 201,021             |  |  |            | 13,556  |  |                     |   | 266,459   |  |  |   | 14,997  | 
|U.S. government obligations            |  |                     | 4,969   |  |                     |   | 69     |            |  |   |                    |  |  |            |        |  |                     |   | 4,969     |  |  |   | 69      | 
|U.S. agency obligations                |  |                     | 1,186   |  |                     |   |       |            |  |   |                    |  |  |            |        |  |                     |   | 1,186     |  |  |   |        | 
|Residential mortgage-backed securities |  |                     | 121,146 |  |                     |   | 5,045  |            |  |   | 121,096             |  |  |            | 37,956  |  |                     |   | 242,242   |  |  |   | 43,001  | 
|Collateralized debt obligations        |  |                     |        |  |                     |   |       |            |  |   | 30,027              |  |  |            | 7,633   |  |                     |   | 30,027    |  |  |   | 7,633   | 
|Other asset-backed securities          |  |                     | 149,130 |  |                     |   | 2,487  |            |  |   | 305,998             |  |  |            | 34,724  |  |                     |   | 455,128   |  |  |   | 37,211  | 
|                                       |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 
|Total temporarily impaired securities  |  | $                   | 638,073 |  |                     | $ | 16,482 |            |  | $ | 694,005             |  |  | $          | 96,296  |  |                     | $ | 1,332,078 |  |  | $ | 112,778 | 
|                                       |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 
|December 31, 2010:                     |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 
|Fixed income securities:               |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 
|Municipal obligations.                 |  | $                   | 281,760 |  |                     | $ | 7,633  |            |  | $ | 33,946              |  |  | $          | 3,981   |  |                     | $ | 315,706   |  |  | $ | 11,614  | 
|Corporate obligations                  |  |                     | 51,806  |  |                     |   | 1,691  |            |  |   | 212,417             |  |  |            | 22,086  |  |                     |   | 264,223   |  |  |   | 23,777  | 
|U.S. government obligations            |  |                     | 4,981   |  |                     |   | 35     |            |  |   |                    |  |  |            |        |  |                     |   | 4,981     |  |  |   | 35      | 
|Residential mortgage-backed securities |  |                     | 22,180  |  |                     |   | 537    |            |  |   | 127,782             |  |  |            | 40,180  |  |                     |   | 149,962   |  |  |   | 40,717  | 
|Collateralized debt obligations        |  |                     |        |  |                     |   |       |            |  |   | 30,433              |  |  |            | 9,132   |  |                     |   | 30,433    |  |  |   | 9,132   | 
|Other asset-backed securities          |  |                     | 101,950 |  |                     |   | 1,515  |            |  |   | 440,731             |  |  |            | 42,342  |  |                     |   | 542,681   |  |  |   | 43,857  | 
|                                       |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 
|Total temporarily impaired securities  |  | $                   | 462,677 |  |                     | $ | 11,411 |            |  | $ | 845,309             |  |  | $          | 117,721 |  |                     | $ | 1,307,986 |  |  | $ | 129,132 | 
|                                       |  |                     |         |  |                     |   |        |            |  |   |                     |  |  |            |         |  |                     |   |           |  |  |   |         | 

Ambac has a formal impairment review process for all securities in its investment portfolio. Ambac conducts
a review each quarter to identify and evaluate investments that have indications of possible impairment that is other than temporary in accordance with ASC Topic 320. Factors considered



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



when assessing impairment include: (i) fair values that have declined by 20% or more below amortized cost; (ii) market values that have declined by 5% or more but less than 20% below
amortized cost for a continuous period of at least six months; (iii) recent downgrades by rating agencies; (iv) the financial condition of the issuer and financial guarantor, as applicable, and an analysis of projected defaults on the
underlying collateral; (v) whether scheduled interest payments are past due; and (vi) whether Ambac has the ability and intent to hold the security for a sufficient period of time to allow for anticipated recoveries in fair value. If we
believe a decline in the fair value of a particular investment is temporary, we record the decline as an unrealized loss net of tax in Accumulated Other Comprehensive Income in Stockholders Equity on our Consolidated Balance Sheets. If
management either: (i) has the intent to sell its investment in a debt security or (ii) determines that the Company more likely than not will be required to sell the debt security before its anticipated recovery of the amortized cost basis
less any current period credit impairment, then an other-than-temporary impairment charge must be recognized in earnings, with the amortized cost of the security being written-down to fair value. If these conditions are not met, but it is determined
that a credit loss exists, the credit impairment loss is recognized in earnings, and the other-than-temporary amount related to all other factors is recognized in other comprehensive income. For fixed income securities that have other-than-temporary
impairments in a period, the previous amortized cost of the security less the amount of the other-than-temporary impairment recorded through earnings, becomes the investments new cost basis. Ambac accretes the new cost basis to par or to the
estimated future cash flows to be recovered over the expected remaining life of the security using the effective interest rate of the security prior to impairment.

Management has determined that the unrealized losses reflected in the table above are temporary in nature as of March 31, 2011 and December 31, 2010 based upon (i) no unexpected principal
and interest payment defaults on these securities; (ii) analysis of the creditworthiness of the issuer and financial guarantor, as applicable, and analysis of projected defaults on the underlying collateral; (iii) management has no intent
to sell these investments in debt securities; and (iv) it is not more likely than not that Ambac will be required to sell these debt securities before the anticipated recovery of its amortized cost basis. The assessment under (iv) is based
on a comparison of future available liquidity from the fixed income investment portfolio against the projected net cash outflow from operating activities and debt service. For purposes of this assessment, available liquidity from the fixed income
investment portfolio is comprised of the fair value of securities for which management has asserted its intent to sell plus the scheduled maturities and interest payments from the remaining securities in the portfolio. To the extent that securities
that management intends to sell are in an unrealized loss position, they would have already been considered other-than-temporarily impaired with the amortized cost written down to fair value. As of March 31, 2011 and December 31, 2010,
management has not asserted an intent to sell any securities from its portfolio. Because the above-described assessment indicates that future available liquidity exceeds projected net cash outflow, it is not more likely than not that we would be
required to sell securities before the recovery of their amortized cost basis. In the liquidity assessment described above, principal payments on securities pledged as collateral are not considered to be available for other liquidity needs until the
collateralized positions are projected to be settled. Projected interest receipts on securities pledged as collateral generally belong to Ambac and are considered to be sources of available liquidity from the investment portfolio. As of
March 31, 2011 and December 31, 2010, for securities that have indications of possible other-than-temporary impairment but which management does not intend to sell and will not more likely than not be required to sell, management compared
the present value of cash flows expected to be collected to the amortized cost basis of the securities to assess whether the amortized cost will be recovered. Cash flows were discounted at the effective interest rate implicit in the security at the
date of acquisition. For floating rate securities, future cash flows and the discount rate used were both adjusted to reflect changes in the index rate applicable to each security as of the evaluation date.

Of the securities that were in a gross unrealized loss position at March 31, 2011, $207,621 of the total fair value and $34,493 of
the unrealized loss related to below investment grade securities and non-rated securities. Of the securities that were in a gross unrealized loss position at December 31, 2010,



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



$110,120 of the total fair value and $31,521 of the unrealized loss related to below investment grade securities and non-rated securities.

Corporate obligations:

The decrease in gross unrealized losses on corporate obligations during the three months ended March 31, 2011, is primarily the result of a decrease in credit spreads on life insurers. Of the $13,556
of unrealized losses on corporate obligations greater than 12 months, one security comprises $7,823 of the total. This security, which was purchased in multiple lots, is a closed-block life insurance issuance that is insured by Assured Guaranty
Municipal Corporation, has been in an unrealized loss position for 20-39 months. The unrealized loss on this security is the result of general credit spread widening on life insurers. Given the insured rating of AA- and Investment Grade underlying
rating, management believes that timely receipt of all principal and interest is probable.

Residential mortgage-backed
securities:

The gross unrealized loss on mortgage-backed securities as of March 31, 2011 is primarily related to
Alt-A residential mortgage-backed securities. Of the $37,956 of unrealized losses on mortgage-backed securities for greater than 12 months, $37,934 or 99.9%, is attributable to 16 individual Alt-A securities. These individual securities have been in
an unrealized loss position for 39 months. Each of these Alt-A securities have very similar characteristics such as vintage of the underlying collateral (2004-2007) and placement in the structure (generally class-A tranche rated triple-A at
issuance). The significant declines in fair value relate to the actual and potential effects of declining U.S. housing prices, recent recession and weak economic conditions in general on the performance of collateral underlying residential mortgage
backed securities. This has been reflected in decreased liquidity for RMBS securities and increased risk premiums demanded by investors resulting in a required return on investment that is significantly higher than at the time the securities were
purchased.

As part of the quarterly impairment review process, management estimates expected future cash flows from
residential mortgage backed securities, considering the likelihood of a wide dispersion of possible outcomes to develop cash flow scenarios. Management has contracted consultants to model each of the securities in our portfolio. This
approach includes the utilization of market accepted software tools in conjunction with detailed data of the historical performance of the collateral pools, which assists in the determination of assumptions such as defaults, severity and voluntary
prepayment rates that are largely driven by home price forecasts as well as other macro-economic factors. These assumptions are used to project various future cash flow scenarios for each security. The expected future cash flows used to
assess impairment are derived by probability-weighting the various cash flow scenarios. Management considered this analysis in making our determination that non-receipt of contractual cash flows is not probable on these transactions.

Other asset-backed securities:

The decrease in gross unrealized losses on other asset-backed securities during the three months ended March 31, 2011 is the result of improved market liquidity for certain higher quality, shorter
term consumer asset-backed securities. As part of the quarterly impairment review process, management monitors each deals performance metrics and other available qualitative and fundamental information in developing an analytical opinion.
Ambac determined that there is sufficient credit enhancement to mitigate recent market stresses. Management believes that the timely receipt of all principal and interest from other asset-backed securities is probable.



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



Realized Gains and Losses and Other-Than-Temporary Impairments:

The following table details amounts included in net realized investment gains and losses and other-than-temporary
impairments included in earnings for the three months ended March 31, 2011 and 2010:



|                                                                                   |  |                             |        |   |      |   |         |  
|---------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------- | -
|                                                                                   |  | Three months
endedMarch 31, |       
|                                                                                   |  | 2011                        |        |   | 2010 |  
|Gross realized gains on securities                                                 |  | $                           | 3,609  |   |      | $ | 130,526 |  
|Gross realized losses on securities                                                |  |                             | (862   | ) |      |   | (75,000 | )
|Net gain on investment agreement terminations                                      |  |                             |       |   |      |   | 4       |  
|Foreign exchange gains                                                             |  |                             | (297   | ) |      |   | 1,019   |  
|                                                                                   |  |                             |        |   |      |   |         |  
|Net realized gains, excluding other-than-temporary impairments                     |  |                             | 2,450  |   |      |   | 56,549  |  
|Net other-than-temporary impairments                                               |  |                             | (1,713 | ) |      |   | (31,349 | )
|                                                                                   |  |                             |        |   |      |   |         |  
|Total net realized gains and other-than-temporary impairments included in earnings |  | $                           | 737    |   |      | $ | 25,200  |  
|                                                                                   |  |                             |        |   |      |   |         |  

Other-than-temporary impairment charges to earnings for the three months ended March 31, 2011 and 2010
included charges of $857 and $18,032, respectively in credit losses on securities guaranteed by Ambac Assurance. Additionally, other-than-temporary impairments for the three months ended March 31, 2011 included charges of $856 related to
write-downs of certain other securities that were believed to be credit impaired. As further described in Note 1, on March 24, 2010, the OCI commenced Segregated Account Rehabilitation Proceedings in order to permit the OCI to facilitate an
orderly run-off and/or settlement of the liabilities allocated to the Segregated Account. As a result of actions taken by OCI, financial guarantee payments on securities guaranteed by Ambac Assurance which have been placed in the Segregated Account
are no longer under the control of Ambac management. Accordingly, estimated cash flows on such securities have been adversely impacted resulting in credit losses. Additionally, other-than-temporary impairment charges for the three months ended
March 31, 2010 included charges of $13,317 to write-down the amortized cost basis of tax-exempt municipal bonds and student loan securities to fair value at their respective impairment date, as a result of managements intent to sell
securities in connection with plans to reposition the investment portfolio and meet general liquidity needs.

Credit losses on
Ambac-guaranteed securities which are included in other-than-temporary impairments for the three months ended March 31, 2011 were estimated using market accepted cash flow models and inputs consistent with those used to develop loss reserves
described in Note 6. These credit losses relate primarily to Ambac-guaranteed RMBS senior bonds collateralized by either first or second-lien mortgage products.

Future cash flows used to measure credit impairment of Ambac-wrapped bonds represents the sum of (i) the bonds intrinsic cash flows and (ii) the estimated fair value of Ambac claim
payments. Under the Segregated Account Rehabilitation Plan, future claim payments made by Ambac Assurance on these securities would be satisfied 25% in cash and 75% in surplus notes. However, it is uncertain whether the actual form and amount of
claim payments ultimately approved by OCI and implemented will conform to that set forth in the Segregated Account Rehabilitation Plan. As a result, estimation of the fair value of future claim payments is highly subjective. Beginning with the
March 31, 2011 analysis, market standard cash flow tools were used to isolate the portion of a securitys projected cash flows attributable to the financial guarantee. In prior periods, due to limitations on such cash flow tools, our
analysis of credit impairment of Ambac-guaranteed securities in our investment portfolio reflected a weighted average of estimated future cash flows under two scenarios: (i) the with guarantor scenario in which Ambac Assurance pays
100% of its claims in cash and (ii) the without guarantor scenario that fully excludes payments from Ambac Assurance .



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The following table presents a roll-forward of Ambacs cumulative credit
impairments that were recognized in earnings on securities held as of March 31, 2011:



|                                                            |  |                  |         | 
|----------------------------------------------------------- |  | ---------------- | ------- | 
|                                                            |  | CreditImpairment |        
|Balance as of January 1, 2011                               |  | $                | 139,766 | 
|Additions for credit impairments recognized on(1):          |  |                  |         | 
|Securities not previously impaired                          |  |                  |        | 
|Securities previously impaired                              |  |                  | 857     | 
|Reductions for credit impairments previously recognized on: |  |                  |         | 
|Securities that matured or were sold during the period      |  |                  |        | 
|                                                            |  |                  |         | 
|Balance as of March 31, 2011                                |  | $                | 140,623 | 
|                                                            |  |                  |         | 



|(1) | These additions are included in the Financial Guarantee net other-than-temporary impairment losses recognized in earnings of $1,713 in the Consolidated Statements of
Operations, as well as impairments on securities for which Ambac intended to sell.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Collateral and
Deposits with Regulators:

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



| | (1) | Cash and securities held in Ambacs investment portfolio  Ambac pledges assets it holds in its investment portfolio to investment and payment
agreement counterparties, and derivative counterparties. Securities pledged to investment and payment agreement counterparties may not then be re-pledged to another entity. Ambacs counterparties under derivative agreements have the right to
pledge or rehypothecate the securities and as such, pledged securities are separately classified on the Consolidated Balance Sheets as Fixed income securities pledged as collateral, at fair value.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (2) | Cash and securities pledged to Ambac under derivative agreements  Ambac may repledge securities it holds from certain derivative counterparties to other
derivative counterparties in accordance with its rights and obligations under those agreements.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The following table presents (i) the sources of collateral either received from
various counterparties where Ambac is permitted to sell or re-pledge or directly held in the investment portfolio and (ii) how that collateral was pledged to various investment and payment agreement, derivative and repurchase agreement
counterparties at March 31, 2011 and December 31, 2010:



|                                                                   |  |                                           |         |  |                                                                                         |   |         |                                                                   |  |   |         | 
|------------------------------------------------------------------ |  | ----------------------------------------- | ------- |  | --------------------------------------------------------------------------------------- | - | ------- | ----------------------------------------------------------------- |  | - | ------- | 
|                                                                   |  | Fair Value ofCash andUnderlyingSecurities |         |  | Fair Value of Cashand SecuritiesPledged toInvestment
andPayment AgreementCounterparties |   |         | Fair Value ofCash andSecuritiesPledged toDerivativeCounterparties | 
|March 31, 2011:                                                    |  |                                           |         |  |                                                                                         |   |         |                                                                   |  |   |         | 
|Sources of Collateral:                                             |  |                                           |         |  |                                                                                         |   |         |                                                                   |  |   |         | 
|Cash and securities pledged directly from the investment portfolio |  | $                                         | 856,458 |  |                                                                                         | $ | 745,989 |                                                                   |  | $ | 110,469 | 
|                                                                   |  |                                           |        
|Cash and securities pledged from its derivative counterparties     |  |                                           |        |  |                                                                                         |   |        |                                                                   |  |   |        | 
|                                                                   |  |                                           |        
|December 31, 2010:                                                 |  |                                           |         |  |                                                                                         |   |         |                                                                   |  |   |         | 
|Sources of Collateral:                                             |  |                                           |         |  |                                                                                         |   |         |                                                                   |  |   |         | 
|                                                                   |  |                                           |        
|Cash and securities pledged directly from the investment portfolio |  | $                                         | 962,919 |  |                                                                                         | $ | 846,124 |                                                                   |  | $ | 116,795 | 
|                                                                   |  |                                           |        
|Cash and securities pledged from its derivative counterparties     |  |                                           | 7,005   |  |                                                                                         |   |        |                                                                   |  |   | 7,005   | 

Securities carried at
$6,924 and $6,947 at March 31, 2011 and December 31, 2010, respectively, were deposited by Ambac Assurance and Everspan with governmental authorities or designated custodian banks as required by laws affecting insurance companies.

(10) Segment Information

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

Ambac Assurance guarantees the swap and
investment agreement obligations of its Financial Services affiliates. Additionally, Ambac Assurance provides loans to the Financial Services businesses. Inter-segment revenues include the premiums and investment income earned under those
agreements. 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 (i) investment advisory, consulting and research services
to the structured credit markets from RangeMark in 2010, and (ii) corporate activities, including interest income on the investment portfolio (2011 and 2010) and interest expense on debentures in 2010. Corporate and other revenue from
unaffiliated customers consists primarily of income from investments.

The following table is a summary of financial
information by reportable segment as of and for the three months ended March 31, 2011 and 2010:



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|-------------------------------- |  | ------------------ | ---------- | - | ----------------- | - | --------- | ------------------ |  | - | ------------------------- | - |  | ------------ | ---- | - |  | - | ---------- | -
|Three months ended March 31,     |  | FinancialGuarantee |            |   | FinancialServices |   |           | Corporateand Other |  |   | Inter-segmentEliminations |   |  | Consolidated |     
|2011:                            |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Revenues:                        |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Unaffiliated customers           |  | $                  | 175,011    |   |                   | $ | 28,195    |                    |  | $ | 77                        |   |  | $            |     |   |  | $ | 203,283    |  
|Inter-segment                    |  |                    | 22,679     |   |                   |   | (22,605   | )                  |  |   |                          |   |  |              | (74  | ) |  |   |           |  
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Total revenues                   |  | $                  | 197,690    |   |                   | $ | 5,590     |                    |  | $ | 77                        |   |  | $            | (74  | ) |  | $ | 203,283    |  
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Income before income taxes:      |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Unaffiliated customers           |  | $                  | (815,081   | ) |                   | $ | 23,390    |                    |  | $ | (400                      | ) |  | $            |     |   |  | $ | (792,091   | )
|Inter-segment                    |  |                    | 21,290     |   |                   |   | (21,826   | )                  |  |   | 536                       |   |  |              |     |   |  |   |           |  
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Total income before income taxes |  | $                  | (793,791   | ) |                   | $ | 1,564     |                    |  | $ | 136                       |   |  | $            |     |   |  | $ | (792,091   | )
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Total assets                     |  | $                  | 25,895,317 |   |                   | $ | 1,447,059 |                    |  | $ | 67,928                    |   |  | $            |     |   |  | $ | 27,410,304 |  
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|2010:                            |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Revenues:                        |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Unaffiliated customers           |  | $                  | (449,155   | ) |                   | $ | (50,288   | )                  |  | $ | 304                       |   |  | $            |     |   |  | $ | (499,139   | )
|Inter-segment                    |  |                    | 31,632     |   |                   |   | (31,528   | )                  |  |   |                          |   |  |              | (104 | ) |  |   |           |  
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Total revenues                   |  | $                  | (417,523   | ) |                   | $ | (81,816   | )                  |  | $ | 304                       |   |  | $            | (104 | ) |  | $ | (499,139   | )
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Income before income taxes:      |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Unaffiliated customers           |  | $                  | (588,803   | ) |                   | $ | (59,349   | )                  |  | $ | (41,803                   | ) |  | $            |     |   |  | $ | (689,955   | )
|Inter-segment                    |  |                    | 29,505     |   |                   |   | (30,200   | )                  |  |   | 695                       |   |  |              |     |   |  |   |           |  
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Total income before income taxes |  | $                  | (559,298   | ) |                   | $ | (89,549   | )                  |  | $ | (41,108                   | ) |  | $            |     |   |  | $ | (689,955   | )
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  
|Total assets                     |  | $                  | 33,877,547 |   |                   | $ | 1,804,928 |                    |  | $ | 133,202                   |   |  | $            |     |   |  | $ | 35,815,677 |  
|                                 |  |                    |            |   |                   |   |           |                    |  |   |                           |   |  |              |      |   |  |   |            |  

The following table summarizes gross premiums written, net premiums earned and the net change in fair value
of credit derivatives included in the Financial Guarantee segment by location of risk for the three months ended March 31, 2011 and 2010:



|                    |  |                                   |          |   |                                   |   |        |                                             |  |   |                      |   |  |                   |          |   |                                             |   |         |  |  |   |          |  
|------------------- |  | --------------------------------- | -------- | - | --------------------------------- | - | ------ | ------------------------------------------- |  | - | -------------------- | - |  | ----------------- | -------- | - | ------------------------------------------- | - | ------- |  |  | - | -------- | -
|                    |  | Three Months Ended March 31, 2011 |          |   | Three Months Ended March 31, 2010 |  
|                    |  | GrossPremiumsWritten              |          |   | Net PremiumsEarned                |   |        | Net Change inFair Value ofCreditDerivatives |  |   | GrossPremiumsWritten |   |  | NetPremiumsEarned |          |   | Net Changein Fair Valueof CreditDerivatives |  
|United States       |  | $                                 | (144,266 | ) |                                   | $ | 71,481 |                                             |  | $ | (7,199               | ) |  | $                 | (114,711 | ) |                                             | $ | 96,277  |  |  | $ | (225,040 | )
|United Kingdom      |  |                                   | (7,269   | ) |                                   |   | 10,933 |                                             |  |   | (682                 | ) |  |                   | (8,789   | ) |                                             |   | 12,304  |  |  |   | 4,857    |  
|Other international |  |                                   | (8,676   | ) |                                   |   | 9,385  |                                             |  |   | (1,022               | ) |  |                   | (25,900  | ) |                                             |   | 16,650  |  |  |   | 53,044   |  
|                    |  |                                   |          |   |                                   |   |        |                                             |  |   |                      |   |  |                   |          |   |                                             |   |         |  |  |   |          |  
|Total               |  | $                                 | (160,211 | ) |                                   | $ | 91,799 |                                             |  | $ | (8,903               | ) |  | $                 | (149,400 | ) |                                             | $ | 125,231 |  |  | $ | (167,139 | )
|                    |  |                                   |          |   |                                   |   |        |                                             |  |   |                      |   |  |                   |          |   |                                             |   |         |  |  |   |          |  



48



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



(11) Fair Value Measurements

ASC Topic 820, Fair Value Measurements and Disclosures establishes a framework for measuring fair value and disclosures about fair value
measurements.

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



|                                                                |  |                |            |  |                     |   |            |                |  |   |                     |  |  |   |            | 
|--------------------------------------------------------------- |  | -------------- | ---------- |  | ------------------- | - | ---------- | -------------- |  | - | ------------------- |  |  | - | ---------- | 
|                                                                |  | March 31, 2011 |            |  | December 31, 2010   |  
|                                                                |  | CarryingAmount |            |  | EstimatedFair Value |   |            | CarryingAmount |  |   | EstimatedFair Value | 
|Financial assets:                                               |  |                |            |  |                     |   |            |                |  |   |                     |  |  |   |            | 
|Fixed income securities(1)                                      |  | $              | 6,083,472  |  |                     | $ | 6,083,472  |                |  | $ | 6,020,895           |  |  | $ | 6,020,895  | 
|Fixed income securities pledged as collateral(1)                |  |                | 107,084    |  |                     |   | 107,084    |                |  |   | 123,519             |  |  |   | 123,519    | 
|Short-term investments                                          |  |                | 792,426    |  |                     |   | 792,426    |                |  |   | 708,797             |  |  |   | 708,797    | 
|Other investments                                               |  |                | 100        |  |                     |   | 100        |                |  |   | 100                 |  |  |   | 100        | 
|Cash                                                            |  |                | 7,626      |  |                     |   | 7,626      |                |  |   | 9,497               |  |  |   | 9,497      | 
|Loans                                                           |  |                | 20,397     |  |                     |   | 22,102     |                |  |   | 20,167              |  |  |   | 21,706     | 
|Derivative assets                                               |  |                | 300,849    |  |                     |   | 300,849    |                |  |   | 290,299             |  |  |   | 290,299    | 
|Other assets                                                    |  |                | 19,005     |  |                     |   | 19,005     |                |  |   | 17,909              |  |  |   | 17,909     | 
|Variable interest entity assets:                                |  |                |            |  |                     |   |            |                |  |   |                     |  |  |   |            | 
|Fixed income securities                                         |  |                | 1,929,691  |  |                     |   | 1,929,691  |                |  |   | 1,904,361           |  |  |   | 1,904,361  | 
|Restricted cash                                                 |  |                | 2,190      |  |                     |   | 2,190      |                |  |   | 2,098               |  |  |   | 2,098      | 
|Loans                                                           |  |                | 14,231,947 |  |                     |   | 14,213,197 |                |  |   | 16,005,066          |  |  |   | 15,990,120 | 
|Derivative assets                                               |  |                |           |  |                     |   |           |                |  |   | 4,511               |  |  |   | 4,511      | 
|Financial liabilities:                                          |  |                |            |  |                     |   |            |                |  |   |                     |  |  |   |            | 
|Obligations under investment, repurchase and payment agreements |  | $              | 717,116    |  |                     | $ | 721,716    |                |  | $ | 805,632             |  |  | $ | 811,263    | 
|Liabilities subject to compromise                               |  |                | 1,622,189  |  |                     |   | 122,535    |                |  |   | 1,622,189           |  |  |   | 115,201    | 
|Long-term debt                                                  |  |                | 210,837    |  |                     |   | 502,271    |                |  |   | 208,260             |  |  |   | 270,600    | 
|Derivative liabilities                                          |  |                | 352,245    |  |                     |   | 352,245    |                |  |   | 348,791             |  |  |   | 348,791    | 
|Liability for net financial guarantees written                  |  |                | 6,812,510  |  |                     |   | 2,279,405  |                |  |   | 5,977,077           |  |  |   | 1,638,181  | 
|Variable interest entity liabilities:                           |  |                |            |  |                     |   |            |                |  |   |                     |  |  |   |            | 
|Long-term debt                                                  |  |                | 14,730,527 |  |                     |   | 14,698,968 |                |  |   | 16,101,026          |  |  |   | 16,073,110 | 
|Derivative liabilities                                          |  |                | 1,214,536  |  |                     |   | 1,214,536  |                |  |   | 1,580,120           |  |  |   | 1,580,120  | 



|(1) | See breakout of fixed income securities in Note 9.
|--- | --------------------------------------------------

Fair value Hierarchy:

ASC Topic 820 specifies a fair value
hierarchy based on whether the inputs to valuation techniques used to measure fair value are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect Company-based market
assumptions. In accordance with ASC Topic 820, the fair value hierarchy prioritizes model inputs into three broad levels as follows:



| |  |           |  |   |  |                                                                                                                                                                                                               
| |  | --------- |  | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  Level 1 |  |  |  | Quoted prices for identical instruments in active markets. Assets and liabilities classified as Level 1 include USTreasury securities, exchange traded futures contracts,
money market funds and mutual funds.
| |  |           | 
| |  |  Level 2 |  |  |  | Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in marketsthat are not active; and model-                                                         



49



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



| |  |           |  |   |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |  | --------- |  | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |           |  |   |  | derived valuations in which all significant inputs and significant value drivers are observable in active markets.Assets and liabilities classified as Level 2 generally
include direct investments in fixed income securitiesrepresenting municipal, asset-backed and corporate obligations, financial services derivatives (including certaininterest rate and currency swap derivatives), certain credit derivative
contracts and most long-term debt of variableinterest entities consolidated under ASC Topic 810.                                                                                                                                                                                                                              
| |  |           | 
| |  |  Level 3 |  |  |  | Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. Thishierarchy requires the use of observable market data when
available. Assets and liabilities classified as Level 3include most credit derivative contracts written as part of the financial guarantee business, certain financial servicesinterest rate swaps contracts which are not referenced to commonly
quoted interest rates, call options on long-termdebt and certain investments in fixed income securities. Additionally, Level 3 assets and liabilities generally includefixed income securities and loan receivables, as well as certain long-term
debt of variable interest entitiesconsolidated under ASC Topic 810.



50



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The following table sets forth Ambacs financial assets and liabilities that were
accounted for at fair value as of March 31, 2011 and December 31, 2010 by level within the fair value hierarchy. As required by ASC Topic 820, financial assets and liabilities are classified in their entirety based on the lowest level of
input that is significant to the fair value measurement.



|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|----------------------------------------------- |  | ------- | --------- |  | ------- | - | ---------- | ------- |  | - | ---------- | - |  | - | ---------- | -
|                                                |  | Level 1 |           |  | Level 2 |   |            | Level 3 |  |   | Total      |  
|March 31, 2011                                  |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Financial assets:                               |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Fixed income securities:                        |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Municipal obligations                           |  | $       |          |  |         | $ | 2,226,852  |         |  | $ |           |   |  | $ | 2,226,852  |  
|Corporate obligations                           |  |         |          |  |         |   | 965,391    |         |  |   | 7,936      |   |  |   | 973,327    |  
|Foreign obligations                             |  |         |          |  |         |   | 97,372     |         |  |   |           |   |  |   | 97,372     |  
|U.S. government obligations                     |  |         | 121,864   |  |         |   |           |         |  |   |           |   |  |   | 121,864    |  
|U.S. agency obligations                         |  |         |          |  |         |   | 86,379     |         |  |   | 1,186      |   |  |   | 87,565     |  
|Residential mortgage-backed securities          |  |         |          |  |         |   | 1,563,151  |         |  |   |           |   |  |   | 1,563,151  |  
|Collateralized debt obligations                 |  |         |          |  |         |   | 602        |         |  |   | 30,027     |   |  |   | 30,629     |  
|Other asset-backed securities                   |  |         |          |  |         |   | 821,785    |         |  |   | 160,927    |   |  |   | 982,712    |  
|Short term investments                          |  |         | 792,426   |  |         |   |           |         |  |   |           |   |  |   | 792,426    |  
|Fixed income securities, pledged as collateral: |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|U.S. government obligations                     |  |         | 98,824    |  |         |   |           |         |  |   |           |   |  |   | 98,824     |  
|Residential mortgage-backed securities          |  |         |          |  |         |   | 8,260      |         |  |   |           |   |  |   | 8,260      |  
|Cash                                            |  |         | 7,626     |  |         |   |           |         |  |   |           |   |  |   | 7,626      |  
|Derivative assets:                              |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Interest rate swapsasset position              |  |         |          |  |         |   | 154,428    |         |  |   | 241,174    |   |  |   | 395,602    |  
|Interest rate swapsliability position          |  |         |          |  |         |   | (79        | )       |  |   | (111,399   | ) |  |   | (111,478   | )
|Future contracts                                |  |         |          |  |         |   |           |         |  |   |           |   |  |   |           |  
|Call options on long-term debt                  |  |         |          |  |         |   |           |         |  |   | 16,725     |   |  |   | 16,725     |  
|Other assets                                    |  |         |          |  |         |   |           |         |  |   | 19,005     |   |  |   | 19,005     |  
|Variable interest entity assets:                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Fixed income securities:                        |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Corporate obligations                           |  |         |          |  |         |   |           |         |  |   | 1,929,691  |   |  |   | 1,929,691  |  
|Restricted cash                                 |  |         | 2,190     |  |         |   |           |         |  |   |           |   |  |   | 2,190      |  
|Loans                                           |  |         |          |  |         |   |           |         |  |   | 14,029,346 |   |  |   | 14,029,346 |  
|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Total financial assets                          |  | $       | 1,022,930 |  |         | $ | 5,924,141  |         |  | $ | 16,324,618 |   |  | $ | 23,271,689 |  
|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Financial liabilities:                          |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Derivative liabilities:                         |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Credit derivatives                              |  | $       |          |  |         | $ |           |         |  | $ | 235,910    |   |  | $ | 235,910    |  
|Interest rate swapsasset position              |  |         |          |  |         |   |           |         |  |   | (7,395     | ) |  |   | (7,395     | )
|Interest rate swaps liability position         |  |         |          |  |         |   | 9,933      |         |  |   | 107,598    |   |  |   | 117,531    |  
|Futures contracts                               |  |         | 319       |  |         |   |           |         |  |   |           |   |  |   | 319        |  
|Currency swaps                                  |  |         |          |  |         |   | 5,848      |         |  |   |           |   |  |   | 5,848      |  
|Other contracts                                 |  |         |          |  |         |   | 132        |         |  |   |           |   |  |   | 132        |  
|Variable interest entity liabilities:           |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Long-term debt                                  |  |         |          |  |         |   | 12,644,176 |         |  |   | 1,872,694  |   |  |   | 14,516,870 |  
|Derivative liabilities:                         |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Interest rate swapsasset position              |  |         |          |  |         |   | (4,761     | )       |  |   |           |   |  |   | (4,761     | )
|Interest rate swapsliability position          |  |         |          |  |         |   | 1,128,138  |         |  |   |           |   |  |   | 1,128,138  |  
|Currency swapsasset position                   |  |         |          |  |         |   | (15,235    | )       |  |   |           |   |  |   | (15,235    | )
|Currency swapsliability position               |  |         |          |  |         |   | 106,394    |         |  |   |           |   |  |   | 106,394    |  
|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Total financial liabilities                     |  | $       | 319       |  |         | $ | 13,874,625 |         |  | $ | 2,208,807  |   |  | $ | 16,083,751 |  
|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  



51



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##### Table of Contents

|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|----------------------------------------------- |  | ------- | --------- |  | ------- | - | ---------- | ------- |  | - | ---------- | - |  | - | ---------- | -
|                                                |  | Level 1 |           |  | Level 2 |   |            | Level 3 |  |   | Total      |  
|December 31, 2010                               |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Financial assets:                               |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Fixed income securities:                        |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Municipal obligations                           |  | $       |          |  |         | $ | 2,204,106  |         |  | $ |           |   |  | $ | 2,204,106  |  
|Corporate obligations                           |  |         |          |  |         |   | 909,839    |         |  |   | 8,069      |   |  |   | 917,908    |  
|Foreign obligations                             |  |         |          |  |         |   | 118,455    |         |  |   |           |   |  |   | 118,455    |  
|U.S. government obligations                     |  |         | 156,873   |  |         |   |           |         |  |   |           |   |  |   | 156,873    |  
|U.S. agency obligations                         |  |         |          |  |         |   | 87,097     |         |  |   | 1,197      |   |  |   | 88,294     |  
|Residential mortgage-backed securities          |  |         |          |  |         |   | 1,498,692  |         |  |   |           |   |  |   | 1,498,692  |  
|Collateralized debt obligations                 |  |         |          |  |         |   | 1,823      |         |  |   | 30,433     |   |  |   | 32,256     |  
|Other asset-backed securities                   |  |         |          |  |         |   | 844,838    |         |  |   | 159,473    |   |  |   | 1,004,311  |  
|Short term investments                          |  |         | 708,797   |  |         |   |           |         |  |   |           |   |  |   | 708,797    |  
|Fixed income securities, pledged as collateral: |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|U.S. government obligations                     |  |         | 115,402   |  |         |   |           |         |  |   |           |   |  |   | 115,402    |  
|Residential mortgage-backed securities          |  |         |          |  |         |   | 8,117      |         |  |   |           |   |  |   | 8,117      |  
|Cash                                            |  |         | 9,497     |  |         |   |           |         |  |   |           |   |  |   | 9,497      |  
|Derivative assets:                              |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Interest rate swapsasset position              |  |         |          |  |         |   | 142,842    |         |  |   | 265,457    |   |  |   | 408,299    |  
|Interest rate swapsliability position          |  |         |          |  |         |   | (105       | )       |  |   | (129,080   | ) |  |   | (129,185   | )
|Future contracts                                |  |         | 11,185    |  |         |   |           |         |  |   |           |   |  |   | 11,185     |  
|Other assets                                    |  |         |          |  |         |   |           |         |  |   | 17,909     |   |  |   | 17,909     |  
|Variable interest entity assets:                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Fixed income securities:                        |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Corporate obligations                           |  |         |          |  |         |   |           |         |  |   | 1,904,361  |   |  |   | 1,904,361  |  
|Restricted cash                                 |  |         | 2,098     |  |         |   |           |         |  |   |           |   |  |   | 2,098      |  
|Loans                                           |  |         |          |  |         |   |           |         |  |   | 15,800,918 |   |  |   | 15,800,918 |  
|Derivative assets:                              |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Credit derivatives                              |  |         |          |  |         |   |           |         |  |   | 4,511      |   |  |   | 4,511      |  
|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Total financial assets                          |  | $       | 1,003,852 |  |         | $ | 5,815,704  |         |  | $ | 18,063,248 |   |  | $ | 24,882,804 |  
|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Financial liabilities:                          |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Derivative liabilities:                         |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Credit derivatives                              |  | $       |          |  |         | $ |           |         |  | $ | 221,684    |   |  | $ | 221,684    |  
|Interest rate swapsasset position              |  |         |          |  |         |   |           |         |  |   | (4,756     | ) |  |   | (4,756     | )
|Interest rate swaps liability position         |  |         |          |  |         |   | 9,550      |         |  |   | 115,382    |   |  |   | 124,932    |  
|Futures contracts                               |  |         |          |  |         |   |           |         |  |   |           |   |  |   |           |  
|Currency swaps                                  |  |         |          |  |         |   | 6,699      |         |  |   |           |   |  |   | 6,699      |  
|Other contracts                                 |  |         |          |  |         |   | 232        |         |  |   |           |   |  |   | 232        |  
|Variable interest entity liabilities:           |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Long-term debt                                  |  |         |          |  |         |   | 14,029,345 |         |  |   | 1,856,366  |   |  |   | 15,885,711 |  
|Derivative liabilities:                         |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Interest rate swapsasset position              |  |         |          |  |         |   | (2,203     | )       |  |   |           |   |  |   | (2,203     | )
|Interest rate swapsliability position          |  |         |          |  |         |   | 1,503,863  |         |  |   |           |   |  |   | 1,503,863  |  
|Currency swapsasset position                   |  |         |          |  |         |   | (26,577    | )       |  |   |           |   |  |   | (26,577    | )
|Currency swapsliability position               |  |         |          |  |         |   | 105,037    |         |  |   |           |   |  |   | 105,037    |  
|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  
|Total financial liabilities                     |  | $       |          |  |         | $ | 15,625,946 |         |  | $ | 2,188,676  |   |  | $ | 17,814,622 |  
|                                                |  |         |           |  |         |   |            |         |  |   |            |   |  |   |            |  



|(1) | Excludes a $100 investment, which is carried in the Consolidated Balance Sheets at cost.
|--- | ----------------------------------------------------------------------------------------

Determination of Fair Value:

When available, the Company generally uses quoted market prices to determine fair value, and classifies such items within Level 1. Because many fixed income securities do not trade on a daily basis,
pricing sources apply available information through processes such as matrix pricing to calculate fair value. In those cases the items are classified within Level 2. If quoted market prices are not available, fair value is based upon models that
use, where possible, current market-based or independently-sourced



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| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



market parameters. Items valued using valuation models are classified according to the lowest level input or value driver that is significant to the valuation. Thus, an item may be classified in
Level 3 even though there may be significant inputs that are readily observable.

The determination of fair value for
financial instruments categorized in Level 2 or 3 involves significant judgment due to the complexity of factors contributing to the valuation. Market disruptions make valuation even more difficult and subjective. Third-party sources from which we
obtain independent market quotes also use assumptions, judgments and estimates in determining financial instrument values and different third parties may use different methodologies or provide different prices for securities. We believe the
potential for differences in third-party pricing levels is particularly significant with respect to residential mortgage backed and certain other asset-backed securities held in our investment portfolio and referenced in our credit derivative
portfolio, due to the low levels of recent trading activity for such securities. In addition, the use of internal valuation models may require assumptions about hypothetical or inactive markets. As a result of these factors, the actual trade value
of a financial instrument in the market, or exit value of a financial instrument position by Ambac, may be significantly different from its recorded fair value.

Ambacs financial instruments carried at fair value are mainly comprised of investments in fixed income securities, derivative instruments, most variable interest entity assets and liabilities and
equity interests in Ambac sponsored special purpose entities.

We reflect Ambacs own creditworthiness in the fair value
of financial liability by including a credit valuation adjustment (CVA) in the determination of fair value. A decline in Ambacs creditworthiness as perceived by market participants will generally result in a higher CVA, thereby
lowering the fair value of Ambacs financial liabilities as reported.

Fixed Income Securities:

The fair values of fixed income investment securities held by Ambac and its operating subsidiaries are based primarily on market prices
received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes generally consider a variety of factors, including recent trades of the same and similar securities. 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 yield curves for asset-type and credit rating characteristics that closely
match those characteristics of the specific investment securities being valued. At March 31, 2011, approximately 6%, 80%, and 3% of the investment portfolio (excluding variable interest entity investments) was valued using dealer quotes,
alternative pricing sources with reasonable levels of price transparency, and internal valuation models, respectively. Approximately 11% of the investment portfolio, which represents short-term money market funds, was valued based on amortized cost.

Third party quotes represent the only input to the reported fair value of Level 2 fixed income securities. Fixed income
securities are classified as Level 3 when the fair value is internally modeled. Information about the valuation inputs for fixed income securities classified as Level 3 is included below:

Corporate obligations: These securities represent interest only strips of investment grade corporate obligations. Fair value was
calculated using a discounted cash flow approach with the discount rate determined from the yields of corporate bonds from the same issuers. Significant inputs for the valuation at March 31, 2011 include the following weighted averages:



| | a. | Coupon rate: 0.60%
| | -- | ------------------



| | b. | Maturity: 22.20 years
| | -- | ---------------------



| | c. | Discount rate: 6.52%
| | -- | --------------------



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| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



U.S. agency obligations: These notes are secured by separate lease rental
agreements with the U.S. Government acting through the General Services Administration. Fair value was calculated using a discounted cash flow approach with the yield based on comparable U.S. agency securities. Significant inputs for the
valuation at March 31, 2011 include the following weighted averages:



| | a. | Coupon rate: 6.88%
| | -- | ------------------



| | b. | Maturity: 0.12 years
| | -- | --------------------



| | c. | Yield: 2.83%
| | -- | ------------

Collateralized
debt obligations (CDO): Securities are floating rate senior notes with the underlying securities of the CDO consist of subordinated bank perpetual preferred securities. Fair value was calculated using a discounted cash flow
approach with expected future cash flows discounted using a yield curve consistent with the security type and rating. Significant inputs for the valuation at March 31, 2011 include the following weighted averages:



| | a. | Coupon rate: 0.76%
| | -- | ------------------



| | b. | Weighted Average Life: 15.24 years
| | -- | ----------------------------------



| | c. | Yield: 9.40%
| | -- | ------------

Asset-backed
securities: These securities are floating rate investment grade notes collateralized by various asset types. Fair value was calculated using a discounted cash flow approach with expected future cash flows discounted using a yield curve
consistent with the security type and rating. Significant inputs for the valuation at March 31, 2011 include the following weighted averages:



| | a. | Coupon rate: 0.96%
| | -- | ------------------



| | b. | Weighted Average Life: 6.41 years
| | -- | ---------------------------------



| | c. | Yield curve rate corresponding to WAL: 4.69%
| | -- | --------------------------------------------

Derivative Instruments:

Ambacs derivative instruments comprise
interest rate, currency, and credit default swaps, exchange traded futures contracts and call options to repurchase Ambac Assurance surplus notes. Fair value is determined based upon market quotes from independent sources, when available. When
independent quotes are not available, fair value is determined using valuation models. These valuation models require market-driven inputs, including contractual terms, credit spreads and ratings on underlying referenced obligations, yield curves
and tax-exempt interest ratios. The valuation of certain interest rate and currency swaps as well as all credit derivative contracts also require the use of data inputs and assumptions that are determined by management and are not readily observable
in the market. Under ASC Topic 820, Ambac is required to consider its own credit risk when measuring the fair value of derivative and other liabilities. The fair value of net credit derivative liabilities was reduced by $707,729 at March 31,
2011, and $886,735 at December 31, 2010, as a result of incorporating a CVA on Ambac Assurance into the valuation model for these transactions. Interest rate swaps, currency swaps or other derivative liabilities may also require an adjustment
to fair value to reflect Ambac Assurances credit risk. Factors considered in estimating the amount of any Ambac CVA on such contracts include collateral posting provisions, right of set-off with the counterparty, the period of time remaining
on the derivatives and the pricing of recent terminations and amendments. Derivative liabilities were reduced by $64,620 at March 31, 2011, and $68,772 at December 31, 2010, as a result of Ambac CVA adjustments to derivative contracts
other than credit derivatives.



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| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



As described further below, certain valuation models require other inputs that are not
readily observable in the market. 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 or may be valued primarily by reference to interest rates and yield curves that are
observable and regularly quoted, such as interest rate and currency swaps, we utilize vendor-developed models. These models provide the net present value of the derivatives based on contractual terms and observable market data. Downgrades of Ambac
Assurance, as guarantor of the financial services derivatives, beginning 2008 have increased collateral requirements and triggered termination provisions in certain interest rate and currency swaps. Increased termination activity since the initial
rating downgrades of Ambac Assurance has provided additional information about the current replacement and/or exit value of our financial services derivatives, which may not be fully reflected in our vendor-models but has been incorporated into the
fair value of these derivatives at March 31, 2011 and December 31, 2010. These fair value adjustments are applied to individual groups of derivatives based on common attributes such as counterparty type and credit condition, term to
maturity, derivative type and net present value. Generally, the need for counterparty (or Ambac) CVAs is mitigated by the existence of collateral posting agreements under which adequate collateral has been posted. Derivative contracts entered into
with financial guarantee customers are not typically subject to collateral posting agreements. Counterparty credit risk related to such customer derivative assets is included in our fair value adjustments.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | For derivatives that do not trade, or trade in less liquid markets such as credit derivatives, a proprietary model is used because such instruments
tend to be unique, contain complex or heavily modified and negotiated terms, and pricing information is not readily available in the market. Derivative fair value models and the related assumptions are continuously re-evaluated by management and
enhanced, as appropriate, based on improvements in modeling techniques. As described further below, beginning with the quarter ended March 31, 2011, measurement of the Ambac CVA on credit derivatives incorporated newly available market
information. Ambac has not made any other significant changes to its modeling techniques for the periods presented.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Credit Derivatives (CDS):

Fair value of Ambacs CDS is
determined using internal valuation models and represents the net present value of the difference between the fees Ambac originally charged for the credit protection and our estimate of what a financial guarantor of comparable credit worthiness
would hypothetically charge to provide the same protection at the balance sheet date. Ambac competed in the financial guarantee market, which differs from the credit markets where Ambac-insured obligations may trade. As a financial guarantor, Ambac
assumes only credit risk; we do not assume other risks and costs inherent in direct ownership of the underlying reference securities. Additionally, as a result of having the ability to influence our CDS counterparty in certain investor decisions,
financial guarantors generally have the ability to actively remediate the credit, potentially reducing the loss given a default. Financial guarantee contracts, including CDS, issued by Ambac and its competitors are typically priced to capture some
portion of the spread that would be observed in the capital markets for the underlying (insured) obligation, with minimum pricing constrained by objective estimates of expected loss and financial guarantor required rates of return. Such pricing was
well established by historical financial guarantee fees relative to capital market spreads as observed and executed in competitive markets, including in financial guarantee reinsurance and secondary market transactions. Because of this relationship
and in the absence



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| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



of severe credit deterioration, changes in the fair value of our credit default swaps (both unrealized gains and losses) will generally be less than changes in the fair value of the underlying
reference obligations.

Key variables used in our valuation of substantially all of our credit derivatives include the balance
of unpaid notional, expected term, fair values of the underlying reference obligations, reference obligation credit ratings, assumptions about current financial guarantee CDS fee levels relative to reference obligation spreads and the CVA applied
against Ambac Assurance liabilities by market participants. Notional balances, expected remaining term and reference obligation credit ratings are monitored and determined by Ambacs Risk Group. Fair values of the underlying reference
obligations are obtained from broker quotes when available, or are derived from other market indications such as new issuance spreads and quoted values for similar transactions. Implicit in the fair values we obtain on the underlying reference
obligations are the markets assumptions about default probabilities, default timing, correlation, recovery rates and collateral values.

Broker quotes on the reference obligations named in our CDS contracts represent an input to determine the estimated fair value of the CDS contract. Broker quotes are indicative values for the reference
obligation and generally do not represent a bid or doing-business quote for the reference instrument. Such quotes follow methodologies that are generally consistent with those used to value similar assets on the quote providers own books.
Methodologies may differ among brokers but are understood to reflect observable trading activity (when available) and modeling that relies on empirical data and reasonable assumptions. For certain CDS contracts referencing unsecuritized pools of
assets, we will obtain counterparty quotes on the credit derivative itself. Such quotes are adjusted to reflect Ambacs own credit risk when determining the fair value of credit derivative liabilities. Third party reference obligation values or
specific credit derivative quotes were used in the determination of CDS fair values related to transactions representing 90% of CDS gross par outstanding and 94% of the CDS derivative liability as of March 31, 2011.

When broker quotes for reference obligations are not available, reference obligation prices used in the valuation model are estimated
internally based on averages of the quoted prices for other transactions of the same bond type and Ambac rating as well as changes in published credit spreads for securities with similar collateral and ratings characteristics. When price quotes of a
similar bond type vary significantly or the number of similar transactions is small, as had been observed with CDO of ABS transactions, management will consider additional factors, such as specific collateral composition and performance and
contractual subordination, to identify similar transactions. Reference obligation prices derived internally as described above were used in the determination of CDS fair values related to transactions representing 10% of CDS gross par
outstanding and 6% of the CDS derivative liability as of March 31, 2011.

Ambacs CDS fair value calculations are
adjusted for increases in our estimates of expected loss on the reference obligations and observable changes in financial guarantee market pricing. If no adjustment is considered necessary, Ambac maintains the same percentage of the credit spread
(over LIBOR) demanded in the market for the reference obligation as existed at the inception of the CDS. Therefore, absent changes in expected loss on the reference obligations or financial guarantee CDS market pricing, the financial guarantee CDS
fee used for a particular contract in Ambacs fair value calculations represent a consistent percentage, period to period, of the credit spread determinable from the reference obligation value at the balance sheet date. This results in a CDS
fair value balance that fluctuates in proportion with the reference obligation value.

The amount of expected loss on a
reference obligation is a function of the probability that the obligation will default and severity of loss in the event of default. Ambacs CDS transactions were all originally underwritten with extremely low expected losses. Both the
reference obligation spreads and Ambacs CDS fees at the inception of these transactions reflect these low expected losses. When reference obligations experience credit deterioration, there is an increase in the probability of default on the
obligation and, therefore, an increase in expected loss. Ambac reflects the effects of changes in



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| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



expected loss on the fair value of its CDS contracts by increasing the percentage of the reference obligation spread (over LIBOR) which would be captured as a CDS fee (relative change ratio) at
the valuation date, resulting in a higher mark-to-market loss on our CDS relative to any price decline on the reference obligation. The fundamental assumption is that financial guarantee CDS fees will increase relative to reference obligation
spreads as the underlying credit quality of the reference obligation deteriorates and approaches payment default. For example, if the credit spread of an underlying reference obligation was 80 basis points at the inception of a transaction and Ambac
received a 20 basis point fee for issuing a CDS on that obligation, the relative change ratio, which represents the CDS fee to cash market spread Ambac would utilize in its valuation calculation, would be 25%. If the reference obligation
spread increased to 100 basis points in the current reporting period, absent any observable changes in financial guarantee CDS market pricing or credit deterioration, Ambacs current period CDS fee would be computed by multiplying the current
reference obligation spread of 100 basis points by the relative change ratio of 25%, resulting in a 25 basis point fee. Thus, the model indicates we would need to receive an additional 5 basis points (25 basis points currently less the 20 basis
points contractually received) for issuing a CDS in the current reporting period for this reference obligation. We would then discount the product of the notional amount of the CDS and the 5 basis point hypothetical CDS fee increase, over the
weighted average life of the reference obligation to compute the current period mark-to-market loss. Using the same example, if the reference obligation spread increased to 100 basis points and there was credit deterioration as evidenced by an
internal rating downgrade which increased the relative change ratio from 25% to 35%, we would estimate a 15 basis point hypothetical CDS fee increase in our model (35% of 100 basis points reference obligation spread, or 35 basis points currently,
less the 20 basis points contractually received). Therefore, we would record a higher mark-to-market loss based on the computations described above absent any observable changes in financial guarantee CDS market pricing.

We do not adjust the relative change ratio until an actual internal rating downgrade has occurred unless we observe new pricing on
financial guarantee CDS contracts. However, because we have active surveillance procedures in place for our entire CDS portfolio, particularly for transactions at or near a below investment grade threshold, we believe it is unlikely that an internal
downgrade would lag the actual credit deterioration of a transaction for any meaningful time period. The factors used to increase the percentage of reference obligation spread captured in the CDS fee (or relative change ratio) are based on rating
agency probability of default percentages determined by management to be appropriate for the relevant bond type. That is, the probability of default associated with the respective tenor and internal rating of each CDS transaction is utilized in the
computation of the relative change ratio in our CDS valuation model. The new relative change ratio in the event of an internal downgrade of the reference obligation is calculated as the weighted average of: (i) a given transactions
inception relative change ratio and (ii) a ratio of 100%. The weight given to the inception relative change ratio is 100% minus the probability of default (i.e. the probability of non-default) and the weight given to using a 100% relative
change ratio is the probability of default. For example, assume a transaction having an inception relative change ratio of 33% is downgraded to B- during the period, at which time it has an estimated remaining life of 8 years. If the estimated
probability of default for an 8 year, B- rated credit of this type is 60% then the revised relative change ratio will be 73.2%. The revised relative change ratio can be calculated as 33% x (100%-60%) + 100% x 60% = 73.2%.

As noted above, reference obligation spreads incorporate market perceptions of default probability and loss severity, as well as
liquidity risk and other factors. Loss severities are generally correlated to default probabilities during periods of economic stress. By increasing the relative change ratio in our calculations proportionally to default probabilities, Ambac
incorporates into its CDS fair value the higher expected loss on the reference obligation (probability of default x loss severity), by increasing the portion of reference obligation spread that should be paid to the CDS provider.

Ambac incorporates its own credit risk into the valuation of its CDS liabilities by applying a CVA to the calculations described above.
Through March 31, 2010, the Ambac CVA was calculated by adjusting



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| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



the discount rate used in the CDS present value calculations. Specifically, the discount rate used for the present value calculations described above was LIBOR plus Ambacs credit spread as
observed from quotes of the cost to purchase credit protection on Ambac Assurance. By incorporating the market cost of credit protection on Ambac into the discount rate, the fair value of Ambacs liability (or the asset from the perspective of
the credit protection buyer) will be decreased by an amount that reflects the markets pricing of the risk that Ambac will not have the ability to pay. The widening of Ambacs own credit spread cannot result in our recognition of an asset
on a CDS contract. Under our methodology, determination of the CDS fair value requires estimating hypothetical financial guarantee CDS fees for a given credit at the valuation date and estimating the present value of those fees. Our approach
begins with pricing in the risk of default of the reference obligation using that obligations credit spread. The widening of the reference obligation spread results in a mark-to-market loss to Ambac, as the credit protection seller, and a
gain to the credit protection buyer because the cost of credit protection on the reference obligation (ignoring CDS counterparty credit risk) will be greater than the amount of the actual contractual CDS fees. Late in March 2010, Ambac
Assurance credit default swap pricing became unobservable following ISDAs declaration of an event of default on such contracts. Therefore the Ambac CVA subsequent to March 31, 2010 could not utilize the same market inputs as had been used
previously. Since June 30, 2010, the Ambac CVA has been a percentage applied to the estimated CDS liability fair value calculated as described above, but using only LIBOR in the present value calculations. The Ambac CVA was estimated using
relevant data points, including the final settlement value of Ambac Assurance credit default swaps (determined through auction in June 2010), updated over time based on changes in quoted prices of securities guaranteed by Ambac Assurance which
indicate the value placed by market participants on Ambac Assurances insurance obligations, and (beginning March 31, 2011) the fair value of Ambac Assurance surplus notes. The resulting Ambac CVA percentage used in the valuation of CDS
liabilities was 75% and 80% as of March 31, 2011 and December 31, 2010, respectively. In instances where narrower reference obligation spreads result in a CDS asset to Ambac, or when Ambac has a CDS asset arising from reinsured CDS
exposure, those hypothetical future CDS fees are discounted at a rate which does not incorporate Ambacs own spread but rather incorporates our counterpartys credit spread (i.e. the discount rate used to value purchased credit derivative
protection is LIBOR plus the current credit spread of the protection provider).

In addition, when there are sufficient
numbers of new observable transactions to indicate a general change in market pricing trends for CDS on a given bond type, management will adjust its assumptions about the percentage of reference obligation spreads captured as CDS fees to match the
current market. No such adjustments were made for the period and year ended March 31, 2011 and December 31, 2010, respectively. Ambac is not transacting CDS business currently and other guarantors have stated they have exited this product.
Although relevant new transactions are not occurring in the financial guarantee marketplace, we have entered into negotiated settlements of CDS contracts in recent quarters. These settlements have primarily related to our written CDS on CDO of ABS
transactions, all of which were terminated as of June 30, 2010. Because of the significant differences between the CDO of ABS transactions compared to the other CDS remaining in the portfolio, including the generally lower credit quality, we do
not believe the settlements of these transactions provided information that warrants adjustment to the fair value model of CDS.

Key variables which impact the Realized gains and losses and other settlements component of Net change in fair value of
credit derivatives in the Consolidated Statements of Operations are the most readily observable variables since they are based solely on the CDS contractual terms and cash settlements. Those variables include (i) premiums received and
accrued on written CDS contracts, (ii) premiums paid or accrued on purchased contracts, (iii) losses paid and payable on written credit derivative contracts and (iv) paid losses recovered and recoverable on purchased credit derivative
contracts for the appropriate accounting period. Losses paid and payable and losses recovered and receivable reported in Realized gains and losses and other settlements include those arising after a credit event that requires a payment
under the contract terms has occurred or in connection with a



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| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



negotiated termination of a contract. The remaining key variables described above impact the Unrealized gains (losses) component of Net change in fair value of credit
derivatives. The net notional outstanding of Ambacs CDS contracts is $18,273,254 and $18,766,354 at March 31, 2011 and December 31, 2010, respectively.

Credit derivative liabilities at March 31, 2011 and December 31, 2010 had a combined fair value of $235,910 and $221,684, respectively , and related to underlying reference obligations that are
classified as either CLOs or Other. Information about the above described model inputs used to determine the fair value of each class of credit derivatives as of March 31, 2011 and December 31, 2010 is summarized below:



|                                            |  |      |            |   |          |   |           |  
|------------------------------------------- |  | ---- | ---------- | - | -------- | - | --------- | -
|As of March 31, 2011                        |  |      |            |   |          |   |           |  
|                                            |  | CLOs |            |   | Other(1) |  
|Notional outstanding                        |  | $    | 11,426,031 |   |          | $ | 4,712,027 |  
|Weighted average reference obligation price |  |      | 92.9       |   |          |   | 86.6      |  
|Weighted average life (WAL) in years        |  |      | 3.3        |   |          |   | 4.9       |  
|Weighted average credit rating              |  |      | AA-        |   |          |   | A         |  
|Weighted average relative change ratio      |  |      | 34.3       | % |          |   | 37.7      | %
|CVA percentage                              |  |      | 75         | % |          |   | 75        | %
|Fair value of derivative liabilities        |  | $    | 70,066     |   |          | $ | 74,610    |  
|                                            |  |     
|As of December 31, 2010                     |  |      |            |   |          |   |           |  
|                                            |  | CLOs |            |   | Other(1) |  
|Notional outstanding                        |  | $    | 11,592,697 |   |          | $ | 4,996,193 |  
|Weighted average reference obligation price |  |      | 91.2       |   |          |   | 85.2      |  
|Weighted average life (WAL) in years        |  |      | 3.4        |   |          |   | 4.1       |  
|Weighted average credit rating              |  |      | AA-        |   |          |   | A+        |  
|Weighted average relative change ratio      |  |      | 34.4       | % |          |   | 38        | %
|CVA percentage                              |  |      | 80         | % |          |   | 80        | %
|Fair value of derivative liabilities        |  | $    | 70,467     |   |          | $ | 72,692    |  



|(1) | Excludes contracts for which fair values are based on credit derivative quotes rather than reference obligation quotes. Such contracts have a combined notional
outstanding of $2,135,196, WAL of 4.8 years and liability fair value of $91,234 as of March 31, 2011. Other inputs to the valuation of these transactions at March 31, 2011 include weighted average quotes of 21% of notional, weighted
average rating of A+ and Ambac CVA percentage of 75%. As of December 31, 2010, these contracts had a combined notional outstanding of $2,177,464, WAL of 5.0 years and liability fair value of $78,524 as of December 31, 2010. Other inputs to
the valuation of these transactions at December 31, 2010 include weighted average quotes of 18% of notional, weighted average rating of A+ and Ambac CVA percentage of 80%.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Call options on long-term debt:

The fair value of Ambac Assurances options to repurchase Ambac Assurance surplus notes at a discount to par is estimated based on a a combination of internal discounted cash flow analysis and market
observations. The discounted cash flow analysis uses multiple discount rate scenarios to determine the present value of the surplus notes assuming exercise and non-exercise of the options, with the difference representing the option value under that
scenario. The results are probability weighted to determine the recorded option value.

Financial Guarantees:

Fair value of net financial guarantees written represents our estimate of the cost to Ambac to completely transfer its
insurance obligation to another financial guarantor of comparable credit worthiness. In theory, this amount should be the same amount that another financial guarantor of



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



comparable credit worthiness would hypothetically charge in the market place, on a present value basis, to provide the same protection as of the balance sheet date.

This fair value estimate of financial guarantees is presented in the table immediately following the first paragraph of this Note 11 on a
net basis and includes direct and assumed contracts written, which represent our liability, net of ceded reinsurance contracts, which represent our asset. The fair value estimate of direct and assumed contracts written is based on the sum of the
present values of (i) unearned premium reserves; and (ii) loss and loss expense reserves, including claims presented and not paid as a result of the claim moratorium imposed by OCI on March 24, 2010. The fair value estimate of ceded
reinsurance contracts is based on the sum of the present values of (i) deferred ceded premiums net of ceding commissions; and (ii) reinsurance recoverables on paid and unpaid losses.

Under our current financial guarantee model, the key variables are par amounts outstanding (including future periods for the calculation
of future installment premiums), expected term, discount rate, and expected net loss and loss expense payments. Net par outstanding is monitored by Ambacs Risk Group. With respect to the discount rate, ASC Topic 820 requires that the
nonperformance risk of a financial liability be included in the estimation of fair value. This nonperformance risk would include considering Ambacs own credit risk in the fair value of financial guarantees we have issued, thus the estimated
fair value for direct contracts written included an Ambac CVA to reflect Ambacs credit risk. The Ambac CVA was estimated using relevant data points, including the final settlement value of Ambac Assurance credit default swaps (determined
through auction in June 2010), updated over time based on changes in quoted prices of securities guaranteed by Ambac Assurance which indicate the value placed by market participants on Ambac Assurances insurance obligations, and (beginning
March 31, 2011) the fair value of Ambac Assurance surplus notes. The resulting CVA was 75% and 80% as of March 31, 2011 and December 31, 2010, respectively. Refer to Note 6 for additional information on factors which influence our
estimate of loss and loss expenses. The estimated fair value of ceded reinsurance contracts factors in any adjustments related to the counterparty credit risk we have with reinsurers.

There are a number of factors that limit our ability to accurately estimate the fair value of our financial guarantees. The first
limitation is the lack of observable pricing data points as a result of Ambac no longer writing new financial guarantee business. Additionally, although the fair value accounting guidance for liabilities requires a company to consider the cost to
completely transfer its obligation to another party of comparable credit worthiness, our primary insurance obligation is irrevocable and thus there is no established active market for transferring such obligations. Variables which are not
incorporated in our current fair value estimate of financial guarantees include the credit spreads of the underlying insured obligations, the underlying ratings of those insured obligations and assumptions about current financial guarantee premium
levels relative to the underlying insured obligations credit spreads.

Liabilities Subject to Compromise:

The fair value of Ambacs debt included in Liabilities Subject to Compromise as of March 31, 2011 is based on
quoted market prices. As described in Note 1, Ambacs Bankruptcy Filing constituted an event of default with respect to these debt securities.

Long-term Debt:

The fair value of surplus notes issued by Ambac Assurance
and classified as long-term debt is internally estimated considering market transactions when available and internally developed discounted cash flow models.

Other Financial Assets and Liabilities:

The fair values of Ambacs
equity interest in Ambac sponsored special purpose entities (included in Other assets), Loans, and Obligations under investment, repurchase and payment agreements are



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



estimated based upon internal valuation models that discount expected cash flows using a discount rates consistent with the credit quality of the obligor after considering collateralization.

Variable Interest Entity Assets and Liabilities:

The assets and liabilities of VIEs consolidated under ASC Topic 810 consist primarily of fixed income securities, loans receivable,
derivative instruments and debt instruments and are generally carried at fair value. These consolidated VIEs are securitization entities which have liabilities and/or assets guaranteed by Ambac. The fair values of VIE debt instruments are determined
using the same methodologies used to value Ambacs fixed income securities in its investment portfolio as described above. VIE debt fair value is based on market prices received from dealer quotes or alternative pricing sources with reasonable
levels of price transparency. Such quotes are considered Level 2 and generally consider a variety of factors, including recent trades of the same and similar securities. For those VIE debt instruments where quotes were not available, the debt
instrument fair values are considered Level 3 and are based on internal discounted cash flow models. VIE debt instruments considered Level 3 include fixed rate, floating rate and zero coupon notes secured by various asset types, primarily European
ABS. Information about the valuation inputs for the various VIE debt categories classified as Level 3 is as follows:

European
ABS transactions: Fair values were calculated by discounting contractual payments to maturity. The discount rates used were based on the rates implied from the third party quoted values (Level 2) for comparable notes from the same
securitization. Significant inputs for the valuation at March 31, 2011 include the following weighted averages:



| | a. | Coupon rate: 4.14%
| | -- | ------------------



| | b. | Maturity: 15.93 years
| | -- | ---------------------



| | c. | Discount rate: 6.37%
| | -- | --------------------

Other
classes: Other classes include European Public Finance Initiatives, utilities, transportation and asset lease financing transactions. Fair values were calculated by discounting contractual payments to maturity. The discount rates used were
derived from the third party quoted values (Level 2) for comparable notes from the same securitization when available. When no quotes were received on notes in a given structure, rates were derived from generic spreads for similar securities.
Significant inputs for the valuation at March 31, 2011 include the following weighted averages:



| | a. | Coupon rate: 7.80%
| | -- | ------------------



| | b. | Maturity: 6.30 years
| | -- | --------------------



| | c. | Discount rate: 5.92%
| | -- | --------------------

VIE
derivative asset and liability fair values are determined using valuation models. When specific derivative contractual terms are available and may be valued primarily by reference to interest rates, exchange rates and yield curves that are
observable and regularly quoted the derivatives are valued using vendor-developed models. Other derivatives within the VIEs that include significant unobservable valuation inputs are valued using internally developed models. All VIE derivatives at
March 31, 2011 and December 31, 2010 use vendor-developed models and do not use significant unobservable inputs.

The fair value of VIE assets are obtained from market quotes when available. Typically the asset fair values are not readily available
from market quotes and are estimated internally. The consolidated VIEs are securitization entities in which net cash flows from assets and derivatives (after adjusting for financial guarantor cash flows and other expenses) will be paid out to note
holders or equity interests. Our valuation of VIE assets (fixed income securities or loans), therefore, are derived from the fair value of notes and derivatives, as described above, adjusted for the fair value of cash flows from Ambacs
financial guarantee. The fair value of financial guarantee cash flows include: (i) estimated future



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



premiums discounted at a rate consistent with that implicit in the fair value of the VIEs liabilities and (ii) internal estimates of future loss payments by Ambac discounted at a rate
that includes Ambacs own credit risk. Estimated future premium payments to be paid by the VIEs were discounted at a weighted average rate of 6.6%. The value of future loss payments to be paid by Ambac to the VIEs are adjusted to consider
Ambacs CVA as described under Credit Derivatives above.

The following tables present the changes in the
Level 3 fair value category for the three month periods ended March 31, 2011 and 2010. Ambac classifies financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the
valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial instruments typically also rely on a number of inputs that are readily observable either directly or indirectly. Thus, the gains and losses
presented below include changes in the fair value related to both observable and unobservable inputs.

Level-3 financial
assets and liabilities accounted for at fair value



|                                                                                                                                                                                     |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |   |             |   |            |               |  |   |        |   |  |   |            |   |  |   |            |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------- | ------- | - | ----------- | - | ------ | ----------- |  | - | -------------------------- | - |  | ----- | --------- | - | ----------- | - | ---------- | ------------- |  | - | ------ | - |  | - | ---------- | - |  | - | ---------- | -
|                                                                                                                                                                                     |  |             |         |   |             |   |        |             |  |   | VIE Assets and Liabilities |   |  |       |          
|Three months ended March 31, 2011                                                                                                                                                    |  | Investments |         |   | OtherAssets |   |        | Derivatives |  |   | Investments                |   |  | Loans |           |   | Derivatives |   |            | Long-termdebt |  |   | Total  |  
|Balance, beginning of period                                                                                                                                                         |  | $           | 199,172 |   |             | $ | 17,909 |             |  | $ | (195,933                   | ) |  | $     | 1,904,361 |   |             | $ | 15,800,918 |               |  | $ | 4,511  |   |  | $ | (1,856,366 | ) |  | $ | 15,874,572 |  
|Total gains/(losses) realized and unrealized:                                                                                                                                        |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |   |             |   |            |               |  |   |        |   |  |   |            |   |  |   |            |  
|Included in earnings                                                                                                                                                                 |  |             | (50     | ) |             |   | 1,096  |             |  |   | 17,645                     |   |  |       | (28,844   | ) |             |   | (49,464    | )             |  |   | (4,511 | ) |  |   | 29,749     |   |  |   | (34,739    | )
|Included in other comprehensive income                                                                                                                                               |  |             | 3,223   |   |             |   |       |             |  |   |                           |   |  |       | 54,174    |   |             |   | 435,170    |               |  |   |       |   |  |   | (52,185    | ) |  |   | 440,382    |  
|Purchases                                                                                                                                                                            |  |             |        |   |             |   |       |             |  |   |                           |   |  |       |          |   |             |   |           |               |  |   |       |   |  |   |           |   |  |   |           |  
|Issuances                                                                                                                                                                            |  |             |        |   |             |   |       |             |  |   |                           |   |  |       |          |   |             |   |           |               |  |   |       |   |  |   |           |   |  |   |           |  
|Sales                                                                                                                                                                                |  |             |        |   |             |   |       |             |  |   |                           |   |  |       |          |   |             |   |           |               |  |   |       |   |  |   |           |   |  |   |           |  
|Settlements                                                                                                                                                                          |  |             | (2,269  | ) |             |   |       |             |  |   | (11,325                    | ) |  |       |          |   |             |   | (262,311   | )             |  |   |       |   |  |   | (873       | ) |  |   | (276,778   | )
|Transfers in Level 3                                                                                                                                                                 |  |             |        |   |             |   |       |             |  |   |                           |   |  |       |          |   |             |   |           |               |  |   |       |   |  |   | (50,125    | ) |  |   | (50,125    | )
|Transfers out of Level 3                                                                                                                                                             |  |             |        |   |             |   |       |             |  |   |                           |   |  |       |          |   |             |   |           |               |  |   |       |   |  |   | 57,106     |   |  |   | 57,106     |  
|Deconsolidation of VIEs                                                                                                                                                              |  |             |        |   |             |   |       |             |  |   |                           |   |  |       |          |   |             |   | (1,894,967 | )             |  |   |       |   |  |   |           |   |  |   | (1,894,967 | )
|                                                                                                                                                                                     |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |   |             |   |            |               |  |   |        |   |  |   |            |   |  |   |            |  
|Balance, end of period                                                                                                                                                               |  | $           | 200,076 |   |             | $ | 19,005 |             |  | $ | (189,613                   | ) |  | $     | 1,929,691 |   |             | $ | 14,029,346 |               |  | $ |       |   |  | $ | (1,872,694 | ) |  | $ | 14,115,811 |  
|                                                                                                                                                                                     |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |   |             |   |            |               |  |   |        |   |  |   |            |   |  |   |            |  
|The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to
assets and liabilities still held at the reporting date |  | $           |        |   |             | $ | 1,096  |             |  | $ | 13,342                     |   |  | $     | (28,844   | ) |             | $ | (49,464    | )             |  | $ | (4,511 | ) |  | $ | 29,749     |   |  | $ | (38,632    | )
|                                                                                                                                                                                     |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |   |             |   |            |               |  |   |        |   |  |   |            |   |  |   |            |  



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



The tables below provide roll-forward information by class of investments and
derivatives measured using significant using significant unobservable inputs. This information is provided for the three months ended March 31, 2011 as required by amendments to ASC Topic 820 effective January 1, 2011.

Level 3  Investments by class



|                                                                                                                                                                                     |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------------------- | ------ | - | --------------------------- | - | -------- | -------------------- |  | - | ----------------------------- | - |  | ---------------- | ------ | - |  | - | -------- | -
|Three months ended March 31, 2011                                                                                                                                                    |  | CollateralizedDebtObligations |        |   | Other AssetBackedSecurities |   |          | CorporateObligations |  |   | U.S. AgencyObligations        |   |  | TotalInvestments |       
|Balance, beginning of period                                                                                                                                                         |  | $                             | 30,433 |   |                             | $ | 159,473  |                      |  | $ | 8,069                         |   |  | $                | 1,197  |   |  | $ | 199,172  |  
|Additions of VIEs for ASC 2009-17                                                                                                                                                    |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|Total gains/(losses) realized and unrealized:                                                                                                                                        |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|Included in earnings                                                                                                                                                                 |  |                               | (6     | ) |                             |   |         |                      |  |   | (43                           | ) |  |                  | (1     | ) |  |   | (1,398   | )
|Included in other comprehensive income                                                                                                                                               |  |                               | 1,132  |   |                             |   | 2,190    |                      |  |   | (90                           | ) |  |                  | (10    | ) |  |   | 4,571    |  
|Purchases                                                                                                                                                                            |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Issuances                                                                                                                                                                            |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Sales                                                                                                                                                                                |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Settlements                                                                                                                                                                          |  |                               | (1,532 | ) |                             |   | (736     | )                    |  |   |                              |   |  |                  |       |   |  |   | (2,269   | )
|Transfers in Level 3                                                                                                                                                                 |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|Transfers out of Level 3                                                                                                                                                             |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|Deconsolidation of VIEs                                                                                                                                                              |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|                                                                                                                                                                                     |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|Balance, end of period                                                                                                                                                               |  | $                             | 30,027 |   |                             | $ | 160,927  |                      |  | $ | 7,936                         |   |  | $                | 1,186  |   |  | $ | 200,076  |  
|                                                                                                                                                                                     |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to
assets and liabilities still held at the reporting date |  | $                             |       |   |                             | $ |         |                      |  | $ | (43                           | ) |  | $                | (1     | ) |  | $ | (44      | )
|                                                                                                                                                                                     |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|                                                                                                                                                                                    
|Level 3  Derivatives by class                                                                                                                                                       | 
|Three months ended March 31, 2011                                                                                                                                                    |  | Interest RateSwaps            |        |   | CreditDerivatives           |   |          | CurrencySwaps        |  |   | Call Optionson 
Long-termdebt |   |  | TotalDerivatives |       
|Balance, beginning of period                                                                                                                                                         |  | $                             | 25,750 |   |                             | $ | (221,683 | )                    |  | $ |                              |   |  | $                |       |   |  | $ | (195,933 | )
|Additions of VIEs for ASC 2009-17                                                                                                                                                    |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|Total gains/(losses) realized and unrealized:                                                                                                                                        |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|Included in earnings                                                                                                                                                                 |  |                               | 9,823  |   |                             |   | (8,903   | )                    |  |   |                              |   |  |                  | 16,725 |   |  |   | 17,645   |  
|Included in other comprehensive income                                                                                                                                               |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Purchases                                                                                                                                                                            |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Issuances                                                                                                                                                                            |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Sales                                                                                                                                                                                |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Settlements                                                                                                                                                                          |  |                               | (6,002 | ) |                             |   | (5,323   | )                    |  |   |                              |   |  |                  |       |   |  |   | (11,325  | )
|Transfers in Level 3                                                                                                                                                                 |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Transfers out of Level 3                                                                                                                                                             |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|Deconsolidation of VIEs                                                                                                                                                              |  |                               |       |   |                             |   |         |                      |  |   |                              |   |  |                  |       |   |  |   |         |  
|                                                                                                                                                                                     |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|Balance, end of period                                                                                                                                                               |  | $                             | 29,571 |   |                             | $ | (235,909 | )                    |  | $ |                              |   |  | $                | 16,725 |   |  | $ | (189,613 | )
|                                                                                                                                                                                     |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  
|The amount of total gains/(losses) included in earnings attributable to the change in unrealized gains or losses relating to
assets and liabilities still held at the reporting date |  | $                             | 13,800 |   |                             | $ | (17,183  | )                    |  | $ |                              |   |  | $                | 16,725 |   |  | $ | 13,342   |  
|                                                                                                                                                                                     |  |                               |        |   |                             |   |          |                      |  |   |                               |   |  |                  |        |   |  |   |          |  



63



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



Level- 3 financial assets and liabilities accounted for at fair value



|                                              |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |  |             |   |            |               |  |   |          |   |  |   |            |   |  |   |            |  
|--------------------------------------------- |  | ----------- | ------- | - | ----------- | - | ------ | ----------- |  | - | -------------------------- | - |  | ----- | --------- |  | ----------- | - | ---------- | ------------- |  | - | -------- | - |  | - | ---------- | - |  | - | ---------- | -
|                                              |  |             |         |   |             |   |        |             |  |   | VIE Assets and Liabilities |   |  |       |          
|                                              |  | Investments |         |   | OtherAssets |   |        | Derivatives |  |   | Investments                |   |  | Loans |           |  | Derivatives |   |            | Long-termdebt |  |   | Total    |  
|Three Months ended March 31, 2010             | 
|Balance, beginning of period                  |  | $           | 189,600 |   |             | $ | 18,843 |             |  | $ | (2,998,447                 | ) |  | $     | 160,518   |  |             | $ | 2,428,352  |               |  | $ |         |   |  | $ | (388,003   | ) |  | $ | (589,137   | )
|Additions of VIEs for ASC 2009-17             |  |             |        |   |             |   |       |             |  |   |                           |   |  |       | 3,817,065 |  |             |   | 17,275,234 |               |  |   | (153,369 | ) |  |   | (6,699,121 | ) |  |   | 14,239,809 |  
|Total gains/(losses) realized and unrealized: |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |  |             |   |            |               |  |   |          |   |  |   |            |   |  |   |            |  
|Included in earnings                          |  |             | (83     | ) |             |   | (1,917 | )           |  |   | (180,363                   | ) |  |       | 148,268   |  |             |   | (403,926   | )             |  |   | (727     | ) |  |   | (189,686   | ) |  |   | (628,434   | )
|Included in other comprehensive income        |  |             | (4,652  | ) |             |   |       |             |  |   |                           |   |  |       |          |  |             |   |           |               |  |   |         |   |  |   |           |   |  |   | (4,652     | )
|Purchases, issuances and settlements          |  |             | (730    | ) |             |   |       |             |  |   | 37,820                     |   |  |       |          |  |             |   |           |               |  |   |         |   |  |   |           |   |  |   | 37,090     |  
|Transfers in (out) of Level 3                 |  |             |        |   |             |   |       |             |  |   |                           |   |  |       |          |  |             |   |           |               |  |   |         |   |  |   |           |   |  |   |           |  
|Deconsolidation of VIEs                       |  |             |        |   |             |   |       |             |  |   |                           |   |  |       |          |  |             |   | (3,158,241 | )             |  |   |         |   |  |   | 1,346,820  |   |  |   | (1,811,421 | )
|                                              |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |  |             |   |            |               |  |   |          |   |  |   |            |   |  |   |            |  
|Balance, end of period                        |  | $           | 184,135 |   |             | $ | 16,926 |             |  | $ | (3,140,990                 | ) |  | $     | 4,125,851 |  |             | $ | 16,141,419 |               |  | $ | (154,096 | ) |  | $ | (5,929,990 | ) |  | $ | 11,243,255 |  
|                                              |  |             |         |   |             |   |        |             |  |   |                            |   |  |       |           |  |             |   |            |               |  |   |          |   |  |   |            |   |  |   |            |  

Invested assets and VIE long-term debt are transferred into Level 3 when internal valuation models that
include significant unobservable inputs are used to estimate fair value. All such securities that have internally modeled fair values have been classified as Level 3 as of March 31, 2011 and December 31, 2010. Derivative instruments are
transferred into Level 3 when the use of unobservable inputs become significant to the overall valuation. During 2011 and 2010, transfers of derivatives to Level 3 related to the inclusion of fair value adjustments to reflect estimated replacement
or exit costs, as described under Derivative Instruments above, which are not reflected in the net present value of the projected contractual cash flows. All transfers into and out of Level 3 represent transfers between Level 3 and Level
2. There were no transfers in or out of Level 1 for the periods presented. All Level 1, 2, and 3 transfers are recognized at the beginning of each accounting period.

Gains and losses (realized and unrealized) relating to Level 3 assets and liabilities included in earnings for periods ended March 31, 2011 and 2010 are reported as follows:



|                                                                                                              |  |                     |     |   |                                                                            |   |       |                                                          |  |   |                            |   |  |                                          |         |   |             |   |          |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------- |  | ------------------- | --- | - | -------------------------------------------------------------------------- | - | ----- | -------------------------------------------------------- |  | - | -------------------------- | - |  | ---------------------------------------- | ------- | - | ----------- | - | -------- | - |  | - | ------ | -
|                                                                                                              |  | Netinvestmentincome |     |   | Realized gainsor (losses) andothersettlements oncredit derivativecontracts |   |       | Unrealizedgains or 
(losses)on creditderivativecontracts |  |   | Derivativeproductsrevenues |   |  | Loss onvariableinterest entityactivities |         |   | Otherincome |  
|2011                                                                                                          |  |                     |     |   |                                                                            |   |       |                                                          |  |   |                            |   |  |                                          |         |   |             |   |          |   |  |   |        |  
|                                                                                                              |  |                     |     |   |                                                                            |  
|Total gains or losses included in earnings for the period                                                     |  | $                   | (50 | ) |                                                                            | $ | 5,323 |                                                          |  | $ | (14,226                    | ) |  | $                                        | 26,548  |   |             | $ | (53,070  | ) |  | $ | 17,821 |  
|Changes in unrealized gains or losses relating to the assets and liabilities still held at the reporting date |  |                     |    |   |                                                                            |   |      |                                                          |  |   | (17,183                    | ) |  |                                          | 13,800  |   |             |   | (53,070  | ) |  |   | 17,821 |  
|                                                                                                              |  |                     |     |   |                                                                            |  
|2010                                                                                                          |  |                     |     |   |                                                                            |   |       |                                                          |  |   |                            |   |  |                                          |         |   |             |   |          |   |  |   |        |  
|                                                                                                              |  |                     |     |   |                                                                            |  
|Total gains or losses included in earnings for the period                                                     |  | $                   | (83 | ) |                                                                            | $ | 9,924 |                                                          |  | $ | (177,063                   | ) |  | $                                        | (13,224 | ) |             | $ | (446,071 | ) |  | $ | (1,917 | )
|Changes in unrealized gains or losses relating to the assets and liabilities still held at the reporting date |  |                     |    |   |                                                                            |   |      |                                                          |  |   | (203,119                   | ) |  |                                          | (19,348 | ) |             |   | (8,243   | ) |  |   | (1,917 | )



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(12) Commitments and Contingencies

Ambac Financial Group, Inc. (defined herein as Ambac or Ambac Financial Group) and certain of its present or
former officers or directors have been named in lawsuits that allege violations of the federal securities laws and/or state law. Various putative class action suits alleging violations of the federal securities laws have been filed against the
Company and certain of its present or former directors and officers. These suits include four class actions filed in January and February of 2008 in the United States District Court for the Southern District of New York that were consolidated on
May 9, 2008 under the caption In re Ambac Financial Group, Inc. Securities Litigation, Lead Case No. 08 CV 411. On July 25, 2008, another suit, Painting Industry Insurance and Annuity Funds v. Ambac Assurance Corporation, et
al., case No. 08 CV 6602, was filed in the United States District for the Southern District of New York. On or about August 22, 2008, a consolidated amended complaint was filed in the consolidated action. The consolidated amended
complaint includes the allegations presented by the original four class actions, the allegations presented by the Painting Industryaction, and additional allegations. The consolidated amended complaint purports to be brought on behalf of
purchasers of Ambacs common stock from October 25, 2006 to April 22, 2008, on behalf of purchasers of Ambacs DISCS, issued in February of 2007, and on behalf of purchasers of equity units and common stock in
Ambacs March 2008 offerings. The suit names as defendants the Company, the underwriters for the three offerings, the Companys independent Certified Public Accountants and certain present and former directors and officers of the Company.
The complaint alleges, among other things, that the defendants issued materially false and misleading statements regarding Ambacs business and financial results and guarantees of CDO and MBS transactions and that the Registration Statements
pursuant to which the three offerings were made contained material misstatements and omissions in violation of the securities laws. On August 27, 2009, the Company and the individual defendants named in the consolidated securities action moved
to dismiss the consolidated amended complaint.On February 22, 2010, the Court dismissed the claims arising out of the March 2008 equity units and common stock offering (resulting in the dismissal of the Companys independent
Certified Public Accountants from the action), and otherwise denied the motions to dismiss. On April 15, 2010, the Court ordered a Discovery Plan and Proposed Pretrial Schedule, pursuant to which discovery was scheduled to commence on
May 10, 2010, with dispositive motions due by December 2, 2011. On December 9, 2010, Ambac and the present or former officers or directors who are defendants in these actions entered into a memorandum of understanding with Plaintiffs
with respect to settlement. And, as discussed in more detail below, on May 6, 2011, Ambac and the present or former officers or directors who are defendants in these actions entered in a stipulation of settlement to settle the claims asserted in
these actions.

On December 24, 2008, a complaint in a putative class action entitled Stanley Tolin et al. v. Ambac
Financial Group, Inc. et al., asserting alleged violations of the federal securities laws was filed in the United States District Court for the Southern District of New York against Ambac, one former officer and director and one former
officer,Case No. 08 CV 11241. An amended complaint was subsequently filed on January 20, 2009. This action is brought on behalf of all purchasers of Structured Repackaged Asset-Backed Trust Securities, Callable Class A
Certificates, Series 2007-1, STRATS(SM) Trust for Ambac Financial Group, Inc. Securities 2007-1 (STRATS) from June 29, 2007 through April 22, 2008. The STRATS are asset-backed securities that were allegedly issued by a
subsidiary of Wachovia Corporation and are allegedly collateralized solely by Ambacs DISCS. The complaint alleges, among other things, that the defendants issued materially false and misleading statements regarding Ambacs business and
financial results and Ambacs guarantees of CDO and MBS transactions, in violation of the securities laws. On April 15, 2009, the Company and the individual defendants named in Tolin moved to dismiss the amended complaint.On
December 23, 2009, the Court initially denied defendants motion to dismiss, but later recalled that decision and requested further briefing from parties in the case before it rendered a decision on the motion to dismiss. The additional
briefing was completed on March 5, 2010, and oral argument on the motion to dismiss was heard on August 4, 2010. On December 9, 2010, Ambac and the former officer and director and the former officer who are defendants in this action
entered into a memorandum of understanding with Plaintiffs with respect to settlement. And, as discussed in more detail below, on May 6, 2011, Ambac and the former officer and director and the former officer who are defendants in this action entered
into a stipulation of settlement to settle the claims asserted in this action.



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Various shareholder derivative actions have been filed against certain present or former
officers or directors of Ambac, and against Ambac as a nominal defendant. These suits, which are brought purportedly on behalf of the Company, are in many ways similar and allege violations of law for conduct occurring between October 2005 and the
dates of suit regarding, among other things, Ambacs guarantees of CDO and MBS transactions, Ambacs public disclosures regarding such guarantees and Ambacs financial condition, and certain defendants alleged insider trading on
non-public information. The suits include (i) three actions filed in the United States District Court for the Southern District of New York that have been consolidated under the caption In re Ambac Financial Group, Inc. Derivative Litigation,
Lead Case No. 08 CV 854; on June 30, 2008, plaintiffs filed a consolidated and amended complaint that asserts violations of state and federal law, including breaches of fiduciary duties, waste of corporate assets, unjust enrichment and
violations of the federal securities laws; on August 8, 2008, the Company and the individual defendants named in the consolidated Southern District of New York derivative action moved to dismiss that action for want of demand and failure to
state a claim upon which relief can be granted; on December 11, 2008, the court granted plaintiffs motion for leave to amend the complaint and plaintiffs filed an amended complaint on December 17, 2008; on June 2, 2009
defendants moved to dismiss the amended complaint; on November 22, 2010, the Court dismissed the consolidated derivative action without prejudice to its renewal when and if the automatic stay provided by the Bankruptcy Code is lifted
(ii) two actions filed in the Delaware Court of Chancery that have been consolidated under the caption In re Ambac Financial Group, Inc. Shareholders Derivative Litigation, Consolidated C.A. No. 3521; on May 7, 2008, plaintiffs filed
a consolidated and amended complaint that asserts claims including breaches of fiduciary duties, waste, reckless and gross mismanagement, and unjust enrichment; on December 30, 2008, the Delaware Court of Chancery granted defendants
motion to stay the Delaware shareholder derivative action in favor of the Southern District of New York Consolidated Derivative Action; plaintiffs in the Delaware action subsequently moved to intervene in the Southern District of New York derivative
action and on May 12, 2009, the motion to intervene was denied; and (iii) two actions filed in the Supreme Court of the State of New York, New York County, that have been consolidated under the caption In re Ambac Financial Group, Inc.
Shareholder Derivative Litigation, Consolidated Index No. 650050/2008E; on September 22, 2008, plaintiffs filed a consolidated and amended complaint that asserts claims including breaches of fiduciary duties, gross mismanagement, abuse of
control, and waste; on January 5, 2010, the New York Supreme Court granted defendants motion to stay the New York Supreme Court action in favor of the Southern District of New York Consolidated Derivative Action; one of the actions consolidated
in the New York Supreme Court actions is currently listed on the Courts docket as dismissed, the other action remains listed as stayed.

Pursuant to the terms of a memorandum of understanding entered into on December 9, 2010, on May 6, 2011, Ambac and all of its present or former officers or directors who are defendants in the Securities
Class Actions or the Derivative Actions, entered into a stipulation of settlement (the Stipulation) with the lead plaintiffs in In re Ambac Financial Group, Inc. Securities Litigation and the named plaintiffs in Tolin v. Ambac
Financial Group, Inc. for settlement of both of the Securities Class Actions. The Stipulation provides that the claims of the putative plaintiff classes, among other claims, will be settled for a cash payment of $27,100. Certain of the insurance
carriers who provided directors and officers liability coverage to Ambacs present and former officers and directors for the period July 2007-July 2009 have agreed to pay $24,600 of the settlement, pursuant to a separate agreement entered
into between Ambac, the present or former officers or directors who are defendants in the Securities Class Actions or the Derivative Actions, and those insurance carriers. Ambac has agreed to pay $2,500 of the settlement and previously deposited
that amount into an escrow account (classified as Restricted Cash on the Consolidated Balance Sheet since these amounts are held in escrow). Lead and named plaintiffs in the Securities Class Actions, on behalf of themselves and all other members of
the settlement class, have agreed to releases of claims against, among others, Ambac and the present or former officers or directors who are parties to the Stipulation. The settlement provided for in the Stipulation is subject to various conditions,
including, among others, approval by the United States District Court for the Southern District of New York and approval by the bankruptcy court of Ambacs entry into the settlement and of certain releases and bar orders that would release and
bar claims (among others) by or on behalf of Ambac, including by any shareholder or creditor of Ambac purportedly acting derivatively on behalf of Ambac, against present or former officers or directors of Ambac that were, could have been, might have
been or might be in the future asserted in any of the Securities Actions or any of the Derivative Actions. The Stipulation further provides that nothing in the Stipulation shall be deemed an admission by any defendant of any fault, liability, or
wrongdoing. The above description of terms of the Stipulation is qualified in its entirety by reference to the text of the Stipulation, which was filed in In re Ambac Financial Group, Inc. Securities Litigation on May 6, 2011.



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On December 14, 2009, a purchaser of Ambacs DISCS filed an individual action
entitled Judy Ehrenreich v. Ambac Financial Group, Inc. et al., asserting alleged violations of the federal securities laws, in the United States District Court for the Southern District of New York, against Ambac and one former officer, Case
No. 09 CV 10173. The complaint alleges, among other things, that the defendants issued materially false and misleading statements regarding Ambacs plans to meet certain investment agreement collateral requirements as well as materially
false and misleading statements regarding Ambacs valuation of certain of its investment securities. On March 9, 2010, the Company and the former officer moved to dismiss. On November 10, 2010, Ambac filed a Notice of
Bankruptcy in the action, advising the Court of its position that in light of Ambacs filing for bankruptcy, as of November 8, 2010, any new or further action against Ambac is stayed pursuant to section 362 of the Bankruptcy Code. On
March 28, 2011, the Court entered an order staying the action.

Karthikeyan V. Veera v. Ambac Financial Group, Inc. et
al., (United States District Court for the Southern District of New York, Case No. 10 CV 4191, filed on or about May 24, 2010, and amended on September 7, 2010). Plaintiff, a former employee and participant in the Companys
Saving Incentive Plan (the Plan), asserts violations of the Employee Retirement Income Security Act of 1974 (ERISA) and names as defendants the Plan Administrative Committee, the Plan Investment Committee, the Compensation
Committee of the Board of Directors of the Company, and a number of current and former officers of the Company. This action is purportedly brought on behalf of all persons, excluding defendants and their immediate families, who were
participants in the Plan from October 1, 2006 through July 2, 2008 and whose Plan accounts included an investment in Ambac stock. The complaint alleges, among other things, breaches of fiduciary duties by defendants in respect of the
continued offering of Ambac stock as an investment option for the Plan and the failure to provide complete and accurate information to Plan participants regarding the Companys financial condition. This ERISA action seeks, among other
things, compensatory damages, a constructive trust for amounts by which the fiduciaries allegedly benefited as a result of their breaches, and attorneys fees. On October 20, 2010, all of the defendants named in the amended complaint moved
to dismiss all of the claims in the amended complaint.In an Opinion and Order issued January 6, 2011, the Court denied the motion to dismiss, but held that the defendants had no affirmative duty under ERISA to disclose information
about the companys financial condition to plan participants. On January 18, 2011, the Company filed an adversary complaint in the Bankruptcy Court against Plaintiff, seeking declaratory relief to confirm the applicability of the
automatic stay under Bankruptcy Code section 362(a) to plaintiffs claims or, alternatively, for injunctive relief under section 105(a) of the Bankruptcy Code to preclude plaintiff from prosecuting his claims pending the effective date of a
chapter 11 plan or further order of the Bankruptcy Court. On February 11, 2011, the Company filed a motion in the adversary proceeding for summary judgment declaring that the protections of the automatic stay apply or should be extended to the
claims in the ERISA action and for injunctive relief. Following a hearing on the Companys motion on March 4, 2011, the Bankruptcy Court entered an order granting the Companys motion, holding that the automatic stay applied to the
ERISA action, but also granted Plaintiff relief from the stay to pursue limited discovery during the extended exclusivity period in the Companys Chapter 11 case.

County of Alameda et al. v. Ambac Assurance Corporation et al. (Superior Court of the State of California, County of San Francisco, filed on or about October 13, 2010) (Alameda
Complaint); Contra Costa County et al. v. Ambac Assurance Corporation et al. (Superior Court of the State of California, County of San Francisco, filed on or about October 13, 2010) (Contra Costa Complaint); The Olympic Club
v. Ambac Assurance Corporation et al. (Superior Court of the State of California, County of San Francisco, filed on or about October 13, 2010) (Olympic Club Complaint). The Contra Costa Complaint is brought on behalf of five
California municipal entities and the non-profit Jewish



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Community Center of San Francisco. The Alameda Complaint is brought on behalf of nineteen California municipal entities. The Olympic Club Complaint is brought on behalf of the non-profit Olympic
Club. The three actions make similar allegations against Ambac Assurance, various other financial guarantee insurance companies and employees thereof (collectively with Ambac Assurance, the Bond Insurer Defendants), and, in the case of
the Contra Costa Complaint and the Olympic Club Complaint, the major credit rating agencies (the Rating Agencies). The actions allege that (1) Ambac Assurance and the other Bond Insurer Defendants colluded with the Rating Agencies
to perpetuate a dual rating system pursuant to which the Rating Agencies rated the debt obligations of municipal issuers differently from corporate debt obligations, thereby keeping municipal ratings artificially low relative to
corporate ratings; (2) Ambac Assurance and the other Bond Insurer Defendants issued false and misleading financial statements which failed to disclose the extent of the insurers respective exposures to mortgage backed securities and
collateralized debt obligations; and (3) as a result of these actions, plaintiffs incurred higher interest costs and bond insurance premiums in respect of their respective bond issues. Ambac Assurance and the other Bond Insurer Defendants filed
a demurrer seeking the dismissal of each of these complaints on September 17, 2010. The plaintiffs filed their opposition papers to the demurrer on October 22, 2010. The reply papers in support of the demurrer were filed on
November 19, 2010 and oral argument on the demurrer is expected to occur in July, 2011. Ambac Financial Group was originally a defendant in each of these actions, but on November 22, 2010, Ambac Financial Group was dismissed without
prejudice as a defendant by the plaintiffs in each of these actions.

NPS LLC v. Ambac Assurance Corporation (United States
District Court, District of Massachusetts, filed on July 8, 2008). This action was brought by NPS LLC (NPS), the owner of Gillette Stadium, the home stadium of the New England Patriots, with respect to the termination of a financial
guarantee insurance policy issued by Ambac Assurance with respect to auction rate bonds issued by NPS in 2006. Due to well-documented disruption of the auction rate securities market, the interest rate on the bonds floated to high levels and NPS
therefore refinanced the bonds in a fixed rate financing without Ambac Assurances involvement. Pursuant to the insurance agreement between NPS and Ambac Assurance, NPS is obligated to pay a make whole premium to Ambac Assurance
equal to the present value of the installment premiums that Ambac Assurance would have earned through 2017 if the bonds had not been redeemed (approximately $2,700). NPS alleged that it is not liable to pay the make whole premium because
Ambac Assurance misrepresented its financial condition at the time the bonds were issued and that the alleged misrepresentations induced NPS to enter into the insurance agreement, thereby causing NPS to incur additional interest costs in connection
with the bonds. NPS also alleged that Ambac Assurance was liable to NPS for the additional interest costs incurred by NPS which resulted from the disruption of the auction rate securities market. On February 25, 2010, the court granted Ambac
Assurances motion for summary judgment as to all of NPSs claims and Ambac Assurances counterclaim for the make whole premium and interest and costs. The parties are awaiting a determination by the court of the amount of
Ambac Assurances legal fees that NPS will be required to pay. NPS has stated that it intends to appeal the grant of summary judgment in favor of Ambac Assurance.

City of Phoenix v. Ambac Assurance Corporation et al. (United States District Court, District of Arizona, filed on or about March 11, 2010). This action is brought by the City of Phoenix against
Ambac Assurance and other financial guarantee insurance companies. The complaint alleges that the defendants sought to perpetuate the Rating Agencies dual rating system, and that the perpetuation of the dual rating
system enabled the defendants to unfairly discriminate against the City of Phoenix in the pricing of bond insurance premiums. Pursuant to the Courts Scheduling Order, discovery is scheduled to be completed by October 3, 2011, with
dispositive motions due by November 1, 2011.

Water Works Board of the City of Birmingham v. Ambac Financial Group, Inc.
and Ambac Assurance Corporation (United States District Court, Northern District of Alabama, Southern Division, filed on November 10, 2009). This action alleged breach of contract, misrepresentation, deceit,



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suppression of truth and negligence. Plaintiff claims that, in connection with plaintiffs purchase of a debt service reserve fund surety bond from Ambac Assurance in March 2007 with respect
to its bond issue, Ambac Assurance misrepresented the stability of its AAA financial strength ratings and subsequently breached a covenant to maintain its AAA ratings, thereby causing loss to plaintiff when it was required to
replace the Ambac Assurance surety bond upon the downgrade of Ambac Assurances ratings. On April 1, 2010, the court granted defendants motion to dismiss all claims. The plaintiff has appealed the dismissal to the U.S. Court of
Appeals for the Eleventh Circuit. On January 25, 2011, the Circuit Court stayed the appeal in light of Ambacs pending bankruptcy proceedings.

Ambac Assurance Corporation v. Adelanto Public Utility Authority (United States District Court, Southern District of New York, filed on June 1, 2009). Ambac Assurance commenced this action to recover
$4,524 from the defendant on account of Ambac Assurances payment under a swap termination surety bond. The defendant has counterclaimed (as amended on June 12, 2010), alleging breach of contract, breach of the covenant of good faith and
fair dealing, violations of California insurance statutes, fraud and promissory estoppel. Defendant claims that, in connection with defendants purchase of a bond insurance policy with respect to its variable rate bond issue in September 2005,
Ambac Assurance misrepresented the stability of its AAA financial strength ratings and subsequently breached an implied covenant by underwriting risky structured obligations that ultimately led to the loss of the AAA ratings.
Ambac Assurance has moved to dismiss all of the defendants counterclaims and that motion has been fully briefed.

Ambac
Assurance has periodically received various regulatory inquiries and requests for information with respect to investigations and inquiries that such regulators are conducting. Ambac Assurance has complied with all such inquiries and requests for
information. On March 24, 2010, Ambac Assurance established a segregated account and allocated to such segregated account certain financial guaranty insurance policies and other contingent liabilities, certain claims and other rights and
certain equity interests in subsidiaries. An insurance rehabilitation proceeding was commenced with respect to the segregated account in the Wisconsin Circuit Court for Dane County (the Rehabilitation Court) on March 24, 2010 by the
Commissioner of Insurance of the State of Wisconsin (the Commissioner) and the Rehabilitation Court entered an order of rehabilitation for the Segregated Account, appointing the Commissioner as rehabilitator, and entered orders enjoining
certain actions that could have an adverse effect on the financial position of the segregated account.

Various third parties
have filed motions or objections in the Rehabilitation Court and/or moved to intervene in the rehabilitation proceedings. On January 24, 2011, the Rehabilitation Court issued its Decision and Final Order Confirming the Rehabilitators Plan
of Rehabilitation, with Findings of Fact and Conclusions of Law (the Confirmation Order). Notices of appeal from the Confirmation Order were filed by various parties, including policyholders. Such appeals are pending.

Ambac Assurances CDS portfolio experienced significant losses. The majority of these CDS contracts are on a pay as you
go basis, and we believe that they are properly characterized as notional principal contracts for U.S. federal income tax purposes. Generally, losses on notional principal contracts are ordinary losses. However, the federal income tax
treatment of credit default swaps is an unsettled area of the tax law. As such, it is possible that the Internal Revenue Service may decide that the pay as you go CDS contracts should be characterized as capital assets or that certain
payments made with respect to the CDS contracts should be characterized as capital losses. Recently, the Internal Revenue Service opened an examination into certain issues related to Ambac Assurances tax accounting methods with respect to such
CDS contracts and Ambac Assurances related characterization of such losses as ordinary losses. Although, as discussed above, Ambac Assurance believes these contracts are properly characterized as notional principal contracts, if the Internal
Revenue Service today were to successfully assert, as a result of its examination, that these contracts should be characterized as capital assets or as



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generating capital losses, Ambac Assurance would be subject to both a substantial reduction in its net operating loss carryforwards and would suffer a material assessment for federal income taxes
up to an estimated amount of $1,079,000. On November 9, 2010, the Company and the IRS agreed to a stipulation on the record that provides that the IRS would give notice at least 5 business days prior to taking any action against the
Companys nondebtor subsidiaries in the consolidated tax group that would violate the State Court Injunction, whether or not in effect. The stipulation permits the status quo to be maintained from November 9, 2010 until a hearing on the
preliminary injunction that the Company plans to seek under Bankruptcy Code section 105(a) barring assessment and collection of the 2003 through 2008 tax refunds by the IRS against the Companys nondebtor subsidiaries in the consolidated tax
group. On the same date, Ambac filed and served a complaint against the IRS for a declaratory judgment relating to the tax refunds. On January 14, 2011, the IRS filed its Answer and opposition to Ambacs Motion for Temporary Restraining
Order and Preliminary Injunction. As of this date, no hearing on such Motion has been scheduled. On January 13, 2011, the IRS filed a motion in the United States District Court for the Southern District of New York (USDC SDNY) to
withdraw the Adversary Proceeding from the Bankruptcy Court to the USDC SDNY. Ambac has opposed such motion. On February 1, 2011, Ambac filed a motion with the Bankruptcy Court for Pretrial Conference and for Authorization to Implement
Alternative Dispute Resolution Procedures. The Bankruptcy Court on March 2, 2011 ordered the process of non-binding mediation to begin on or about May 1, 2011 and to conclude no later than on or about September 6, 2011. Mediation is
currently scheduled to commence on July 6, 2011. The Bankruptcy Court also approved a scheduling order which, among other things, ordered fact discovery in the Adversary proceeding to be completed by August 5, 2011; dispositive motions to
be filed by September 16, 2011, and trial to be scheduled, thereafter, pursuant to further order of the Court.

The IRS
has also sought to assert legal rights against Ambac Assurance, as joint and several obligor in respect of any assessment for federal income taxes against the consolidated Ambac tax group. On December 8, 2010, the IRS removed the Wisconsin
rehabilitation proceeding involving the Segregated Account to the United States District Court for the Western District of Wisconsin (the District Court). On December 17, 2010, the IRS filed a motion in the District Court to
dissolve the supplemental injunction that had been entered by the Rehabilitation Court on November 8, 2010 to prevent certain actions by the IRS that could have an adverse effect on the financial position of the Segregated Account. The
Commissioner moved to remand the proceeding back to the Rehabilitation Court, and on January 14, 2011, that motion was granted by the District Court, which found that it lacked subject matter jurisdiction. The IRS has appealed this decision to
the United States Court of Appeals for the Seventh Circuit. On January 20, 2011, the Seventh Circuit ordered the IRS to show cause why its appeal should not be dismissed for lack of jurisdiction, which led to additional briefing. On
February 9, 2011, the IRS filed a complaint and a motion for a preliminary injunction in the District Court seeking, inter alia, to enjoin enforcement of the injunction issued by the Rehabilitation Court and the Confirmation Order against the
IRS. The District Court dismissed the suit for lack of subject matter jurisdiction on February 18, 2011, and the IRS filed a notice of appeal on February 22, 2011. The appeals at the Seventh Circuit are pending.

Ambac is involved from time to time in various routine legal proceedings, including proceedings related to litigation with present or
former employees. Although Ambacs litigation with present or former employees is routine and incidental to the conduct of its business, such litigation can result in large monetary awards when a civil jury is allowed to determine compensatory
and/or punitive damages for, among other things, termination of employment that is wrongful or in violation of implied contracts.

In the ordinary course of their businesses, certain of Ambacs subsidiaries assert claims in legal proceedings against third parties to recover losses already paid and/or mitigate future losses. The
amounts recovered and/or losses avoided which may be result from these proceedings is uncertain, although recoveries and/or losses avoided in any one or more of these proceedings during any quarter or fiscal year could be material to Ambacs
results of operations in that quarter or fiscal year.



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In connection with Ambacs efforts to seek redress for breaches of representations
and warranties and fraud related to the information provided by both the underwriters and the sponsors of various transactions and for failure to comply with the obligation by the sponsors
to repurchase ineligible loans, Ambac Assurance has filed the following lawsuits:



| |  |  | Ambac Assurance Corporation v. EMC Mortgage Corporation and J.P. Morgan Securities, Inc, (formerly known as Bear, Stearns & Co. Inc.) (Supreme
Court of the State of New York, County of New York, filed February 17, 2011). This case is the continuation of a case that was originally filed on November 5, 2008 in the U.S. District Court for the Southern District of New York but that
was dismissed from federal court after Ambac was granted leave to amend its complaint to add certain new claims (but not others) and a new party, which deprived the federal court of jurisdiction over the litigation. After the decision by the federal
judge, dated February 8, 2011, Ambac Assurance re-filed the suit in New York state court on February 17, 2011. In its state-court action, Ambac Assurance asserts claims for breach of contract, indemnification and reimbursement against EMC,
as well as claims of fraudulent conduct by EMC and J. P. Morgan Securities Inc. Subsequently, EMC filed a notice of appeal of certain aspects of the federal judges decision, and EMC and J. P. Morgan Securities Inc. have moved for a stay
of the state-court litigation pending its appeal of the decision of the federal judge, a motion which Ambac Assurance is contesting.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Ambac Assurance Corporation and the Segregated Account of Ambac Assurance Corporation v. DLJ Mortgage Capital, Inc. and Credit Suisse Securities
(USA) LLC (Supreme Court of the State of New York, County of New York, filed on January 12, 2010). Ambac Assurance alleged breach of contract, fraudulent inducement, breach of implied duty of good faith and fair dealing, indemnification,
reimbursement and requested the repurchase of loans that breach representations and warranties as required under the contracts, as well as damages. On July 8, 2010, the defendants moved to dismiss the complaint. Ambac Assurance opposed the
motion and the Court held oral argument on October 12, 2010. In a decision dated April 7, 2011, the Court granted the defendants motion in part dismissing only Ambac Assurances cause of action for fraudulent inducement and
striking Ambac Assurances claim for consequential damages and jury demand. The Court otherwise denied the defendants motion.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Ambac Assurance Corporation and The Segregated Account of Ambac Assurance Corporation v. Countrywide Securities Corp., Countrywide Financial Corp.
(a.k.a. Bank of America Home Loans) and Bank of America Corp. (Supreme Court of the State of New York, County of New York, filed on September 28, 2010). Ambac has alleged breach of contract, fraudulent inducement, indemnification and
reimbursement, breach of representations and warranties and has requested the repurchase of loans that breach representations and warranties as required under the contracts as well as damages and has asserted a successor liability claim against Bank
of America.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

It is not reasonably possible to predict whether additional suits will be filed or whether
additional inquiries or requests for information will be made, and it is also not possible to predict the outcome of litigation, inquiries or requests for information. It is possible that there could be unfavorable outcomes in these or other
proceedings. Legal accruals for certain litigation matters discussed above which are probable and reasonably estimable, and managements estimated range of loss for such matters, are not material to the operating results or financial position
of the Company. For the remaining litigation matters that do not meet the probable and reasonably estimable accrual threshold and where no loss estimates have been provided above, management is unable to make a meaningful estimate of the
amount or range of loss that could result from unfavorable outcomes but, under some circumstances, adverse results in any such proceedings could be material to our business, operations, financial position, profitability or cash



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|Item 1. | Notes to Unaudited Consolidated Financial Statements
|------- | ----------------------------------------------------

| | (Dollars in thousands, except share amounts)
| | --------------------------------------------



flows. The Company believes that it has substantial defenses to the claims filed against it in these lawsuits and, to the extent that these actions proceed, the Company intends to defend itself
vigorously; however, the Company is not able to predict the outcomes of these actions.

(13) Restricted Cash

Cash that we do not have the right to use for general purposes as of reporting period end is recorded as restricted cash in our
consolidated balance sheets. Restricted cash include: i) cash held in an escrow account for the purpose of pending litigation settlement subject to Bankruptcy Court approval and ii) consolidated variable interest entity cash restricted to fund the
obligations of the consolidated VIEs.

(14) Future Application of Accounting Standards

In October 2010, the FASB issued ASU 2010-26, Financial ServicesInsurance (Topic 944): Accounting for Costs Associated with
Acquiring or Renewing Insurance Contractsa consensus of the FASB Emerging Issues Task Force. ASU 2010-26 modifies the types of costs incurred by insurance entities that can be capitalized in the acquisition of new and renewal insurance
contracts. ASU 2010-26 requires only incremental costs or costs directly related to the successful acquisition of new or renewal contracts to be capitalized as a deferred acquisition cost. ASU 2010-26 is effective for interim and annual periods
beginning after December 15, 2011 with either prospective or retrospective application permitted. Early adoption is permitted. Ambac will adopt ASU 2010-26 on January 1, 2012 on a prospective basis. Ambac is currently evaluating the
implications of ASU 2010-26 on its financial statements.



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

In this Quarterly Report, we have included statements that may constitute forward-looking statements within the meaning of the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as estimate, project, plan, believe, anticipate, intend, planned,
potential and similar expressions, or future or conditional verbs such as will, should, would, could, and may, or the negative of those expressions or verbs, identify
forward-looking statements. We caution readers that these statements are not guarantees of future performance. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, which, may by their
nature be inherently uncertain and some of which may be outside our control. These statements may relate to plans and objectives with respect to the future, among other things which may change. We are alerting you to the possibility that our actual
results may differ, possibly materially, from the expected objectives or anticipated results that may be suggested, expressed or implied by these forward-looking statements. Important factors that could cause our results to differ, possibly
materially, from those indicated in the forward-looking statements include, among others, those discussed under Risk Factors in Part I, Item 1A of the 2010 Annual Report on Form 10-K and Part II, Item 1A of the Form 10-Q.

Any or all of managements forward-looking statements here or in other publications may turn out to be incorrect and are
based on Ambac Financial Group, Inc. (Ambac or the Company) managements current belief or opinions. Ambacs actual results may vary materially, and there are no guarantees about the performance of Ambacs
securities. Among events, risks, uncertainties or factors that could cause actual results to differ materially are: (1) a plan of reorganization under Chapter 11 will not be confirmed; (2) if Ambac is not successful in filing a plan of
reorganization under Chapter 11, it is likely it would have to liquidate pursuant to Chapter 7; (3) the impact of the bankruptcy proceeding on the holders of Ambac securities; (4) the unlikely ability of Ambac Assurance Corporation
(Ambac Assurance) to pay dividends to Ambac in the near term; (5) litigation between Ambac and Ambac Assurance regarding the allocation of net operating losses (NOLs) and other claims could reduce the overall value of
the Company; (6) adverse events arising from the Segregated Account Rehabilitation Proceedings, including the injunctions issued by the Wisconsin rehabilitation court to enjoin certain adverse actions related to the Segregated Account being
successfully challenged as not enforceable; (7) litigation arising from the Segregated Account Rehabilitation Proceedings; (8) decisions made by the rehabilitator for the benefit of policyholders may result in material adverse consequences
for Ambacs securityholders; (9) potential of a full rehabilitation proceeding against Ambac Assurance or material changes to the plan of rehabilitation, with resulting adverse impacts; (10) inadequacy of reserves established for
losses and loss expenses, including our inability to realize the remediation recoveries included in our reserves; (11) market risks impacting assets in our investment portfolio or the value of our assets posted as collateral in respect of
investment agreements and interest rate swap and currency swap transactions; (12) risks relating to determination of amount of impairments taken on investments; (13) credit and liquidity risks due to unscheduled and unanticipated
withdrawals on investment agreements; (14) market spreads and pricing on insured collateralized loan obligations (CLOs) and other derivative products insured or issued by Ambac; (15) Ambacs financial position and the
Segregated Account Rehabilitation Proceedings may prompt departures of key employees and may impact our ability to attract qualified executives and employees; (16) the risk of litigation and regulatory inquiries or investigations, and the risk
of adverse outcomes in connection therewith, which could have a material adverse effect on our business, operations, financial position, profitability or cash flows; (17) credit risk throughout our business, including credit risk related to
residential mortgage-backed securities, CLOs, public finance obligations and large single exposures to reinsurers; (18) disputes with reinsurers regarding amounts owed us under our reinsurance agreements; (19) default by one or more of
Ambac Assurances portfolio investments, insured issuers, counterparties or reinsurers; (20) the risk that our risk management



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policies and practices do not anticipate certain risks and/or the magnitude of potential for loss as a result of unforeseen risks; (21) factors that may influence the amount of installment
premiums paid to Ambac, including the imposition of the payment moratorium with respect to claims payments as a result of Segregated Account Rehabilitation Proceedings; (22) changes in prevailing interest rates; (23) the risk of volatility
in income and earnings, including volatility due to the application of fair value accounting, required under the relevant derivative accounting guidance, to the portion of our credit enhancement business which is executed in credit derivative form;
(24) changes in accounting principles or practices that may impact Ambacs reported financial results; (25) legislative and regulatory developments; (26) operational risks, including with respect to internal processes, risk
models, systems and employees; (27) changes in tax laws, tax disputes and other tax-related risks; (28) other factors described in the Risk Factors section in Part I, Item 1A of Ambacs Annual Report on Form 10-K for the fiscal
year ended December 31, 2010 and also disclosed from time to time by Ambac in its subsequent reports on Form 10-Q and Form 8-K, which are available on the Ambac website at www.ambac.com and at the SECs website, www.sec.gov; and
(29) other risks and uncertainties that have not been identified at this time.

Overview

Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose affiliates provided financial guarantees and
financial services to clients in both the public and private sectors around the world. Ambac filed for a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code (Bankruptcy Code) in the United States
Bankruptcy Court for the Southern District of New York (Bankruptcy Court). The Company will continue to operate in the ordinary course of business as debtor-in-possession under the jurisdiction of the Bankruptcy Court and in
accordance with the applicable provisions of the Bankruptcy Code and the orders of the Bankruptcy Court. Ambacs activities are divided into two business segments: (i) Financial Guarantee and (ii) Financial Services.

Ambac provided financial guarantee insurance for public and structured finance obligations through its principal operating subsidiary,
Ambac Assurance Corporation (Ambac Assurance). Ambac Assurances financial strength ratings were downgraded by the independent rating agencies during 2008, 2009 and 2010. As a result of these rating agency actions, as well as
investor concern with respect to these actions, Ambac Assurance has not written new business since mid-2008. As such, Ambacs principal business consists of mitigating losses in Ambac Assurances insured portfolio and maximizing the yield
on its investment portfolio. On April 7, 2011 Ambac Assurance requested that Moodys Investors Service, Inc. (Moodys) withdraw its ratings of Ambac Assurance and each of its affiliates. As a result, the rating agreement
between Ambac Assurance and Moodys was terminated on such date. As of April 7, 2011, Ambac Assurance is no longer rated by any of the independent rating agencies. Refer to Note 1 to the Unaudited Consolidated Financial Statements in this
Form 10-Q for discussion of the establishment of Segregated Account of Ambac Assurance Corporation and the subsequent rehabilitation proceedings of the Segregated Account by the OCI.

Through its financial services subsidiaries, Ambac provided financial and investment products including investment agreements, funding
conduits, interest rate and currency swaps, principally to its clients of the financial guarantee business. The Companys existing investment agreement and derivative product portfolios are in active runoff.

Financial information concerning our business segments is set forth in the unaudited consolidated financial statements and the notes,
Managements Discussion and Analysis of Financial Condition and Results of Operations, and Quantitative and Qualitative Disclosures About Market



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Risk, which are in Part I of this Quarterly Report on Form 10-Q. Our Internet address is www.ambac.com. We make available free of charge, on or through the investor relations section of our
web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as well as proxy
statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission. Our Investor Relations Department can be contacted at Ambac Financial Group, Inc., One
State Street Plaza, New York, New York 10004, Attn: Investor Relations, telephone: 212-208-3222.

Critical Accounting
Policies and Estimates

The discussion and analysis of our financial condition and results of operations is 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 policies are considered critical because they place significant importance on management to
make difficult, complex or subjective estimates regarding matters that are inherently uncertain. Financial results could be materially different if alternative methodologies were used or if management modified its assumptions or estimates.
Management has identified the accounting for loss and loss expenses of non-derivative financial guarantees, the valuation of financial instruments, including the determination of whether an impairment is other-than-temporary and the valuation
allowance on deferred tax assets, as critical accounting policies. This discussion should be read in conjunction with the Consolidated Financial Statements and notes thereon included elsewhere in this report. We have discussed with the Audit
Committee managements assessment of such critical accounting policies, the reasons why they are considered critical, and how current and anticipated future events impact those determinations. The Companys critical accounting policies and
estimates are as follows:

Financial Guarantee Insurance Losses and Loss Expenses:

The loss and loss expense reserves for financial guarantee insurance discussed herein relates only to Ambacs non-derivative
insurance business for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE. 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.

Financial guarantee insurance is accounted for in accordance with ASC Topic 944, Financial ServicesInsurance. Under ASC Topic 944, a loss reserve is recorded on the balance sheet for the
excess of: (a) the present value of expected net cash outflows to be paid under an insurance contract, (i.e., the expected loss), over (b) the unearned premium reserve (UPR) for that contract. To the extent (a) is less
than (b), no loss reserve is recorded. Changes to the loss reserve estimate in subsequent periods are recorded as a loss and loss expense on the income statement. Expected losses 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 expected losses is subject to certain estimates and judgments based on our assumptions regarding the probability of default and
expected severity of performing credits as well as our active surveillance of the insured book of business and observation of deterioration in the obligors credit standing.



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Ambacs loss reserves are based on managements on-going review of the
non-derivative financial guarantee credit portfolio. Active surveillance of the insured portfolio enables Ambacs surveillance group to track credit migration of insured obligations from period to period and update internal credit ratings for
each transaction. Non-adversely classified credits are assigned a Class I or Survey List (SL) risk classification, while adversely classified credits are assigned a risk classification of Class IA through Class V. The criteria for an
exposure to be assigned an adversely classified credit includes the deterioration of an issuers financial condition, underperformance of the underlying collateral (for collateral dependent transactions such as mortgage-backed securitizations),
poor performance by 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 and loss mitigation efforts could cause an increase in
delinquencies and potential defaults of the underlying obligations. Similarly, loss severities increase when a servicer does not effectively handle loss mitigation activities such as (i) the advancing of delinquent principal and interest and
default-related expenses which are deemed to be recoverable by the servicer, (ii) pursuit of loan charge-offs which maximize cash flows from the mortgage loan pool, and (iii) foreclosure and real estate owned disposition strategies and
timelines.

The population of credits evaluated in Ambacs loss reserve process are (i) all adversely classified
credits (Class IA through V) and (ii) non-adversely classified credits (Class I and SL) which have been downgraded since the transactions inception. One of two approaches is then utilized to estimate expected losses to ultimately
determine if a loss reserve should be established. The first approach is a statistical expected loss approach, which considers the likelihood of all possible outcomes. The base case statistical expected loss is the product of:
(i) the net par outstanding on the credit; (ii) internally developed historical default information (taking into consideration internal ratings and average life of an obligation); (iii) internally developed loss severities; and
(iv) a discount factor. The loss severities and default information are based on rating agency information, are specific to each bond type and were established and approved by Ambacs senior management. For certain credit exposures,
Ambacs additional monitoring and loss remediation efforts may provide information relevant to adjust this estimate of base case statistical expected losses. As such, the loss severities used in estimating the base case
statistical expected losses may be adjusted based on the professional judgment of the surveillance analyst monitoring the credit with the approval of senior management. Analysts may accept the base case statistical expected loss as the
best estimate of expected loss or assign multiple probability weighted severities to determine an adjusted statistical expected loss that better reflects a given transactions potential severity.

The second approach entails the use of more precise estimates of expected net cash outflows (future claim payments, net of potential
recoveries, expected to be paid to the holder of the insured financial obligation). Ambacs surveillance group will consider the likelihood of various possible outcomes and develop cash flow scenarios. This approach can include the utilization
of internal or external models to project net claim payment estimates. We have utilized such tools for residential mortgage-backed, student loan, as well as certain other types of exposures. In general, these tools use historical performance of the
collateral pools in order to then assume or derive future performance characteristics, such as default and voluntary prepayment rates, that in turn determine projected future net claim payments. In this approach a probability-weighted expected loss
estimate is developed based on assigning probabilities to multiple net claim payment scenarios and applying an appropriate discount factor. A loss reserve is recorded for the excess, if any, of estimated expected losses (net cash outflows) using
either of these two approaches, over UPR. For certain policies, estimated potential recoveries exceed estimated future claim payments because all or a portion of such recoveries relate to claims previously paid. The expected net cash inflows for
these policies are recorded as a subrogation recoverable asset.



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The discount factor applied to both of the above described approaches is based on a
risk-free discount rate corresponding to the remaining expected weighted-average life of the exposure and the exposure currency. The discount factor is updated for the current risk-free rate each reporting period.

Ambac establishes loss expense reserves based on our estimate of expected net cash outflows for loss expenses, such as legal and
consulting costs.

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, credit or other unforeseen events could have an adverse impact on default probabilities and loss severities. Loss reserves for public finance or
other non-collateral dependent transactions whose underlying financial obligations have already defaulted (that is a 100% probability of default) are only sensitive to severity assumptions. Loss reserves for collateral dependent transactions (such
as mortgage-backed security transactions) for which only a portion of the underlying collateral has already defaulted will be sensitive to both severity assumptions as well as probability of default of the underlying collateral.

Loss reserve volatility will be a direct result of the credit performance of our insured portfolio, including the number, size, bond
types and quality of credits included in our loss reserves. The number and severity of credits included in our loss reserves 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. Reinsurance recoveries do not have a significant effect on loss reserve volatility because Ambac has little exposure ceded to reinsurers and has received collateral from the majority of its
reinsurers. Please refer to Part I, Item 3 Quantitative and Qualitative Disclosures About Market RiskCredit Risk for further information and discussion.

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 significant claims. We have observed
that, with respect to three bond types, it is reasonably possible that a material change in actual loss severities and defaults could occur over time. In the future, including as a result of the current credit market crisis, our experience may
differ with respect to the types of guaranteed bonds affected or the magnitude of the effect. The three bond types are residential mortgage-backed securities (RMBS), collateralized debt obligations (CDOs) and student loan
securities. These three bond types represent 92% of our ever-to-date claims presented with RMBS comprising 90% of our ever-to-date claims payments.

The table below indicates the number of credits, gross par outstanding and gross loss reserves (including loss adjustment expenses) on credits at March 31, 2011:



|                         |  |                  |     |  |                      |   |        |                                        |  |   |       |    
|------------------------ |  | ---------------- | --- |  | -------------------- | - | ------ | -------------------------------------- |  | - | ----- | ---
|($ in millions)          |  | Number ofcredits |     |  | Gross paroutstanding |   |        | Gross Loss Reservesand Loss
Expense(2) | 
|RMBS                     |  |                  | 187 |  |                      | $ | 19,692 |                                        |  | $ | 3,764 |    
|Student Loans            |  |                  | 97  |  |                      |   | 10,063 |                                        |  |   | 926   |    
|All other credits        |  |                  | 67  |  |                      |   | 5,544  |                                        |  |   | 710   |    
|Loss adjustment expenses |  |                  |    |  |                      |   |       |                                        |  |   | 91    |    
|                         |  |                  |     |  |                      |   |        |                                        |  |   |       |    
|Totals                   |  |                  | 351 |  |                      | $ | 35,299 |                                        |  | $ | 5,491 | (1)
|                         |  |                  |     |  |                      |   |        |                                        |  |   |       |    



|(1) | Loss reserves of $5,491 are included in the balance sheet in the following line items: Loss and loss expense reserve$6,297; Subrogation recoverable$797; and
Other assets$9.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Ceded Par Outstanding and ceded loss reserves are $1,758 and $132, respectively. Ceded loss reserves are included in Reinsurance Recoverable on paid and unpaid losses.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



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RMBS:

Ambac insures RMBS transactions that contain first-lien mortgages. Ambac classifies its insured first-lien RMBS exposure principally into two broad credit risk classes: Alt-A (including mid-prime,
interest only, and negative amortization) and sub-prime. Alt-A loans were typically made to borrowers who had stronger credit profiles, while sub-prime loans were typically made to borrowers with weaker credit profiles. Compared with Alt-A loans,
sub-prime loans typically had higher loan-to-value ratios, reflecting the greater difficulty that sub-prime borrowers have in making down payments and the propensity of these borrowers to extract equity during refinancing. The Alt-A category
includes:



| |  |  | Loans with specific payment features that afforded borrowers the option to have lower payments in the early years with resets after several years. For
example, so called interest only loans have monthly payments comprised of interest but no principal in the early years. So called negative amortization loans permit borrowers to defer interest and principal in the early years and then make higher
payments in the period after the reset. Both types may also have lower interest rates in the early period. Future increases in monthly payments, commonly called payment shock, increases the probability of delinquencies and defaults given the decline
in house prices over the past few years.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Loans backed by borrowers who typically did not meet standard agency guidelines for documentation requirement, property type or loan-to-value ratio.
These are typically higher-balance loans made to individuals who might have past credit problems that were not severe enough to warrant sub-prime classification, or borrowers who chose not to obtain a prime mortgage due to documentation
requirements.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Ambac has also insured RMBS transactions that contain predominantly second-lien mortgage
loans such as closed-end seconds and home equity lines of credit. A second-lien mortgage loan is a type of loan in which the borrower uses the equity in their home as collateral and the second-lien loan is subordinate to the first-lien loan
outstanding on the home. The borrower is obligated to make monthly payments on both their first and second-lien loans. If the borrower defaults on the payments due under these loans and the property is subsequently liquidated, the liquidation
proceeds are first utilized to pay off the first-lien loan (as well as costs due the servicer) and any remaining funds are applied to pay off the second-lien loan. As a result of this subordinate position to the first-lien loan, second-lien loans
carry a significantly higher severity in the event of a loss, typically at or above 100% in the current housing market.

RMBS
transaction-specific behavior is analyzed on a risk-priority basis. We employ a screening tool to assess the sufficiency of credit enhancement remaining in a transaction, as well as other adverse credit data that may result in deterioration.
Transactions which are experiencing escalating delinquencies and increasing loss severities and/or which are experiencing declining levels of subordination or overcollateralization relative to collateral losses are identified as underperforming. For
underperforming transactions, historical collateral performance is examined and future collateral performance and cash flows are projected and evaluated. These underperforming transactions are then included in an adversely classified credit list and
assigned a credit classification consistent with the degree of underperformance.

The table below distinguishes between
credits for which we have not established a representation and warranty subrogation recovery and those for which we have, providing in both cases the number of credits, gross par outstanding, gross loss reserves before subrogation, subrogation, and
gross reserves net of subrogation for all RMBS exposures for which Ambac established reserves at March 31, 2011:



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|                                  |  |                  |     |  |                     |   |        |                                              |  |   |                          |  |  |                                              |        |   |  |   |       |  
|--------------------------------- |  | ---------------- | --- |  | ------------------- | - | ------ | -------------------------------------------- |  | - | ------------------------ |  |  | -------------------------------------------- | ------ | - |  | - | ----- | -
|($ in millions)                   |  | Number ofcredits |     |  | Grossparoutstanding |   |        | Gross lossreservebeforesubrogationrecoveries |  |   | Subrogation(1)recoveries |  |  | Gross lossreserve aftersubrogationrecoveries |       
|Second-lien                       |  |                  | 30  |  |                     | $ | 2,897  |                                              |  | $ | 603                      |  |  |                                              | NA     |   |  | $ | 603   |  
|First-lien-Alt A                  |  |                  | 82  |  |                     |   | 7,301  |                                              |  |   | 2,452                    |  |  |                                              | NA     |   |  |   | 2,452 |  
|First-lien-Sub-prime              |  |                  | 31  |  |                     |   | 1,460  |                                              |  |   | 65                       |  |  |                                              | NA     |   |  |   | 65    |  
|Other                             |  |                  | 16  |  |                     |   | 820    |                                              |  |   | 286                      |  |  |                                              | NA     |   |  |   | 286   |  
|                                  |  |                  |     |  |                     |   |        |                                              |  |   |                          |  |  |                                              |        |   |  |   |       |  
|Total Credits Without Subrogation |  |                  | 159 |  |                     |   | 12,478 |                                              |  |   | 3,406                    |  |  |                                              | NA     |   |  |   | 3,406 |  
|                                  |  |                  |     |  |                     |   |        |                                              |  |   |                          |  |  |                                              |        |   |  |   |       |  
|Second-lien                       |  |                  | 19  |  |                     |   | 4,088  |                                              |  |   | 1,983                    |  |  |                                              | (1,867 | ) |  |   | 116   |  
|First-lien Mid-prime              |  |                  | 4   |  |                     |   | 738    |                                              |  |   | 248                      |  |  |                                              | (289   | ) |  |   | (41   | )
|First-lien Sub-prime              |  |                  | 5   |  |                     |   | 2,389  |                                              |  |   | 626                      |  |  |                                              | (343   | ) |  |   | 283   |  
|                                  |  |                  |     |  |                     |   |        |                                              |  |   |                          |  |  |                                              |        |   |  |   |       |  
|Total Credits With Subrogation    |  |                  | 28  |  |                     |   | 7,215  |                                              |  |   | 2,857                    |  |  |                                              | (2,499 | ) |  |   | 358   |  
|                                  |  |                  |     |  |                     |   |        |                                              |  |   |                          |  |  |                                              |        |   |  |   |       |  
|Total                             |  |                  | 187 |  |                     | $ | 19,693 |                                              |  | $ | 6,263                    |  |  | $                                            | (2,499 | ) |  | $ | 3,764 |  
|                                  |  |                  |     |  |                     |   |        |                                              |  |   |                          |  |  |                                              |        |   |  |   |       |  



|(1) | Refer to Representations and Warranty Breaches by RMBS Transaction Sponsors below for further discussion.
|--- | ---------------------------------------------------------------------------------------------------------

Methodology for Projecting Losses in our RMBS Portfolio

Prior to January 1, 2011, we utilized an internal roll-rate model to project losses for our second lien transactions and a
third-party multi-scenario stochastic (Monte Carlo) cash flow model (stochastic model) to project losses for our first-lien transactions. Effective January 1, 2011, we are also using a recently licensed statistical regression model
(regression model) to develop additional estimates of projected losses for both our second and first-lien transactions. Both the regression model and the stochastic model include home price appreciation (HPA) among their
primary drivers. We rely upon recognized sources for HPA projections.

The regression model uses a statistical approach
considering historical and recent market performance to perform a survival analysis to model the timing of prepayment and default events. Depending upon the availability of underlying data, the model utilizes either of two approaches: first-lien
transactions generally use a loan level approach, while the second-lien transactions generally use the deal-level approach, as home loan data is not available from recognized market sources for second-lien mortgage loans. The specific methodologies
in all three of our models are described below.

Our reserves reflect a blending of the results of the two approaches used for
each transaction, with 50% probability assigned to the regression model and 50% assigned to either our internal roll-rate model in the case of second-lien transactions or to the stochastic model in the case of our first-lien transactions. Although
there can be no certainty with regard to projecting losses, we believe the 50/50 blend is a reasonable approach to projecting losses in our RMBS portfolio.

The regression model differentiates among servicers and their impact on loan performance, and also acknowledges the extension of liquidation timelines that has exacerbated loss severities. The regression
model also takes into account payment shock (i.e., the increased likelihood of borrower defaults when adjustable payment mortgages reset to higher monthly payments). While these aspects of the regression model represent enhancements from our other
approaches, we also believe the regression model may be overly sensitive to the combined loan-to-value of home loans. This view is based upon our comparison of projected performance using similar house price forecasts under the different approaches
and the fact that the regression model currently does not consider borrowers payment history. We believe



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borrowers with strong payment histories will experience lower default rates than borrowers with poor payment history.

Prior to utilizing the results of the regression model, our internal RMBS credit and quantitative professionals evaluated and analyzed the results of the regression model versus loss estimates generated
utilizing: a) our internal roll-rate model for second-lien transactions and, b) our stochastic model for first-lien transactions. This cross disciplined team compared the specific drivers and methodology of the regression model with our existing
approaches, and analyzed deal performance and model outputs across the portfolio. For example, the team considered the general reasonableness of the models projected defaults of borrowers not currently in seriously delinquent or worse payment
status and also conducted selective collateral analyses. The team also assessed the models cumulative loss estimates and compared such estimates by asset type and vintage with rating agency and other published loss projections. Based upon this
comprehensive analysis, we believe the 50/50 blend of the models results achieves the best mix of these models capabilities.

Eleven of our mortgage-backed transactions have pool level mortgage insurance. Pool mortgage insurance is a master policy issued to the mortgage securitization trust, which indemnifies the trust either on
a first loss or mezzanine basis in the event that covered mortgage loans in the trust default. The mortgage insurance master policy specifies the particular characteristics and conditions of each individual loan within the mortgage trust that is
subject to coverage. The policy also includes various conditions including exclusions (conditions for denying coverage), conditions for notification of loans in default, and claims settlement. We have noted with regard to these transactions that
mortgage insurers generally have not paid the majority of claims presented by the mortgage trusts. This unwillingness to pay by the mortgage insurers results in higher claim payments under Ambacs financial guarantee policies. As a
result of the uncertainty of the timing and amount of any recoveries by the mortgage trust under these pool mortgage insurance policies, Ambac does not reflect any potential benefit (either via recoveries of previously paid claims or reductions in
future claim payments) until there is sufficient information to allow for a reasonable estimation of any such benefit. Generally, sufficient information is not available prior to the date when amounts are received by the mortgage trust and reported
in the respective remittance report.

In our experience, market performance and model characteristics change and are updated
through time and a regular review of models and the overall approach to loss estimation is beneficial. Our ability to drive change in the models we license is limited and subject to the expertise and views of the independent developer/vendor. On the
other hand, our ability to estimate losses without such models is difficult and challenging for a large portfolio across multiple RMBS exposure types.

Summarized below is our approach to projecting claims and ultimate losses in our RMBS portfolio.

Second-Lien:

In evaluating our portfolio of insured second-lien
transactions we use the regression model as well as our internal roll-rate model.

The regression model estimates mortgage
loan collateral performance, the effect of such collateral cash flows within the transaction waterfall and the liability structure we insure. Collateral performance is modeled at the deal level given the paucity of mortgage loan level data for
second-lien transactions. Without the specific loan-level information, the deal-level approach processes a loan pool as if it were a single loan, selecting certain aggregated deal-level characteristics to then perform a survival



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analysis using a multinomial logistic regression. We model three HPA scenarios to develop a base case as well as stress and upside cases. The highest probability is assigned to the base case,
with significantly lower probabilities to the stress and upside cases.

This deal-level approach of the regression model takes
a relatively complicated monthly cash flow and simplifies it into two parts: a borrower-behavior-dependent stage and a servicer-behavior-dependent stage. The borrower stage is designed to forecast the probability of a loans present delinquency
status to any of eight future statuses. Through the borrower-behavior-dependent stage, at any given monthly period, a loan can take on one of the following eight statuses: current, 30, 60, 90, 120, 150, 180+ delinquent or prepaid. The deal-level
approach calculates defaults using a roll-rate that evaluates the possible future state of a set of loans based on its current status and three variables: average FICO, average current CLTV, and an overall quality indicator.

The servicer-behavior-dependent stage of the regression model governs a loans life cycle after it reaches 180 or more days
delinquent. This stage evaluates the servicers propensity to foreclose or pursue a short sale, the speed of the foreclosure process, and the speed of the post-foreclosure distressed property liquidation. The transition probabilities between
advanced delinquency and foreclosure, foreclosure and REO, and finally REO and ultimate liquidation are assumed by the model to depend upon how long a loan has already been in a particular status, as well as by the servicer and state-specific
liquidation timeline factors.

The internal roll-rate model observes trends in delinquencies, defaults, loss severities and
prepayments and extrapolates ultimate performance from this data on an individual transaction basis (and their component pools where they exist). As more information (performance and other) accumulates for each underperforming transaction
we are able to update assumptions in this model to reflect these changes. By employing the roll-rate methodology, we examined the historical rate at which delinquent loans in each transaction rolled into later delinquency categories (i.e.
30-59 days, 60-89 days, 90+ days). This historical rate is adjusted each period to reflect current performance. The key inputs for this model are prepayment rates and loss severity. Voluntary prepayments have declined, driven by negative HPA, an
impaired mortgage market, and borrowers inability to prepay balances. In our opinion, these factors will not improve in the foreseeable future and thus we generally project recent trends into the future. This results in projected prepayment
rates in the 2% to 5% range. We estimate loss severities between 100% and 105% as we expect complete write-offs in this asset class exacerbated by carrying costs. We determined a pool specific current-to-30-to-59 day delinquency curve and
applied a statistical regression technique to historical roll rates. We carried forward the non-performing mortgages through the delinquency pipeline through the 60-89 and 90+ day delinquency categories all the way through
to charge-off. We use this data to project a default curve for the life of the transaction.

First-Lien:

In evaluating our portfolio of insured first-lien transactions we use the regression model as well as the stochastic
model.

For most first-lien transactions, the regression model utilizes home mortgage loan level data from recognized market
sources to calculate each loans probability of default and prepayment based on the characteristics of the loan. The loan-level approach of the regression model performs a survival analysis that prepays and defaults each loan on a monthly
basis based on its embedded risks. For first-lien transactions that do not have loan-level data available, we use the deal-level approach of the regression model that is described in the Second-Lien section above.



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There are three transitional stages with the loan-level approach of the regression
model: current, prepayment or default. The model then looks beyond the stages to assess a set of loans based on a number of individual characteristics that are distinct to that set of loans. These individual characteristics are property type,
occupancy status, loan purpose, documentation type, cumulative loan-to-value ratio, originator quality rating, servicer quality rating, FICO score, original loan balance, interest rate margin, and regional unemployment rate. The model then estimates
the rate at which a loan will prepay or default reducing the balance of each loan monthly during the projection period based on the borrowers given probability of defaulting or prepaying for that month. Servicer behavior is a unique variable
in the loan-level approach of the regression model and is used to calculate the impact of servicer performance on expected prepayments and defaults. Consistent with the second-lien modeling, we consider three HPA scenarios in the regression model to
develop a base case as well as stress and upside cases. The highest probability is assigned to the base case, with significantly lower probabilities to the stress and upside cases.

The stochastic model projects multiple scenarios at the individual mortgage loan level using various inputs, including:



| | (i) | Home price projections obtained from an independent third party at the Core Based Statistical Area (CBSA) level;
| | --- | ----------------------------------------------------------------------------------------------------------------



| | (ii) | An interest rate tool to generate term interest rate scenarios;
| | ---- | ---------------------------------------------------------------



| | (iii) | An unemployment module to project unemployment rates at the state level;
| | ----- | ------------------------------------------------------------------------



| | (iv) | A mortgage home loan-level credit module to estimate the probability of monthly loan level credit performance through time across eight possible status states (current,
30 day delinquent, 60 day delinquent, 90 + day delinquent, foreclosure, REO, prepay, and default); and
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (v) | A severity module which pairs with the credit module and, on the basis of loan level information, generates a Loss Given Default severity time line.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------

The pool of mortgage loans backing each securitization is selected from a loan-level database and the loss and
prepayment scenarios across all loans are used to generate aggregated future collateral cash flows. The stochastic model embeds all the priority of payments and cash-diversion structures documented in the contracts which define the liability payment
obligations of the security being analyzed. We take the average of the 300 stochastic claim cash-flow scenarios and discount it, as appropriate, to estimate the gross claim liability.

Government programs:

In May of 2009, the Federal Government initiated the Home Affordable Modification Plan (HAMP) which allows servicers to modify loans. After determining a borrowers eligibility, a servicer can take a
series of steps to reduce the monthly mortgage payment. HAMP is applicable to the Ambac-wrapped transactions serviced by the servicers that have signed servicer participation agreements to modify loans under HAMP. Based on the current activity of
the HAMP offers and the latest indications from government published sources through March 31, 2011, we assume some impact for this government program in our first-lien portfolio utilizing the stochastic model. Neither the regression model nor
our internal roll-rate model includes the impact of HAMP. Specifically, we assume in the first-lien stochastic model that 0.5% of HAMP-eligible loans will be modified monthly for 24 months (for a total of 12% of HAMP-eligible loans ultimately
modified) for Ambac portfolios serviced by HAMP participating servicers. At March 31, 2010, Ambacs first-lien stochastic model assumed that 4% of HAMP-eligible loans will be modified monthly for 12 months (for a total of 48% of
HAMP-eligible loans ultimately modified) for Ambac portfolios serviced by HAMP participating servicers. We reduced the rate of modification during 2010 to reflect the actual performance of HAMP and the observance of the continued
slower-than-expected pace of trial modifications.



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Servicer Intervention:

With the exception of our internal second-lien roll-rate model we are able to include in our modeling the steps which Ambac is taking to
address shortcomings in servicing performance including transfers of servicing where the legal right exists to do so. Ambac expects to initiate, with the cooperation of the rehabilitator of the Segregated Account, additional programs with servicers
that will provide for loan modifications (principal forgiveness), improved liquidation timelines, short sales, and selected rate reductions. Ambac believes these are the principal factors that will result in reduced losses over time. In all cases,
we are projecting that only exposures that have already transferred servicing or entered into special servicing agreements will benefit from the effects of servicer intervention strategies.

Representation and Warranty Breaches by RMBS Transaction Sponsors:

In an effort to better understand the unprecedented levels of delinquencies and defaults, Ambac or its counsel engaged consultants with
significant mortgage lending experience to review the underwriting documentation for mortgage loans underlying certain insured RMBS transactions. Transactions which have exhibited exceptionally poor performance were chosen for further examination of
the underwriting documentation supporting the underlying loans. Factors which Ambac believes to be indicative of poor performance include (i) increased levels of early payment defaults, (ii) significant number of loan liquidations or
charge-offs and resulting high level of losses, and (iii) rapid elimination of credit protections inherent in the transactions structures. With respect to item (ii), loan liquidations refers to loans for which the servicer has
liquidated the related collateral and the securitization has realized losses on the loan; charge-offs refers to loans which have been written off as uncollectible by the servicer, thereby generating no recoveries to the securitization,
and may also refer to the unrecovered balance of liquidated loans. In either case, the servicer has taken such actions as it has deemed viable to recover against the collateral, and the securitization has incurred losses to the extent such actions
did not fully repay the borrowers obligations. Generally, the sponsor of the transaction provides representations and warranties with respect to the securitized loans including the loan characteristics, the absence of fraud or other misconduct
in the origination process, including those attesting to the compliance of home loans with the prevailing underwriting policies. Per the underlying transaction documents, the sponsor of the transaction is contractually obligated to repurchase, cure
or substitute any loan that breaches the representations and warranties.

Subsequent to the forensic exercise of examining
loan files to ascertain whether the loans conformed to the representations and warranties, we submit nonconforming loans to the sponsor for repurchase. To effect a repurchase, depending on the transaction, the sponsor is obligated to repurchase the
loan at (a) for loans which have not been liquidated or charged off, either (i) the current unpaid principal balance of the loan, (ii) the current unpaid principal balance plus accrued unpaid interest, or (iii) the current unpaid
principal balance plus accrued interest plus unreimbursed servicer advances/expenses and/or trustee expenses resulting from the breach of representations and warranties that trigger the repurchase, and (b) for a loan that has already been
liquidated or charged-off, the amount of the realized loss (which in certain cases excludes accrued unpaid interest). Notwithstanding the material breaches of representations and warranties, up until the establishment of the Segregated Account and
the associated Segregated Account Rehabilitation Proceedings, Ambac had continued to pay claims submitted under the financial guarantee insurance policies related to these securitizations and will resume paying such claims once a Rehabilitation Plan
becomes effective. In cases where loans are repurchased by a sponsor, the effect is typically to offset current period losses and then to increase the over-collateralization of the securitization, depending on the extent of loan repurchases and the
structure of the securitization. Specifically, the repurchase price is paid by the sponsor to the securitization trust which



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holds the loan. The cash becomes an asset of the trust, replacing the loan that was repurchased by the sponsor. On a monthly basis the cash received related to loan repurchases by the sponsor is
aggregated with cash collections from the underlying mortgages and applied in accordance with the trust indenture payment waterfall. This payment waterfall typically includes principal and interest payments to the note holders, various expenses of
the trust and reimbursements to Ambac, as financial guarantor, for claim payments made in previous months. Notwithstanding the reimbursement of previous monthly claim payments, to the extent there continues to be insufficient cash in the waterfall
in the current month to make scheduled principal and interest payments to the note holders, Ambac is required to make additional claim payments to cover this shortfall.

Ambacs estimate of subrogation recoveries includes two components: (1) estimated dollar amounts of loans with material breaches of representations and warranties based on an extrapolation of
the breach rate identified in a random sample of loans taken from the entire population of loans in a securitization (random sample approach); and (2) dollar amount of actual loans with identified material breaches of
representations and warranties discovered from samples of impaired loans in a securitization (adverse sample approach). We do not include estimates of damages in our estimate of subrogation recoveries under either approach. The amount
the sponsors believe to be their liability for these breaches is not known; however, certain large financial institutions who have served as sponsors for certain transactions that Ambac has insured have disclosed that they have established reserves
related to claims by financial guarantors and others for breaches of representations and warranties in RMBS transactions. Further in April 2011, Assured Guaranty Ltd., a financial guarantor, reached a comprehensive settlement with Bank of America
Corporation, including Countrywide Financial Corporation, regarding their liabilities with respect to RMBS transactions insured by Assured Guaranty, including claims relating to reimbursement for breaches of representations and warranties.

The random sample approach to estimate subrogation recoveries was based on obtaining a statistically valid random sample for
all the original loans in the pool. First, a breach rate was computed by dividing (i) the loans identified in the sample as having breached representations and warranties by (ii) the total sample size. Second, an extrapolation
to the entire loan pool was performed by multiplying the breach rate by the sum of (a) the current unpaid loan pool balance (CULPB) plus (b) realized losses resulting from loan liquidations or charge-offs to date, to compute an
estimated repurchase obligation. The CULPB includes principal only on non-charged-off and non-liquidated loans, and the realized losses include principal, interest and unreimbursed servicer advances and/or trustee expenses on charged-off and
liquidated loans. As a result, the CULPB and realized loss components, which are used in extrapolating the estimated repurchase obligation, do not precisely correspond to each sponsors contractual repurchase obligation as defined in the
transaction documents. Nonetheless, the CULPB and realized loss components are provided through trustee reports we receive in the normal course of our surveillance of these transactions and is the best information we have available to estimate the
sponsors repurchase obligation under the random sample approach. Third, a realization factor (which incorporates Ambacs views about the uncertainties surrounding the litigation process and/or settlement negotiation) was then applied to
the estimated repurchase obligation to compute the undiscounted subrogation recovery. The realization factor was developed from a range of realization factors using Ambacs own assumptions about the likelihood of outcomes based on all the
information available to it including (i) discussions with external legal counsel and their views on ultimate settlement, (ii) recent experience with loan put back negotiations where the existence of a material breach was debated and
negotiated at the loan level, and (iii) the pervasiveness of the breach rates. Finally, a discount factor was applied to the undiscounted subrogation recovery to compute the estimated subrogation recovery.

Due to the nature of the sampling methodology used, the subrogation recovery estimate Ambac has recorded based on the above-described
random sample approach includes all breached loans which



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Ambac believes the sponsor is contractually required to repurchase, including extrapolation to a loan pool which includes loans which have not defaulted, and, in fact, may not default in the
future (i.e., performing loans). In theory, a loan that continues to perform in accordance with its terms through repayment should have little or no effect on Ambacs anticipated claim payments, regardless of whether or not the sponsor
repurchases the loan. In other words, since there will be sufficient cash flows to service the notes in either situation (i.e., whether cash is received from a sponsor loan repurchase or whether cash is received from the underlying performing loan),
there should be no claim payment under Ambacs insurance policy in respect of such loans. Nonetheless, Ambac may have recorded a subrogation recovery for certain performing loans because it believes the breaches of representations and
warranties are so pervasive that a court would deem it impractical to have the sponsor re-underwrite every loan in a given transaction and repurchase only individual loans that have breached. Rather, Ambac believes there is precedent for the
utilization of a statistical sampling and extrapolation methodology across a population to prove liability and damages where it would be impractical to make a determination on an individual loan basis (a recent court ruling in a similar suit
unrelated to Ambac, but in the same jurisdiction in which Ambac has filed its litigation to date, supports the view that a sampling methodology is permissible.) Ambac believes a court would likely award damages based on a reasonable methodology,
such as our random sample approach, which damages would be either remitted directly to Ambac, placed in the securitization trust, or otherwise held under an arrangement for the benefit of the securitization trust; however, Ambac believes that under
such an approach individual loans would not be repurchased from the trust. In either case, Ambac believes those damages would compensate Ambac for past and future claim payments. Consequently, since the sponsor is contractually obligated to
repurchase those loans which breach representations and warranties regardless of whether they are current or defaulted, Ambac believes the appropriate measure in estimating subrogation recoveries is to apply the breach rate to both performing and
defaulted loans.

The adverse sample approach to estimate subrogation recoveries was based on a sample taken from those loans
in the pool that were impaired, meaning loans greater than 90 days past due, charged-off, in foreclosure, REO or bankruptcy. The estimated subrogation recovery under this approach represents 100% of the original principal balance of those specific
loans identified as having not met the underwriting criteria or otherwise breaching representations and warranties (i.e., the adverse loans), multiplied by a discount factor using the same assumptions used for the discount factor in the random
sample approach. For transactions subject to the adverse sample approach, given Ambacs limitations in developing a statistically valid random sample and its belief that the subrogation estimate under this approach is inherently conservative
(for reasons discussed below), Ambac did not attempt to develop probability-weighted alternative cash flow scenarios as it believes such results would not be meaningful. The three primary differences between this adverse sample approach and the
random sample approach, discussed in the previous paragraphs, are as follows:



| | (i) | There is no extrapolation to the CULPB and realized losses under the adverse sample approach. At March 31, 2011 the adverse sample approach is being used for 16
transactions that are with the same sponsor, who has limited our access to the underlying loan files and, therefore, a statistically valid random sample from the entire loan pool cannot be selected. This is in contrast to the transactions subject to
the random sample approach where Ambacs access to individual loan files has not been limited and the Company, therefore, has been able to develop a statistically valid representative sample.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (ii) | The adverse sample approach is based on the original principal balance rather than the principal balance at the time of default and liquidation or
charge-off. Furthermore, it does not include other components of the sponsors contractual repurchase obligation where the sponsor is also obligated to repay accrued interest, servicer advances and/or trustee expenses. The adverse sample
approach relies on individual loan level data where all of the components of the sponsors buyback obligation have not been specifically provided by the sponsor, or the sponsors buyback obligation is not easily estimable. For example,
home equity lines of credit
| | ---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | (HELOCs) are revolving loans whose principal balances may be higher or lower at the time of default and liquidation or charge-off than at the time of origination. However, given the limited
information available to Ambac in estimating such principal balances at the time of liquidation or charge-off, the original principal balance was used in calculating subrogation recoveries. Another example is closed-end second lien RMBS where the
interest due on a particular loan will be a function of the length of time of delinquency prior to liquidation or charge-off, and cannot be readily estimated. Incremental costs, including fees and servicer advances for such items as property taxes
and maintenance, are likewise not readily estimatable.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (iii) | Unlike the random sample approach, for the adverse sample approach Ambac did not apply a realization factor to the estimated repurchase obligation for the adverse loans
related to uncertainties surrounding settlement negotiation or litigation processes given that the adverse loans selected represent only approximately 39% of the value of the impaired population of loans, only approximately 5% of the value of the
original loans in the pool, and the breach rate in the sample was pervasive. In other words, because the adverse loans selected represent only a fraction of the population of impaired loans and a very small proportion of the original loans in the
pools, Ambac believes there is an ample population of additional impaired loans where breaches of representations and warranties exist that could potentially replace any adverse loans it already identified that might be successfully challenged in
negotiations or litigation.
| | ----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Ambac has updated its estimated subrogation recoveries from $2,417.1 million
($2,391.3 million, net of reinsurance) at December 31, 2010 to $2,498.8 million ($2,472.1 million, net of reinsurance) at March 31, 2011. The balance of subrogation recoveries and the related claim liabilities at March 31, 2011 and
December 31, 2010 are as follows:



|                |  |                   |    |     |                                                 |   |         |                          |  |   |                                                 |   |  |   |        |  
|--------------- |  | ----------------- | -- | --- | ----------------------------------------------- | - | ------- | ------------------------ |  | - | ----------------------------------------------- | - |  | - | ------ | -
|($ in millions) |  | March 31, 2011    |   
|Method          |  | Count             |    |     | Gross claimliabilitybeforesubrogationrecoveries |   |         | Subrogationrecoveries(1) |  |   | Gross claimliability aftersubrogationrecoveries |  
|Adverse samples |  |                   | 16 | (2) |                                                 | $ | 1,750.5 |                          |  | $ | (776.1                                          | ) |  | $ | 974.4  |  
|Random samples  |  |                   | 12 | (3) |                                                 |   | 1,106.0 |                          |  |   | (1,722.7                                        | ) |  |   | (616.7 | )
|                |  |                   |    |     |                                                 |   |         |                          |  |   |                                                 |   |  |   |        |  
|Totals          |  |                   | 28 |     |                                                 | $ | 2,856.5 |                          |  | $ | (2,498.8                                        | ) |  | $ | 357.7  |  
|                |  |                   |    |     |                                                 |   |         |                          |  |   |                                                 |   |  |   |        |  
|                | 
|($ in millions) |  | December 31, 2010 |   
|Method          |  | Count             |    |     | Gross claimliabilitybeforesubrogationrecoveries |   |         | Subrogationrecoveries(1) |  |   | Gross claimliability aftersubrogationrecoveries |  
|Adverse samples |  |                   | 15 | (2) |                                                 | $ | 1,644.5 |                          |  | $ | (719.4                                          | ) |  | $ | 925.1  |  
|Random samples  |  |                   | 12 | (3) |                                                 |   | 1,010.7 |                          |  |   | (1,697.7                                        | ) |  |   | (687.0 | )
|                |  |                   |    |     |                                                 |   |         |                          |  |   |                                                 |   |  |   |        |  
|Totals          |  |                   | 27 |     |                                                 | $ | 2,655.2 |                          |  | $ | (2,417.1                                        | ) |  | $ | 238.1  |  
|                |  |                   |    |     |                                                 |   |         |                          |  |   |                                                 |   |  |   |        |  



|(1) | The amount of recorded subrogation recoveries related to each securitization is limited to ever-to-date paid losses plus the present value of projected
future paid losses for each policy. To the extent significant losses have been paid but not yet
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| | recovered, the recorded amount of subrogation recoveries may exceed the projected future paid losses for a given policy. The net cash inflow for these policies is recorded as a Subrogation
recoverable asset. For those transactions where the subrogation recovery is less than projected future paid losses, the net cash outflow for these policies is recorded as a Loss and loss expense reserve liability. Of the $2,498.8
million of subrogation recoveries recorded at March 31, 2011, $1,513.6 million was included in Subrogation recoverable and $985.2 million was included in Loss and loss expense reserves.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Of these 16 transactions (15 for 2010), 11 contractually require the sponsor to repurchase loans at the unpaid principal balance and 6 (5 for 2010) contractually
require the sponsor to repurchase loans at unpaid principal plus accrued interest. However, for reasons discussed above in the description of the adverse sample approach, our estimated subrogation recovery for these transactions may not include all
the components of the sponsors contractual repurchase obligation.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Of these 12 transactions, 3 contractually require the sponsor to repurchase loans at unpaid principal plus accrued interest and 9 contractually require the sponsor to
repurchase loans at unpaid principal plus accrued interest plus servicer advances/expense and/or trustee expenses. However, for reasons discussed above in the description of the random sample approach, our estimated subrogation recovery for these
transactions may not include all the components of the sponsors contractual repurchase obligation.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

While
the obligation by sponsors to repurchase loans with material breaches is clear, generally the sponsors have not yet honored those obligations. Ambacs approach to resolving these disputes has included negotiating with individual sponsors at the
transaction level and in some cases at the individual loan level and has resulted in the repurchase of some loans. Ambac has utilized the results of the above described loan file examinations to make demands for loan repurchases from sponsors or
their successors and, in certain instances, as a part of the basis for litigation filings. Ambac has initiated and will continue to initiate lawsuits seeking compliance with the repurchase obligations in the securitization documents. Ambac estimates
that it will take approximately three years from the initiation of litigation with the sponsor to ultimate resolution. Based on this estimate as a basis for projecting the future subrogation cash flows, Ambac assumes, on average, approximately three
and a half years to collect recoveries, discounted at a risk-free rate of 2.70 and 2.39% at March 31, 2011 and December 31, 2010, respectively. Estimated recoveries will continue to be revised and supplemented as the scrutiny of the
mortgage loan pools progresses.

We have performed the above-mentioned, detailed examinations on a variety of second-lien and
first-lien transactions that have experienced exceptionally poor performance. However, the loan file examinations and related estimated recoveries we have reviewed and recorded to date have been limited to only those transactions whose sponsors (or
their successors) are subsidiaries of large financial institutions, all of which carry an investment grade rating from at least one nationally recognized rating agency. A total of seven sponsors represent the 28 transactions which have been reviewed
as of March 31, 2011. While our contractual recourse is generally to the sponsor/subsidiary, rather than to the financial institutional parent, each of these financial institutions has significant financial resources and an ongoing interest in
mortgage finance, and we therefore believe that the financial institution/parent would not seek to disclaim financial responsibility for these obligations if the sponsor/subsidiary is unable to honor its contractual obligations or pay a judgment
that we may obtain in litigation. Additionally, in the case of successor institutions, we are not aware of any provisions that explicitly preclude or limit the successors obligations to honor the obligations of the original sponsor. In fact,
we have witnessed to date, certain successor financial institutions make significant payments to certain claimants to settle breaches of representations and warranties perpetrated by sponsors that have been acquired by such financial institutions,
including the Assured Guaranty Ltd. settlement noted above. As a result, we did not make any significant adjustments to our estimated subrogation recoveries with respect to the credit risk of these sponsors or their successors. We believe that
focusing our loan remediation efforts on large financial institutions first will provide the greatest economic benefit to Ambac. Ambac retains the right to review other RMBS transactions for representations and warranties breaches. Since a
significant number of other second-lien and first-lien transactions are also experiencing poor performance, management is considering expanding the scope of this effort.



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Below is the rollforward of RMBS subrogation for the period December 31, 2010
through March 31, 2011:



|                                                               |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 
|-------------------------------------------------------------- |  | ------------ | ------- | - | --------- |  | --- | ------------- |  | - | --------- | - |  |  | --- | 
|($ in millions)                                                |  | Randomsample |         |   | # ofdeals |  |     | AdverseSample |  |   | # ofdeals |  
|Rollforward:                                                   |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 
|Discounted RMBS subrogation (gross of reinsurance) at 12/31/10 |  | $            | 1,697.7 |   |           |  | 12  |               |  | $ | 719.4     |   |  |  | 15  | 
|                                                               |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 
|Changes recognized in 2011:                                    |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 
|Additional transactions reviewed                               |  |              |        |   |           |  |    |               |  |   | 34.8      |   |  |  | 1   | 
|Additional adverse sample loans reviewed                       |  |              |        |   |           |  | n/a |               |  |   |          |   |  |  | n/a | 
|Loans repurchased by the sponsor                               |  |              | (16.9   | ) |           |  | n/a |               |  |   | (2.8      | ) |  |  | n/a | 
|                                                               |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 
|Subtotal of changes recognized in current period               |  |              | (16.9   | ) |           |  | n/a |               |  |   | 32.0      |   |  |  | n/a | 
|                                                               |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 
|Changes from re-estimation of opening balance:                 |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 
|Change in pre-recovery loss reserves                           |  |              | 41.9    |   |           |  | n/a |               |  |   | 24.7      |   |  |  | n/a | 
|                                                               |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 
|Discounted RMBS subrogation (gross of reinsurance) at 03/31/11 |  | $            | 1,722.7 |   |           |  | 12  |               |  | $ | 776.1     |   |  |  | 16  | 
|                                                               |  |              |         |   |           |  |     |               |  |   |           |   |  |  |     | 

As a consequence of the Segregated Account Rehabilitation Proceedings, the rehabilitator retains operational
control and decision-making authority with respect to all matters related to the Segregated Account, including surveillance, remediation and loss mitigation. All RMBS policies were allocated to the Segregated Account and as such, the foregoing
discussion of Ambacs risk management practices is qualified by reference to the rehabilitators exercise of its discretion to alter or eliminate the above risk management practices relating to representation and warranty breaches by RMBS
transaction sponsors.

Our ability to recover the RMBS subrogation recoveries is subject to significant uncertainty, including
risks inherent in litigation, collectability of such amounts from counterparties (and/or their respective parents and affiliates), timing of receipt of any such recoveries, regulatory intervention which could impede our ability to take actions
required to realize such recoveries and uncertainty inherent in the assumptions used in estimating such recoveries. Our current estimate considers that we will receive subrogation recoveries of $865.0 and $1,733.2 million in 2012 and 2013,
respectively (gross of discounting, reinsurance and credit risk valuation in the amount of $93.7 million, $26.7 million and $5.7 million, respectively). The amount of these subrogation recoveries is significant and if we are unable to recover any
amounts our future available liquidity to pay claims would be reduced and our stockholders deficit as of March 31, 2011 would increase from $2,093.9 million to $4,566.0 million.

Reasonably Possible Additional Losses:

RMBS:

It is possible that our loss estimate assumptions for the RMBS
insurance policies discussed above could be materially under-estimated as a result of continued deterioration in housing prices, poor servicing, the effects of a weakened economy marked by growing unemployment and wage pressures and/or continued
illiquidity of the mortgage market. Additionally, our actual subrogation recoveries could be lower than our current estimates if the sponsors of these transactions: (i) fail to honor their obligations to repurchase the mortgage loans,
(ii) successfully dispute our breach findings, or (iii) no longer have the financial means to fully satisfy their obligations under the transaction documents or (iv) an election to accept a lower settlement.

We have attempted to identify the reasonably possible losses using more stressful assumptions in each of our existing models, and blended
the stress cases to be consistent with our approach to reserving. Different methodologies, assumptions and models could produce different base and reasonably possible outcomes and actual results may differ materially from all of these various
modeled results.



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In the case of second-lien exposures, we stressed both the regression and internal
roll-rate models, and weighted each at 50% to determine the reasonably possible losses. Using this approach, the reasonably possible increase in loss reserves for second-lien credits for which we have an estimate of expected loss at March 31,
2011 could be approximately $536 million. The stress case for the regression model assumes a significantly harsher HPA projection which in turn drives higher defaults and severities. The reasonably possible scenario in our roll-rate model
generally assumes that the voluntary constant prepayment rate decreases by 1 to 5 percentage points (depending on transaction performance), and the current-to-30 day roll assumption over a twelve month period increases by 0.25 to 1 percentage
points (depending on transaction performance). In addition, the loss severities for second-lien products may be greater because of increased carrying costs and servicing advances that are not recovered and we frequently increased them in a
range between 1 to 3 percentage points.

In the case of first-lien credits, we stressed both the regression and stochastic
models and weighted each at 50% to determine the reasonably possible losses. Using this approach, the reasonably possible increase in loss reserves for first-lien credits for which we have an estimate of expected loss at March 31, 2011 could be
approximately $510 million. The stress case for the regression model assumes a significantly harsher HPA projection which in turn drives higher defaults and severities. The reasonably possible scenario for first-lien mortgage credits in the
stochastic model assumes that aggravated losses occur as a result of deterioration of macroeconomic factors and a reduced impact from government programs and servicer intervention.

Student Loans:

It is possible that our loss estimate assumptions for student loan credits could be materially under-estimated as a result of various uncertainties including but not limited to, the interest rate
environment, an increase in default rates and loss severities on the collateral due to economic factors, as well as a failure of issuers to refinance insured bonds which have a failed debt structure, such as auction rate securities and variable rate
debt obligations. Refer to Auction Rate Securities and Variable Rate Demand Obligations in Part 1, Item 1 of Ambacs 2010 Form 10-K for further information on our exposures to such failed debt structures. Our student loan
portfolio consists of credits collateralized by (i) federally guaranteed loans under the Federal Family Education Loan Program (FFELP) and (ii) private student loans. Whereas FFELP loans are guaranteed for a minimum of 97% of
defaulted principal and interest, private loans have no government guarantee and therefore are subject to credit risk as with other types of unsecured credit. Recent default data has shown a significant deterioration in the performance of private
student loans underlying our transactions. Additionally, due to the failure of the auction rate and variable rate markets, the interest rates on these securities increased significantly to punitive levels pursuant to the terms of the documents. Such
increases have caused the collateralization ratio in these transactions to deteriorate on an accelerated basis due to negative excess spread and/or the use of principal receipts to pay current interest. Although some issuers have been successful in
refinancing some of their failed debt obligations, refinancing alternatives are limited, and refinancing options for private loans are severely impaired. Effective July 1, 2010, lenders are unable to originate guaranteed loans, due to the
termination of the FFELP program. The resulting reduction in new revenues may adversely affect a number of issuers, whose ability to continue as administrator of the relevant transaction trusts may become at risk. For student loan credits for which
we have an estimate of expected loss at March 31, 2011, the reasonably possible increase in loss reserves from the March 31, 2011 balance could be approximately $2,294 million. The reasonably possible scenario considers the highest stress
scenario that was utilized in the development of our probability weighted expected loss at March 31, 2011.

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



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Valuation of Financial Instruments:

Ambacs financial instruments that are reported on the Consolidated Balance Sheets at fair value and subject to valuation estimates
include investments in fixed income securities, VIE assets and liabilities, and derivatives comprising credit default, interest rate and currency swap transactions. Surplus notes issued in connection with claim or commutation settlements are
recorded at fair value at the date of issuance and subsequently reported at amortized cost within Long-term debt on the Consolidated Balance Sheet. Determination of fair value for newly issued surplus notes is a highly subjective process which
relies upon the use of significant unobservable inputs and management judgment consistent with a Level 3 valuation.

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. ASC Topic 820, Fair Value Measurements and Disclosures requires the
categorization of these assets and liabilities according to a fair value valuation hierarchy. Approximately 81% of our assets and approximately 55% of our liabilities are carried at fair value and categorized in either Level 2 of the valuation
hierarchy (meaning that their fair value was determined by reference to quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in inactive markets and other observable inputs) or Level 3 (meaning
that their fair value was determined by reference to significant inputs that are unobservable in the market and therefore require a greater degree of management judgment). The determination of fair value for financial instruments categorized in
Level 2 or 3 involves significant judgment due to the complexity of factors contributing to the valuation. Third-party sources from which we obtain independent market quotes also use assumptions, judgments and estimates in determining financial
instrument values and different third parties may use different methodologies or provide different prices for securities. In addition, the use of internal valuation models for certain highly structured instruments, such as credit default swaps,
require assumptions about markets in which there has been a negligible amount of trading activity for several years. As a result of these factors, the actual trade value of a financial instrument in the market, or exit value of a financial
instrument position owned by Ambac, may be significantly different from its recorded fair value. Refer to Note 11 to the Unaudited Consolidated Financial Statements in Part 1, Item 1 of this Form 10-Q for discussion related to the transfers in
and/or out of Level 1, 2 and 3 fair value categories.

Investment in Fixed Income Securities:

Investments in fixed income securities are accounted for in accordance with ASC Topic 320, InvestmentsDebt and Equity
Securities. ASC Topic 320 requires that all debt instruments and certain equity instruments be classified in Ambacs Consolidated Balance Sheets according to their purpose and, depending on that classification, be carried at either cost or
fair market value. The fair values of fixed income investments held in the investment portfolios of Ambac and its operating subsidiaries are based primarily on quoted market prices received from dealer quotes or alternative pricing sources with
reasonable levels of price transparency. For those fixed income investments where quotes were not available, fair values are based on internal valuation models. Refer to Note 11 to the Unaudited Consolidated Financial Statements in Part 1,
Item 1 of this Form 10-Q for further discussion of the valuation methods, inputs and assumptions for fixed income securities. Ambac performs various review and validation procedures to quoted and modeled prices for fixed income securities,
including price variance analyses, missing and static price reviews, overall valuation analyses by senior traders and finance managers and reviews associated with our ongoing impairment analysis. Unusual prices identified through these procedures
will be evaluated further against separate broker quotes (if available) or internally modeled prices, and the pricing source values will be challenged as necessary. Price challenges generally result in the use of the pricing sources quote as
originally provided or as revised by the source following their internal diligence process. A price challenge may result in a determination by the pricing source that they cannot provide a reasonable value for a security, in which case Ambac would
resort to



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using either other quotes or internal models. Valuation results, particularly those derived from valuation models and quotes on certain mortgage and asset-backed securities, could differ
materially from amounts that would actually be realized in the market.

Ambacs investments in fixed income securities
(excluding VIE investments) classified as available-for-sale are carried at fair value, with the after-tax difference from amortized cost reflected in stockholders equity as a component of Accumulated Other Comprehensive Income
(AOCI). One of the significant estimates related to available-for-sale securities is the evaluation of investments for other-than-temporary impairments. Under GAAP, if management assesses that it either (i) has the intent to sell
its investment in a debt security or (ii) more likely than not will be required to sell the debt security before the anticipated recovery of its amortized cost basis less any current period credit loss, then an other-than-temporary impairment
charge must be recognized in earnings, with the amortized cost of the security being written-down to fair value. If these conditions are not met, but it is determined that a credit loss exists, the impairment is separated into the amount related to
the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recognized in other comprehensive income. To determine whether a credit loss has occurred, management considers certain factors, including the
length of time and extent to which the fair value of the security has been less than its amortized cost and downgrades of the securitys credit rating. If such factors indicate that a potential credit loss exists, then management will compare
the present value of estimated cash flows from the security to the amortized cost basis to assess whether the entire amortized cost basis will be recovered. When it is determined that all or a portion of the amortized cost basis will not be
recovered, a credit impairment charge is recorded in earnings in the amount of the difference between the present value of cash flows and the amortized cost at the balance sheet date, with the amortized cost basis of the impaired security
written-down to the present value of cash flows. Ambac estimates expected future cash flows from residential mortgage backed securities, considering the likelihood of a wide dispersion of possible outcomes to develop cash flow scenarios. Estimated
cash flows are discounted at the effective interest rate implicit in the security at the date of acquisition or upon last impairment. For floating rate securities, estimated cash flows are projected using the relevant index rate forward curve and
the discount rate is adjusted for changes in that curve since the date of acquisition or last impairment. For fixed income securities, the Company accretes the new cost basis to par or to the estimated future cash flows to be recovered over the
expected remaining life of the security using the effective interest rate of the security prior to impairment.

Ambacs
investment portfolio includes certain securities that are guaranteed by Ambac Assurance. As described further in Note 9 to the Unaudited Consolidated Financial Statements, future cash flows used to measure credit impairment of Ambac-wrapped bonds
represents the sum of (i) the bonds intrinsic cash flows and (ii) the estimated fair value of Ambac claim payments. Under the Segregated Account Rehabilitation Plan, future claim payments made by Ambac Assurance on these securities
would be satisfied 25% in cash and 75% in surplus notes. However, it is uncertain whether the actual form and amount of claim payments ultimately approved by OCI and implemented will conform to that set forth in the Segregated Account Rehabilitation
Plan. As a result, estimation of the fair value of future claim payments is highly subjective.

The evaluation of securities
for impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and
uncertainties include changes in general economic conditions, the issuers or guarantors financial condition and/or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. There is
also significant judgment in determining whether Ambac intends to sell securities or will continue to have the ability to hold temporarily impaired securities until recovery. Future events could occur that were not reasonably foreseen at the time
management rendered its judgment on the Companys intent to retain such securities until recovery. Examples of such events include, but are not limited to, the deterioration in the



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issuers or guarantors creditworthiness, a change in regulatory requirements or a major business combination or major disposition.

VIE Assets and Liabilities:

The assets and liabilities of VIEs consolidated under ASC Topic 810, Consolidation consist primarily of fixed income securities, loans receivable, derivative instruments and debt instruments and
are generally carried at fair value with changes in fair value recognized in Financial Guarantee: Loss on variable interest entities of the Consolidated Statements of Operations. These consolidated VIEs are securitization entities which have
liabilities and/or assets guaranteed by Ambac. The fair values of VIE debt instruments are determined using the same methodologies used to value Ambacs fixed income securities in its investment portfolio as described above.

VIE derivative asset and liability fair values are determined using valuation models. When specific derivative contractual terms are
available and may be valued primarily by reference to interest rates, exchange rates and yield curves that are observable and regularly quoted, the derivatives are valued using vendor-developed models. Other derivatives within the VIEs that include
significant unobservable valuation inputs are valued using internally developed models.

The fair value of VIE assets are
obtained from market quotes when available. Typically the asset fair values are not readily available from market quotes and are estimated internally. The consolidated VIEs are securitization entities in which net cash flows from assets and
derivatives (after adjusting for financial guarantor cash flows and other expenses) will be paid out to note holders or equity interests. Our valuation of VIE assets (fixed income securities or loans), therefore, are derived from the fair value of
debt and derivatives, as described above, adjusted for the fair value of cash flows from Ambacs financial guarantee. The fair value of financial guarantee cash flows include: (i) estimated future premiums discounted at a rate consistent
with that implicit in the fair value of the VIEs liabilities and (ii) internal estimates of future loss payments by Ambac discounted to consider Ambacs own credit risk.

Derivatives:

Ambacs operating subsidiaries exposure to
derivative instruments is created through interest rate and currency swaps, US Treasury futures contracts and credit default swaps. These contracts are accounted for at fair value under ASC Topic 815, Derivatives and Hedging. Valuation models
are used for the derivatives portfolios, using market data from a variety of third-party data sources. Several of the more significant types of market data that influence fair value include interest rates (taxable and tax-exempt), credit spreads,
default probabilities, recovery rates, comparable securities with observable pricing, and the credit rating of the referenced entities. The valuation of certain interest rate and currency swaps as well as all credit derivative contracts also require
the use of data inputs and assumptions that are determined by management and are not readily observable in the market. Refer to Note 11 to the Unaudited Consolidated Financial Statements in Part 1, Item 1 of this Form 10-Q for further
discussion of the models, model inputs and assumptions used to value derivative instruments. Due to the inherent uncertainties of the assumptions used in the valuation models to determine the fair value of derivative instruments, actual value
realized in a market transaction may differ significantly from the estimates reflected in our financial statements.

The fair
values of credit derivatives are sensitive to changes in credit ratings on the underlying reference obligations, particularly when such changes reach below investment grade levels. Ratings changes are reflected in Ambacs valuation model as
changes to the relative change ratio, which represents the ratio of the estimated cost of credit protection relative to the cash market spread on the reference obligation. Such adjustments to the relative change ratio have primarily
impacted the fair value of CDO of ABS transactions containing over 25% MBS exposure which suffered significant credit downgrades. All remaining CDO of ABS transactions were settled in 2010. Within the remaining CDS



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portfolio as of March 31, 2011, transactions comprising approximately 87% of par outstanding have experienced some degree of credit rating downgrade since inception, including three
structured finance transactions that are internally rated below investment grade. The relative change ratio on these transactions averaged 93.7% at March 31, 2011. The average rating for all other transactions that have been downgraded was AA-
as of March 31, 2011 and, therefore, changes to the relative change ratio have not been significant.

Ambacs credit
derivative valuation model, like any financial model, has certain strengths and weaknesses. We believe our models primary strength is that it maximizes the use of market-driven inputs, and, most importantly, its use of market-based fair values
of the underlying reference obligations and discount rate utilized. Ambac employs a three-level hierarchy for obtaining reference obligation fair values used in the model as follows: (i) broker quotes on the reference obligation,
(ii) broker quotes on a subordinate obligation within the same capital structure as the reference obligation and (iii) proxy spreads from similarly structured deals or other market proxies. We believe using this type of approach is
preferable to other models, which may emphasize modeled expected losses or which rely more heavily on the use of market indices that may not be reflective of the underlying reference obligation. Another strength is that our model is relatively easy
to understand, which increases its transparency.

A potential weakness of our valuation model is our reliance on broker quotes
obtained from dealers which originated the underlying transactions, who in certain cases may also be the counterparty to our CDS transaction. All of the transactions falling into this category are illiquid and it is usually difficult to obtain
alternative quotes. Ambac employs various procedures to corroborate the reasonableness of quotes received; including comparing to other quotes received on similarly structured transactions, observed spreads on structured products with comparable
underlying assets and, on a selective basis when possible, values derived through internal estimates of discounted future cash flows. Each quarter, the portfolio of CDS transactions is reviewed to ensure every reference obligation price has been
updated. Period to period valuations are compared for each CDS and by underlying bond type. For each CDS, this analysis includes comparisons of key valuation inputs to the prior period and against other CDS within the bond type. No adjustments were
made to the broker quotes we received when determining fair value of CDS contracts as of March 31, 2011. Another potential weakness of our valuation model is the lack of new CDS transactions executed by financial guarantors, which makes it
difficult to validate the percentage of the reference obligation spread which would be captured as a CDS fee at the valuation date, (i.e. the relative change ratio, a key component of our valuation calculation). Changes to the relative change ratio
based on internal ratings assigned are another potential weakness as internal ratings could differ from actual ratings provided by rating agencies. However, we believe our internal ratings are updated at least as frequently as the external ratings.
Nonetheless, we believe the approach we have developed, described above, to increase the relative change ratio as the underlying reference obligation experiences credit deterioration is consistent with a market-based approach to valuation.
Ultimately, our approach exhibits the same weakness as other modeling approaches, as it is unclear if we could execute at these values.

Valuation of Deferred Tax Assets:

Our provision for taxes is based on our income, statutory tax rates and tax planning opportunities available to us in the jurisdictions in which we operate. Tax laws are complex and subject to different
interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating our tax positions. We review our tax positions quarterly and adjust the balances as new
information becomes available. Deferred tax assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carry forwards. More specifically,
deferred tax assets represent a future tax benefit (or receivable) that results from losses recorded under U.S. GAAP in a current period which are only deductible for tax purposes in future periods and net operating loss carry forwards. In
accordance with ASC Topic 740,Income Taxes, we evaluate our deferred income taxes



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quarterly to determine if valuation allowances are required. ASC Topic 740 requires that companies assess whether valuation allowances should be established against their deferred tax assets
based on the consideration of all available evidence using a more likely than not standard. All available evidence, both positive and negative, needs to be identified and considered in making the determination with significant weight
given to evidence that can be objectively verified. The level of deferred tax asset recognition is influenced by managements assessment of future expected taxable income, which depends on the existence of sufficient taxable income of the
appropriate character (ordinary vs. capital) within the carry back or carry forward periods available under the tax law. In the event that we determine that we would not be able to realize all or a portion of our deferred tax assets, we would record
a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable in the period in which that determination is made.

Financial Guarantee Exposures

The following table provides a breakdown of
guaranteed net par outstanding by market sector at March 31, 2011 and December 31, 2010. Guaranteed net par outstanding includes the exposures of policies that insure VIEs consolidated in accordance with ASC Topic 810:



|                          |  |               |       |  |                  |   |       | 
|------------------------- |  | ------------- | ----- |  | ---------------- | - | ----- | 
|($ in billions)           |  | March 31,2011 |       |  | December 31,2010 |  
|Public Finance            |  | $             | 194.8 |  |                  | $ | 199.4 | 
|Structured Finance        |  |               | 69.0  |  |                  |   | 73.8  | 
|International Finance     |  |               | 46.7  |  |                  |   | 45.7  | 
|                          |  |               |       |  |                  |   |       | 
|Total net par outstanding |  | $             | 310.5 |  |                  | $ | 318.9 | 
|                          |  |               |       |  |                  |   |       | 

The following tables provide a rating distribution of guaranteed total net par outstanding based upon
internal Ambac Assurance credit ratings at March 31, 2011 and December 31, 2010 and a distribution by bond type of Ambac Assurances below investment grade exposures at March 31, 2011 and December 31, 2010. Below investment
grade is defined as those exposures with a credit rating below BBB-:

Percentage of Guaranteed Portfolio(1)



|      |  |               |     |   |                  |  |     |  
|----- |  | ------------- | --- | - | ---------------- |  | --- | -
|      |  | March 31,2011 |     |   | December 31,2010 | 
|AAA   |  |               | 1   | % |                  |  | 1   | %
|AA    |  |               | 24  |   |                  |  | 23  |  
|A     |  |               | 43  |   |                  |  | 43  |  
|BBB   |  |               | 19  |   |                  |  | 19  |  
|BIG   |  |               | 13  |   |                  |  | 14  |  
|      |  |               |     |   |                  |  |     |  
|Total |  |               | 100 | % |                  |  | 100 | %
|      |  |               |     |   |                  |  |     |  



|(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 guaranteed 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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Summary of Below Investment Grade Exposure



|                                            |  |               |        |  |                  |   |        | 
|------------------------------------------- |  | ------------- | ------ |  | ---------------- | - | ------ | 
|Bond Type                                   |  | March 31,2011 |        |  | December 31,2010 |  
|($ in millions)                             |  |              
|Public Finance:                             |  |               |        |  |                  |   |        | 
|Transportation                              |  | $             | 1,164  |  |                  | $ | 1,175  | 
|Health care                                 |  |               | 104    |  |                  |   | 259    | 
|General obligation                          |  |               | 232    |  |                  |   | 234    | 
|Tax-backed                                  |  |               | 521    |  |                  |   | 531    | 
|Other                                       |  |               | 1,326  |  |                  |   | 1,345  | 
|                                            |  |               |        |  |                  |   |        | 
|Total Public Finance                        |  |               | 3,347  |  |                  |   | 3,544  | 
|                                            |  |               |        |  |                  |   |        | 
|Structured Finance:                         |  |               |        |  |                  |   |        | 
|Mortgage-backed and home equityfirst lien  |  |               | 12,390 |  |                  |   | 12,836 | 
|Mortgage-backed and home equitysecond lien |  |               | 9,674  |  |                  |   | 10,121 | 
|Auto Rentals                                |  |               | 1,000  |  |                  |   | 1,270  | 
|Student loans                               |  |               | 10,314 |  |                  |   | 11,044 | 
|Enhanced equipment trust certificates       |  |               | 429    |  |                  |   | 430    | 
|Mortgage-backed and home equityother       |  |               | 358    |  |                  |   | 369    | 
|Other CDOs                                  |  |               | 85     |  |                  |   | 100    | 
|Other                                       |  |               | 1,523  |  |                  |   | 1,662  | 
|                                            |  |               |        |  |                  |   |        | 
|Total Structured Finance                    |  |               | 35,773 |  |                  |   | 37,832 | 
|                                            |  |               |        |  |                  |   |        | 
|International Finance:                      |  |               |        |  |                  |   |        | 
|Airports                                    |  |               | 1,585  |  |                  |   | 1,505  | 
|Other                                       |  |               | 831    |  |                  |   | 922    | 
|                                            |  |               |        |  |                  |   |        | 
|Total International Finance                 |  |               | 2,416  |  |                  |   | 2,427  | 
|                                            |  |               |        |  |                  |   |        | 
|Total                                       |  | $             | 41,536 |  |                  | $ | 43,803 | 
|                                            |  |               |        |  |                  |   |        | 

The decrease in mortgage-backed and home equity (first and second-liens) below investment grade exposures is
primarily the result of principal pay-downs. The decrease in student loans is the result of commutations and the refinancing of certain student loan transactions.

In connection with its financial guarantee business, Ambac has outstanding commitments to provide guarantees (includes both insurance and credit derivatives) of $5.3 billion at March 31, 2011. These
commitments relate to potential future debt issuances or increases in funding levels for existing insurance or credit derivative transactions. Commitments generally have fixed termination dates and are contingent on the satisfaction of all
conditions set forth in the contract. These commitments may expire unused or be reduced or cancelled at the counterpartys request. Additionally, approximately 83% of the total commitment amount represents commitments that contain one or more
of the following provisions: (i) the commitment may be terminated at Ambacs election upon a material adverse change, (ii) in order for the funding levels to be increased, certain eligibility requirements must be met, or,
(iii) for commitments to provide protection, the commitment may not be exercised upon an event of default or after the reinvestment period. Moreover, as a consequence of the Segregated Account Rehabilitation Proceedings and under the terms of a
settlement agreement with CDO counterparties in 2010, it is unclear whether such new policies could be issued. Accordingly, the $5.3 billion of commitments outstanding at March 31, 2011 do not necessarily reflect actual future amounts. Additionally,
due to Ambacs current financial strength ratings and investor concern with respect to our financial position, certain commitments are unlikely to be exercised.



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RESIDENTIAL MORTGAGE-BACKED SECURITIES EXPOSURE

RMBS portfolio exposures included in financial guarantee insurance portfolio

Ambac has exposure to the U.S. mortgage market through direct financial guarantees of RMBS. Ambac insures tranches issued in RMBS,
including transactions that contain risks to first and second-liens. The following tables provide current gross par outstanding and gross claim liability by vintage and type, and underlying credit rating of Ambacs affected U.S. RMBS book of
business:



|                         |  |                                                                                          |          |   |           |   |         |          |  |   |         |  
|------------------------ |  | ---------------------------------------------------------------------------------------- | -------- | - | --------- | - | ------- | -------- |  | - | ------- | -
|                         |  | Total Gross Par
Outstanding(1)At March 31, 2011 ($ in millions)                          |         
|Year of Issue            |  | Second Lien                                                                              |          |   | Sub-prime |   |         | Alt-A(2) | 
|1998-2001                |  | $                                                                                        | 116.1    |   |           | $ | 694.6   |          |  | $ | 7.1     |  
|2002                     |  |                                                                                          | 54.7     |   |           |   | 632.3   |          |  |   | 71.6    |  
|2003                     |  |                                                                                          | 37.4     |   |           |   | 970.8   |          |  |   | 524.4   |  
|2004                     |  |                                                                                          | 1,340.7  |   |           |   | 520.9   |          |  |   | 845.4   |  
|2005                     |  |                                                                                          | 1,362.2  |   |           |   | 1,165.9 |          |  |   | 2,772.6 |  
|2006                     |  |                                                                                          | 3,435.2  |   |           |   | 844.5   |          |  |   | 2,128.0 |  
|2007                     |  |                                                                                          | 3,849.9  |   |           |   | 556.3   |          |  |   | 3,244.4 |  
|                         |  |                                                                                          |          |   |           |   |         |          |  |   |         |  
|Total                    |  | $                                                                                        | 10,196.2 |   |           | $ | 5,385.3 |          |  | $ | 9,593.5 |  
|                         |  |                                                                                          |          |   |           |   |         |          |  |   |         |  
|% of Total MBS Portfolio |  |                                                                                          | 35.6     | % |           |   | 18.8    | %        |  |   | 33.5    | %
|                         | 
|                         |  | Gross claim liability, before Subrogation Recoveries(1)At March 31, 2011 ($ in millions) |         
|Year of Issue            |  | Second Lien                                                                              |          |   | Sub-prime |   |         | Alt-A(2) | 
|1998-2001                |  | $                                                                                        | 1.4      |   |           | $ | 29.2    |          |  | $ | 0.0     |  
|2002                     |  |                                                                                          | 0.3      |   |           |   | 30.0    |          |  |   | 1.5     |  
|2003                     |  |                                                                                          | 0.8      |   |           |   | 6.4     |          |  |   | 21.6    |  
|2004                     |  |                                                                                          | 238.9    |   |           |   | 12.5    |          |  |   | 16.4    |  
|2005                     |  |                                                                                          | 403.1    |   |           |   | 225.5   |          |  |   | 756.5   |  
|2006                     |  |                                                                                          | 1,516.9  |   |           |   | 291.9   |          |  |   | 901.8   |  
|2007                     |  |                                                                                          | 502.0    |   |           |   | 152.8   |          |  |   | 1,070.4 |  
|                         |  |                                                                                          |          |   |           |   |         |          |  |   |         |  
|Total                    |  | $                                                                                        | 2,663.4  |   |           | $ | 748.3   |          |  | $ | 2,768.2 |  
|                         |  |                                                                                          |          |   |           |   |         |          |  |   |         |  
|                         | 
|                         |  | Gross Subrogation
Recoveries(1)At March 31, 2011 ($ in millions)                         |         
|Year of Issue            |  | Second Lien                                                                              |          |   | Sub-prime |   |         | Alt-A(2) | 
|1998-2001                |  | $                                                                                        |         |   |           | $ |        |          |  | $ |        |  
|2002                     |  |                                                                                          |         |   |           |   |        |          |  |   |        |  
|2003                     |  |                                                                                          |         |   |           |   |        |          |  |   |        |  
|2004                     |  |                                                                                          | (90.5    | ) |           |   |        |          |  |   |        |  
|2005                     |  |                                                                                          | (171.5   | ) |           |   | (85.0   | )        |  |   |        |  
|2006                     |  |                                                                                          | (684.6   | ) |           |   | (135.0  | )        |  |   |        |  
|2007                     |  |                                                                                          | (920.0   | ) |           |   | (123.0  | )        |  |   | (289.2  | )
|                         |  |                                                                                          |          |   |           |   |         |          |  |   |         |  
|Total                    |  | $                                                                                        | (1,866.6 | ) |           | $ | (343.0  | )        |  | $ | (289.2  | )
|                         |  |                                                                                          |          |   |           |   |         |          |  |   |         |  



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|                                |  |                                                                     |      |   |           |  |    |          |  |  |    |  
|------------------------------- |  | ------------------------------------------------------------------- | ---- | - | --------- |  | -- | -------- |  |  | -- | -
|                                |  | Percent of Related RMBS Transactions(1) Gross ParAt March 31, 2011 |     
|Internal Ambac Credit
Rating(3) |  | Second Lien                                                         |      |   | Sub-prime |  |    | Alt-A(2) | 
|AAA                             |  |                                                                     | 0    | % |           |  | 5  | %        |  |  | 1  | %
|AA                              |  |                                                                     | <0.1 | % |           |  | 4  | %        |  |  | 5  | %
|A                               |  |                                                                     | 2    | % |           |  | 10 | %        |  |  | 7  | %
|BBB(4)                          |  |                                                                     | 2    | % |           |  | 2  | %        |  |  | 1  | %
|Below investment grade(4)       |  |                                                                     | 96   | % |           |  | 79 | %        |  |  | 86 | %



|(1) | Excludes prime, manufactured housing, pooled RMBS outside the U.S., and other mortgage exposures.
|--- | -------------------------------------------------------------------------------------------------

|(2) | Alt-A includes mid-prime transactions and affordability product transactions, which includes interest only or option adjustable rate features.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Ambac ratings set forth above reflect the internal Ambac ratings as of March 31, 2011, and may be changed at any time based on our internal credit review. Ambac
undertakes no obligation to update such ratings. This does not constitute investment advice. Ambac or one of its affiliates has guaranteed 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.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Ambacs BBB internal rating reflects bonds which are of medium grade credit quality with adequate capacity to pay interest and repay principal. Certain protective
elements and margins may weaken under adverse economic condition and changing circumstances. These bonds are more likely than higher rated bonds to exhibit unreliable protection levels over all cycles. Ambacs below investment grade internal
ratings reflect bonds which are of speculative grade credit quality with the adequacy of future margin levels for payment of interest and repayment of principal potentially adversely affected by major ongoing uncertainties or exposure to adverse
conditions. Ambacs below investment grade category includes transactions on which we are currently paying claims.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

RMBS exposure in collateralized debt obligations

Ambacs
outstanding CDO exposures are comprised of the following asset type and credit ratings as of March 31, 2011 and December 31, 2010:



|                                            |         |                |      |            |                   |  |         |   |  |            |      |  |  |  |     |  
|------------------------------------------- | ------- | -------------- | ---- | ---------- | ----------------- |  | ------- | - |  | ---------- | ---- |  |  |  | --- | -
|Business Mix by Net Par
($ in billions)     |         | March 31, 2011 |      |            | December 31, 2010 | 
|                                            | Net Par |                |      | Percentage |                   |  | Net Par |   |  | Percentage |     
|High yield corporate (CLO)                  |         | $              | 13.9 |            |                   |  | 82      | % |  | $          | 14.7 |  |  |  | 80  | %
|Market value CDOs                           |         |                | 1.1  |            |                   |  | 6       |   |  |            | 1.5  |  |  |  | 8   |  
|CDO of ABS < 25% MBS                        |         |                | 0.5  |            |                   |  | 3       |   |  |            | 0.5  |  |  |  | 3   |  
|Other                                       |         |                | 1.5  |            |                   |  | 9       |   |  |            | 1.5  |  |  |  | 9   |  
|                                            |         |                |      |            |                   |  |         |   |  |            |      |  |  |  |     |  
|Total                                       |         | $              | 17.0 |            |                   |  | 100     | % |  | $          | 18.2 |  |  |  | 100 | %
|                                            |         |                |      |            |                   |  |         |   |  |            |      |  |  |  |     |  
|                                            |         |               
|Ambac Ratings by Net
Par(1) ($ in
billions) |         | March 31, 2011 |      |            | December 31, 2010 | 
|                                            | Net Par |                |      | Percentage |                   |  | Net Par |   |  | Percentage |     
|AAA                                         |         | $              | 2.0  |            |                   |  | 12      | % |  | $          | 2.1  |  |  |  | 12  | %
|AA                                          |         |                | 9.6  |            |                   |  | 56      |   |  |            | 9.9  |  |  |  | 54  |  
|A                                           |         |                | 4.9  |            |                   |  | 29      |   |  |            | 5.7  |  |  |  | 31  |  
|BBB                                         |         |                | 0.2  |            |                   |  | 1       |   |  |            | 0.2  |  |  |  | 1   |  
|Below investment grade                      |         |                | 0.3  |            |                   |  | 2       |   |  |            | 0.3  |  |  |  | 2   |  
|                                            |         |                |      |            |                   |  |         |   |  |            |      |  |  |  |     |  
|Total                                       |         | $              | 17.0 |            |                   |  | 100     | % |  | $          | 18.2 |  |  |  | 100 | %
|                                            |         |                |      |            |                   |  |         |   |  |            |      |  |  |  |     |  



|(1) | Internal Ambac credit ratings are provided solely to indicate the underlying credit quality of guaranteed obligations based on the view of Ambac. Ambac
ratings set forth above reflect the internal Ambac ratings as of March 31, 2011, and may be changed at any time based on our internal credit review. This does not constitute investment advice. Ambac or one of its
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | affiliates has guaranteed the obligations included above and may also provide other products or services to the issuers of these obligations for which Ambac may have received premiums or fees.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

RMBS investment portfolio exposure

Ambac also has RMBS exposure in the Financial Guarantee and Financial Services investment portfolios. Please refer to the tables in the
Liquidity and Capital ResourcesBalance Sheet section below which display: (i) the fair value of mortgage and asset-backed securities by classification, (ii) the fair value of RMBS by vintage and type, and (iii) the
ratings distribution of the fixed income investment portfolio by segment.

Results of Operations

On November 8, 2010 (the Petition Date), Ambac (Debtor) filed a voluntary petition for relief under Chapter
11 (Bankruptcy Filing) of the Bankruptcy Code in the Bankruptcy Court. Ambac will continue to operate in the ordinary course of business as debtor-in-possession under the jurisdiction of the Bankruptcy Court and in accordance
with the applicable provisions of the Bankruptcy Code and the orders of the Bankruptcy Court.

We follow the accounting
prescribed by Financial Accounting Standards Board Accounting Standards Codification Topic 852, Reorganizations (ASC Topic 852). Entities operating in bankruptcy and expecting to reorganize under Chapter 11 of the Bankruptcy
Code are subject to the additional accounting and financial reporting guidance in ASC Topic 852. While ASC Topic 852 provides specific guidance for certain matters, other portions of US GAAP continue to apply so long as the guidance does not
conflict with ASC Topic 852. This accounting literature provides guidance for periods subsequent to a Chapter 11 filing, among other things, the presentation of liabilities that are and are not subject to compromise by the Bankruptcy Court
proceedings, as well as the treatment of interest expense and presentation of costs associated with the proceedings. Accordingly, the financial results in the prior periods or filed in future filings may not be comparable to 2011.

Ambacs diluted loss was ($819.3) million or ($2.71) per share, and ($690.1) million, or ($2.39) per share, for the three months
ended March 31, 2011 and 2010, respectively. The first quarter 2011 financial results compared to 2010 were primarily negatively impacted by (i) a higher provision for loss and loss expenses; (ii) lower net premiums earned;
(iii) lower net investment income; (iv) reorganization items related to our Chapter 11 bankruptcy filing and (v) interest expense related to the issuance of surplus notes by Ambac Assurance, partially offset by (i) lower net
unrealized losses in the change in the fair value of credit derivatives; (ii) lower net losses related to variable interest entity activities; (iii) higher derivative product revenue; (iv) higher Financial Guarantee other income, and
no corporate interest expense as a result of our bankruptcy filing.

The following paragraphs describe the consolidated
results of operations of Ambac and its subsidiaries for the three months ended March 31, 2011 and 2010 and its financial condition as of March 31, 2011 and December 31, 2010. These results are presented for Ambacs two reportable
segments: Financial Guarantee and Financial Services.

Financial Guarantee:

Effective January 1, 2010, Ambac adopted ASU 2009-16, Transfers and Servicing (Topic 860): Accounting for Transfers of
Financial Assets and ASU 2009-17, Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities.Among



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other things, ASU 2009-17 requires an enterprise to perform an analysis to determine whether the enterprises variable interests give it a controlling financial interest in a VIE. ASU
2009-17 identifies the primary beneficiary of a VIE as the enterprise that has both the following characteristics: a) the power to direct the activities of the VIE that most significantly impact the VIEs economic performance and b) the
obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. As a result, a cumulative effect adjustment of $705.0 million was
recorded as a net increase to total equity at January 1, 2010. Refer to Note 4 to the Unaudited Consolidated Financial Statements in Part 1, Item 1 of this Form 10-Q for further discussion of the cumulative effect of adopting the
standard.

Commutations, Terminations and Settlements of Financial Guarantee and Credit Derivative Contracts.

In the first quarter of 2011, the Segregated Account of Ambac Assurance completed the commutation of two student
loan transactions with cash payment of $11.0 million and the issuance of Segregated Account Surplus Notes with a par value of $3.0 million.

In 2010, Ambac Assurance entered into a settlement agreement with respect to certain CDO-related obligations. The settlement agreement commuted $17.9 billion of par exposure for a payment by Ambac
Assurance of approximately $2,600 million plus $2,000 million of surplus notes. Ambac Assurance commuted another CDO of ABS transaction in an amount equal to its remaining par value of $90 million. In addition to these commutations, Ambac Assurance
has also commuted for $96.5 million of cash, certain additional obligations, including certain non-CDO of ABS obligations with par of $1,407 million.

In connection with our principal business strategy, Ambac is engaged in additional commutation discussions with a number of counterparties.

Net Premiums Earned. Net premiums earned for the three months ended March 31, 2011 were $91.8 million, a decrease of
$33.4 million, or 27%, from $125.2 million for the three months ended March 31, 2010. Net premiums earned include accelerated premiums, which result from refunding, calls and other accelerations. Ambac had accelerated earnings of $(0.1) million
during the first quarter of 2011 versus $12.1 million in the first quarter of 2010. The decrease in accelerated earnings was driven by a decrease in overall volume of calls within the public finance market and by negative accelerations on certain
structured finance transactions which terminated during the period as the GAAP premiums receivable for these transactions were in excess of the related unearned premium reserve at termination, resulting in negative accelerated earned premiums.
Normal net premiums earned excludes accelerated premiums. Normal net premiums earned for the three months ended March 31, 2011 has been negatively impacted by the runoff of the insured portfolio either via transaction terminations / refundings
or scheduled maturities. As a result of the new consolidations standard and the resulting consolidation of VIEs, $11.0 million and $17.7 million of net premiums earned were not recognized for the three months ended March 31, 2011 and 2010,
respectively, rather, the total income statement results of such VIEs were recorded in Financial Guarantee: Loss on variable interest entities. Normal net premiums earned and accelerated premiums are reconciled to total net premiums earned in the
table below.



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The following table provides a breakdown of net premiums earned by market sector:



|                             |  |                              |      |   |      |   |       | 
|---------------------------- |  | ---------------------------- | ---- | - | ---- | - | ----- | 
|                             |  | Three Months EndedMarch 
31, |     
|($ in millions)              |  | 2011                         |      |   | 2010 |  
|Public Finance               |  | $                            | 42.4 |   |      | $ | 45.2  | 
|Structured Finance           |  |                              | 29.7 |   |      |   | 40.6  | 
|International Finance        |  |                              | 19.8 |   |      |   | 27.3  | 
|                             |  |                              |      |   |      |   |       | 
|Total normal premiums earned |  |                              | 91.9 |   |      |   | 113.1 | 
|Accelerated earnings         |  |                              | (0.1 | ) |      |   | 12.1  | 
|                             |  |                              |      |   |      |   |       | 
|Total net premiums earned    |  | $                            | 91.8 |   |      | $ | 125.2 | 
|                             |  |                              |      |   |      |   |       | 

Net Investment Income. Net investment income for the three months ended March 31, 2011
was $71.7 million, a decrease of 39% from $117.6 million in the three months ended March 31, 2010. The decline in net investment income resulted from a decrease in the invested asset base, as well as lower average yields in the portfolio. The
lower invested asset base in 2011 was driven by reductions in the portfolio to pay insurance losses and credit default swap commutations, partially offset by cash flow from the collection of financial guarantee premiums and coupon receipts on
invested assets. The lower yield on the portfolio for the three months ended March 31, 2011 compared to 2010 resulted from the allocation of financial guarantee policies on Ambac-wrapped securities to Segregated Account in March 2010. As a
result of the allocation of such policies to the Segregated Account, net investment income was reduced since Ambac claims payments were deferred subsequent to being allocated to the Segregated Account. The impact of lower 2011 income on
Ambac-wrapped securities was partially offset by the positive impact of investment re-allocation on the portfolios pre-tax yield. Compared to first quarter 2010, the first quarter of 2011 portfolio mix has shifted from tax-exempt municipals
toward taxable securities, primarily corporate bonds and taxable municipals. The portfolio also held a lower percentage of short-term investments in the first quarter 2011 than in the comparable quarter of 2010. At March 31, 2011 the
portfolio included $745.5 million of short-term investments in anticipation of recommencing claim payments, including payment of 25% of back claims in cash. This compares to short-term holdings at March 31, 2010 of $2,439.6 million to provide
liquidity for the CDO of ABS bank settlement which closed in June 2010.

Other-Than-Temporary Impairment Losses.Charges for other-than-temporary impairment losses were $1.7 million and $31.3 million for the three months ended March 31, 2011 and 2010, respectively. Other-than-temporary impairments for the three months ended March 31, 2011
resulted from adverse changes to projected cash flows on Ambac-wrapped securities. As further described in Note 1 to the Unaudited Consolidated Financial Statements located in Part 1, Item 1 of this Form 10-Q, on March 24, 2010, the OCI
commenced the Segregated Account Rehabilitation Proceedings in order to permit the OCI to facilitate an orderly run-off and/or settlement of the liabilities allocated to the Segregated Account. As a result of actions taken by the OCI, financial
guarantee payments on securities guaranteed by Ambac Assurance which have been placed in the Segregated Account were suspended in March 2010 and are no longer under the control of Ambac management. Claim payments under Segregated Account policies
have remained suspended throughout the first quarter 2011. Accordingly, estimated cash flows on such securities have been adversely impacted. Other-than-temporary impairments for the three months ended March 31, 2010 reflect charges to
write-down structured finance securities to fair value as a result of managements intent to sell securities to meet liquidity needs as well as credit losses on securities guaranteed by Ambac Assurance arising from the impact of the Segregated
Account Rehabilitation Plan on projected cash flows from those securities. As of March 31, 2011, management has not asserted an intent to sell any securities from its portfolio. Future changes in our estimated liquidity needs could result in a
determination that Ambac no longer has the ability to hold such securities, which could result in additional other-than-temporary impairment charges.



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Net Realized Investment Gains.The following table provides a breakdown
of net realized gains for the three months ended March 31, 2011 and 2010:



|                                       |  |                              |      |   |      |   |      | 
|-------------------------------------- |  | ---------------------------- | ---- | - | ---- | - | ---- | 
|                                       |  | Three Months EndedMarch 
31, |     
|($ in millions)                        |  | 2011                         |      |   | 2010 |  
|Net gains on securities sold or called |  | $                            | 0.3  |   |      | $ | 54.1 | 
|Foreign exchange (losses) gains        |  |                              | (0.3 | ) |      |   | 1.0  | 
|                                       |  |                              |      |   |      |   |      | 
|Total net realized gains (losses)      |  | $                            |     |   |      | $ | 55.1 | 
|                                       |  |                              |      |   |      |   |      | 

Change in fair value of credit derivatives. The net change in fair value of credit derivatives
was ($8.9) million and ($167.1) million for the three months ended March 31, 2011 and 2010, respectively.

The net loss
on change in fair value of credit derivatives for the three months ended March 31, 2011 resulted from a reduction of the Ambac credit valuation adjustment (CVA) to reflect Ambacs own credit risk in the fair value of credit
derivatives (see Note 11 to the Unaudited Consolidated Financial Statements for a description of the methodology used to determine the CVA amount), partially offset by improvement in reference obligation prices, gains associated with runoff of the
portfolio and CDS fees earned during the quarter. The Ambac CVA had remained stable from June 30, 2010 through December 31, 2010. The CVA was lowered as of March 31, 2011 to reflect indications observed of increases in the market
value of Ambac Assurances direct and guarantee obligations during the first quarter of 2011. The net loss for the three months ended March 31, 2010 included losses of $416 million from the change in fair value on transactions included in
the 2010 CDO of ABS commutation, and mark-to-market losses attributable to the impact of a lower Ambac CVA on contracts remaining in the portfolio at March 31, 2010, partially offset by gains from increases in reference obligation pricing in
asset classes other than CDO of ABS.

Realized gains and other settlements on credit derivative contracts were $5.3 million
and $9.9 million for the three months March 31, 2011 and 2010, respectively. These amounts represent premiums received and accrued on written contracts, premiums paid and accrued on purchased contracts and net losses and settlements paid and
payable where a formal notification of shortfall has occurred. Losses and settlements included in net realized gains for the three months ended March 31, 2011 and 2010 were $0.6 million and $0.3 million, respectively.

Unrealized gains (losses) on credit derivative contracts were ($14.2) million and ($177.1) million in the three months ended
March 31, 2011 and 2010, respectively. The net unrealized gains (losses) in fair value of credit derivatives reflect the same factors as the overall change in fair value of credit derivatives as noted above, adjusted for the reclassification of
losses (recoveries) from unrealized to realized losses of $0 and ($0.3) million for the three months ended March 31, 2011 and 2010, respectively

Other Income.Other income for the three months ended March 31, 2011 and 2010 was $28.3 million and $(55.9) million, respectively. Included within other income are non-investment
related foreign exchange gains and losses, deal structuring fees, commitment fees, certain changes in the fair value of call options on Ambac Assurances surplus notes and reinsurance settlement gains (losses). Other income for the three months
ended March 31, 2011 and March 2010 includes the impact of the movement in the British Pound and Euro to US Dollar exchange rate upon premium receivables, resulting in a gain and loss of approximately $3.0 million and $54.7 million,
respectively. Financial guarantee other income in the first quarter of 2011 includes a mark-to-market gain of $16.7 million related to Ambacs option to call up to $500 million par of bank surplus notes at 20% of the par value.



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Loss on variable interest entities. Loss on variable interest entities
for the three months ended March 31, 2011 and 2010 was $6.1 million and $492.7 million, respectively. Included within loss on variable interest entities are income statement amounts relating to VIEs consolidated under the applicable
consolidation accounting standards, including gains or losses attributable to consolidating or deconsolidating VIEs subsequent to the adoption of new consolidation accounting requirements on January 1, 2010. The loss for the three months ended
March 31, 2011 primarily reflects the loss upon deconsolidation of a transaction. The deconsolidation loss reflects the difference between the carrying value of the VIEs net assets in consolidation (at fair value) and that of the related
insurance policy net assets following deconsolidation.

Results for the first three months of 2010 were affected by the
deconsolidation of many VIEs in March 2010. With the implementation of the new consolidation standard (ASU 2009-17), Ambac consolidated significantly more VIEs beginning January 1, 2010 (89 VIEs). Further, as a result of the Rehabilitation of
the Segregated Account of Ambac Assurance, effective March 24, 2010 Ambac no longer had the unilateral power to direct the activities of certain previously consolidated VIEs that most significantly impact the VIEs economic performance.
Accordingly, Ambac deconsolidated 49 VIEs, mostly RMBS transactions on March 24, 2010. The net loss related to these deconsolidated VIEs for the three months ended March 31, 2010 was $495.1 million. The loss upon deconsolidation primarily
arises from re-establishment of the carrying value of insurance loss reserves and other insurance accounts which have an aggregate net liability balance at March 31, 2010 greater than the aggregate net liabilities of the VIEs which were carried
at fair value. Refer to Note 4 of the Unaudited Consolidated Financial Statements included in Part 1, Item 1 of this Form 10-Q for further information on the accounting for VIEs.

Losses and Loss Expenses. Losses and loss expenses are based upon estimates of the aggregate losses inherent in the
non-derivative financial guarantee portfolio for insurance policies issued to beneficiaries, including VIEs, for which we do not consolidate the VIE as of the reporting date. Loss and loss expenses for the three months ended March 31, 2011 and
2010 were $919.6 million and $89.2 million, respectively. Losses for the three months ended March 31, 2011 were driven by higher estimated losses in the first-lien RMBS portfolio, offset by a reduction in estimated losses for the second lien
RMBS portfolio, as well as higher expected losses for certain structured insurance, student loan, and transportation credits.

Prior to January 1, 2011, we utilized an internal roll-rate model to project losses for our second- lien transactions and a
stochastic model to project losses for our first-lien transactions. Effective January 1, 2011, we are also using a recently licensed regression model to develop additional estimates of projected losses for both our second and
first-lien transactions. Please refer to the Critical Accounting Estimates section of this Managements Discussion and Analysis and to Note 6 of the Unaudited Consolidated Financial Statements, located in Part 1, Item 1 of this
Form 10-Q for further information on loss reserves.



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The following table summarizes the changes in the total net loss reserves for the three
months ended March 31, 2011 and the year ended December 31, 2010:



|                                                                                   |  |                                  |         |   |                             |   |         |  
|---------------------------------------------------------------------------------- |  | -------------------------------- | ------- | - | --------------------------- | - | ------- | -
|($ in millions)                                                                    |  | Three MonthsEnded March 31, 2011 |         |   | YearEnded December 31, 2010 |  
|Beginning balance of loss reserves, net of Subrogation recoverable and reinsurance |  | $                                | 4,424.5 |   |                             | $ | 3,777.3 |  
|                                                                                   |  |                                  |         |   |                             |   |         |  
|Impact of adopting ASU 20009-17                                                    |  |                                  |        |   |                             |   | (503.8  | )
|                                                                                   |  |                                  |         |   |                             |   |         |  
|Beginning balance of net loss reserves                                             |  | $                                | 4,424.5 |   |                             | $ | 3,273.5 |  
|Provision for losses and loss expenses                                             |  |                                  | 919.6   |   |                             |   | 719.4   |  
|Losses paid (recovered)                                                            |  |                                  | (23.0   | ) |                             |   | (368.1  | )
|Recoveries of losses paid from reinsurers                                          |  |                                  | 6.2     |   |                             |   | 14.6    |  
|Other recoveries, net of reinsurance                                               |  |                                  | 23.7    |   |                             |   | 107.9   |  
|Other adjustments (including foreign exchange)                                     |  |                                  | 7.9     |   |                             |   | 0.5     |  
|Deconsolidation of certain VIEs(1)                                                 |  |                                  |        |   |                             |   | 676.7   |  
|                                                                                   |  |                                  |         |   |                             |   |         |  
|Ending balance of net loss reserves                                                |  | $                                | 5,358.9 |   |                             | $ | 4,424.5 |  
|                                                                                   |  |                                  |         |   |                             |   |         |  



|(1) | Relates to VIEs where Ambac no longer has the unilateral power to direct the activities of the VIEs and, accordingly, Ambac deconsolidated the affected VIEs. Included
here are VIEs that have insurance policies that were allocated to the Segregated Account.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The losses and loss
expense reserves as of March 31, 2011 and December 31, 2010 are net of estimated recoveries under representation and warranty breaches for certain RMBS transactions in the amount of $2,472.1 million and $2,391.3 million, respectively.
Please refer to the Critical Accounting Estimates section of this Managements Discussion and Analysis and to Note 6 of the Unaudited Consolidated Financial Statements in Part 1, Item 1 for further background information on the
change in estimated recoveries.

The following tables provide details of net claims presented, net of recoveries received for
the three months ended March 31, 2011 and 2010:



|                                    |  |                                      |       |  |                                   |   |       | 
|----------------------------------- |  | ------------------------------------ | ----- |  | --------------------------------- | - | ----- | 
|($ in millions)                     |  | Three MonthsEnded 
March 31, 2011(1) |       |  | Three MonthsEnded March 
31, 2010 |  
|Net losses presented / (recovered): |  |                                      |       |  |                                   |   |       | 
|Public Finance                      |  | $                                    | 5.3   |  |                                   | $ | 3.5   | 
|Structured Finance                  |  |                                      | 345.1 |  |                                   |   | 310.5 | 
|International Finance               |  |                                      |      |  |                                   |   | 24.4  | 
|                                    |  |                                      |       |  |                                   |   |       | 
|Total                               |  | $                                    | 350.4 |  |                                   | $ | 338.4 | 
|                                    |  |                                      |       |  |                                   |   |       | 

As a result of the claim moratorium on the Segregated Account of Ambac Assurance by the Rehabilitator on
March 24, 2010, $357.3 million and $130.1 million of claims were presented and not paid in the three months ended March 31, 2011 and 2010, respectively.



|(1) | Includes cash commutation payments of $11 million plus $0.7 million of fair value of surplus notes issued by the Segregated Account of Ambac Assurance.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------

At March 31, 2011, expected future claims to be presented (gross of reinsurance and net of expected
recoveries) on credits that have already defaulted totaled $2,587.8 million. Included therein are amounts of $1,119.3 million, ($99.6) million, ($1,130.6) million, $317.9 million and $240.6 million for 2011, 2012, 2013, 2014, and 2015, respectively.
These amounts are net of the previously mentioned representation and warranty breach recoveries totaling $2,592.3 million ($864.5 million and $1,727.8 million in 2012 and 2013, respectively).



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Underwriting and Operating Expenses. Underwriting and operating expenses
for the three months ended March 31, 2011 and 2010 were $42.4 million and $50.5 million, respectively, a decrease of 16%. The decrease in underwriting and operating expenses was primarily due to lower compensation costs, lower consulting and
legal costs, partially offset by higher premium tax expenses. Underwriting and operating expenses consist of gross underwriting and operating expenses, plus the amortization of previously deferred expenses and net reinsurance commissions received.

Interest Expense. Interest of $28.1 million and $0 for the three months ended March 31, 2011 and 2010,
respectively, relates to accrued interest on surplus notes issued by Ambac Assurance and the Segregated Account of Ambac Assurance.

Financial Services:

Through its Financial Services subsidiaries, Ambac historically provided financial and investment products including investment
agreements, funding conduits and derivative products. Since 2008, all Financial Services portfolios have been in runoff. The portfolios of the Financial Services segment during 2010 and the first quarter of 2011 included interest rate and currency
swaps and investment agreements, including the associated invested asset portfolio. While the derivative products business generally seeks to remain neutral to interest rate and currency fluctuations, the portfolio could experience gains or losses
related to certain aspects of portfolio positioning. The derivative products portfolio has been positioned to benefit from rising interest rates in order to mitigate exposure to floating rate obligations in the Financial Guarantee segment.

Revenues. The following table provides a breakdown of Financial Services revenues for the three months ended
March 31, 2011 and 2010:



|                                                                      |  |                              |      |  |      |   |       |  
|--------------------------------------------------------------------- |  | ---------------------------- | ---- |  | ---- | - | ----- | -
|                                                                      |  | Three Months EndedMarch 
31, |     
|($ in millions)                                                       |  | 2011                         |      |  | 2010 |  
|Investment income                                                     |  | $                            | 4.7  |  |      | $ | 9.2   |  
|Derivative products                                                   |  |                              | 21.0 |  |      |   | (58.2 | )
|Net realized investment (losses) gains                                |  |                              | 2.5  |  |      |   | 1.4   |  
|Net mark-to-market gains (losses) on non-trading derivative contracts |  |                              |     |  |      |   | (2.7  | )
|                                                                      |  |                              |      |  |      |   |       |  
|Total Financial Services revenue                                      |  | $                            | 28.2 |  |      | $ | (50.3 | )
|                                                                      |  |                              |      |  |      |   |       |  

Investment Income. The decrease in investment income for the three months ended March 31,
2011 was driven primarily by a smaller portfolio of investments in the investment agreement business. The portfolio decreased significantly, primarily as a result of sales of securities to fund repayment of investment agreements as Ambacs
investment agreement obligations were reduced from $1.2 billion at March 31, 2010 to $0.7 billion at March 31, 2011.

Derivative Products. The income in derivative product revenues for the three months ended March 31, 2011 compared to
the loss for the three months ended March 31, 2010 resulted primarily from mark-to-market gains and losses caused by changes in long-term interest rates during the respective periods. The derivative products portfolio is positioned to
benefit from rising rates as an economic hedge against interest rate exposure in the financial guarantee portfolio. This additional interest rate sensitivity contributed gains of $23.5 million for the three months ended March 31, 2011 compared
to losses of $8.2 million for the three months ended March 31, 2010. The loss in Derivative product revenues for the three months ended March 31, 2010 also included losses of $40.7 million related to swap terminations. Termination fees
generally reflect the counterparties cost to replace Ambac on their swaps. These fees



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are realized upon the swap counterparties exercise of termination rights allowed by Ambac Assurances rating downgrades or upon negotiated settlements. The fair value of derivatives
remaining in the portfolio include a provision for the estimated value of these termination rights. Many derivative counterparties retain the right to terminate contracts. The value of future terminations cannot be determined with certainty until
such terminations occur. Accordingly, further termination losses may occur in the future.

Net Realized Investment
Gains.The following table details amounts included in net realized investment gains for the three months ended March 31, 2011 and 2010:



|                                       |  |                              |     |  |      |   |     | 
|-------------------------------------- |  | ---------------------------- | --- |  | ---- | - | --- | 
|                                       |  | Three Months EndedMarch 
31, |    
|(Dollars in Millions)                  |  | 2011                         |     |  | 2010 |  
|Net gains on securities sold or called |  | $                            | 2.5 |  |      | $ | 1.4 | 
|                                       |  |                              |     |  |      |   |     | 
|Total net realized investment gains    |  | $                            | 2.5 |  |      | $ | 1.4 | 
|                                       |  |                              |     |  |      |   |     | 

Expenses. Expenses for the three months ended March 31, 2011 and 2010 were $4.8 million
and $9.1 million, respectively, down 47%. These declines stemmed primarily from reductions in interest expenses on outstanding investment agreements as the portfolio declined to $0.7 billion from $1.2 billion at March 31, 2011 and 2010,
respectively.

Corporate and Other:

Other Income. Other income for the three months ended March 31, 2011 and 2010 was $0.1 million and $0.3 million, respectively. Included with other income are (i) investment income
from corporate investments, and (ii) RangeMark Financial Services, Inc. (RangeMark) investment advisory, consulting and research services (prior to the sale in July 2010).

Interest Expense. Interest expense for the three months ended March 31, 2011 and 2010 was $0 and $30.2 million,
respectively. Interest was no longer accrued after Ambac filed for bankruptcy on November 8, 2010. If Ambac had continued to accrue interest on its debt obligations, contractual interest expense would have been $28.6 million for the three month
ended March 31, 2011, and for the three months ended March 31, 2010.

Corporate Expense. Corporate
expense for the three months ended March 31, 2011 and 2010 was $0.5 million and $11.9 million, respectively. The decrease is due to (i) Rangemark expenses of $6.7 million in the first quarter of 2010, compared to none in 2011, and
(ii) lower legal and consulting costs relating to Ambac. In 2011, such professional fees are reflected in reorganization items.

Reorganization Items. Reorganization items are primarily expenses directly attributed to our Chapter 11 reorganization process. Reorganization items reported in 2011 include professional
advisory fees (approximately $10 million) and other bankruptcy-related costs. On March 1, 2011, Ambac, Ambac Assurance, the Segregated Account of Ambac Assurance and One State Street, LLC (OSS) entered into a settlement agreement to
terminate the Companys office lease with OSS and agree to settle all claims among the parties. The Settlement Agreement provides that OSS will have an allowed general unsecured claim in Ambacs bankruptcy case for the amount that the
Company would owe OSS under the U. S. Bankruptcy Code upon rejection of the existing lease, which is currently estimated at $14.3 million. The Ambac Payment will be made by the Company in the same form as payment is made to the Companys other
creditors.



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Provision for Income Taxes. The income tax expense of $2.4 million for
the three months ended March 31, 2011 relates predominantly to pre-tax profits in Ambac UKs Italian branch, which can not be offset by losses in other jurisdictions.

Ambac Assurance Statutory Basis Results.Ambac Assurances statutory financial statements are prepared on the basis of
accounting practices prescribed or permitted by the OCI (SAP). OCI recognizes only statutory accounting practices prescribed or permitted by the State of Wisconsin for determining and reporting the financial condition and results of
operations of an insurance company for determining its solvency under Wisconsin Insurance Law. The National Association of Insurance Commissioners (NAIC) Accounting Practices and Procedures manual (NAIC SAP) has been adopted
as a component of prescribed practices by the State of Wisconsin.

On March 24, 2010, Ambac Assurance acquiesced to the
request of OCI to establish a Segregated Account. Under Wisconsin insurance law, the Segregated Account is a separate insurer from Ambac Assurance and accordingly is subject to all of the filing and statutory reporting requirements of Wisconsin
domiciled insurers. The purpose of the Segregated Account is to segregate certain segments of Ambac Assurances liabilities. The total assets, total liabilities, and total surplus of the Segregated Account are reported as discrete components of
Ambac Assurances assets, liabilities, and surplus reported in Ambac Assurances statutory basis financial statements. Accordingly, Ambac Assurances statutory financial statements include the results of Ambac Assurances general
account, the Segregated Account as well as Ambac Assurances equity investment in its subsidiaries.

Ambac Assurance
reported statutory capital and surplus of $822.2 million and $1,026.9 million as of March 31, 2011 and December 31, 2010, respectively. Ambac Assurance, combined with Everspan, reported contingency reserves of $536.6 million and
$512.6 million as of March 31, 2011 and December 31, 2010, respectively. Ambac Assurance reported a statutory net loss of $169.1 million for the three-months ended March 31, 2011. The primary drivers of the statutory net loss were
statutory loss and loss expenses related primarily to Ambac Assurances RMBS financial guarantee portfolio for both initial defaults and continued deterioration in previously defaulted credits.

Statutory surplus is sensitive to: (i) further credit deterioration on the defaulted credits in the insured portfolio,
(ii) deterioration in CDS exposures that give rise to further impairments, (iii) first time payment defaults of insured obligations, which increases statutory loss reserves, (iv) commutations of insurance policies or credit derivative
contracts at amounts that differ from the amount of liabilities recorded, (v) reinsurance contract terminations at amounts that differ from net assets recorded, (vi) reductions in the fair value of previously impaired investments or
additional downgrades of the ratings on investment securities to below investment grade by the independent rating agencies, (vii) settlements of representation and warranty breach claims at amounts that differ from amounts recorded, including
failures to collect such amounts, (viii) issuance of surplus notes, (ix) intercompany loan impairments could change based on changes to interest rates and/or early terminations of investment agreements at amounts that differ from the
amount of liabilities recorded, and (x) defaults by reinsurers.

The significant differences from U.S. GAAP are that
under SAP:



| |  |  | Loss reserves are only established for losses on guaranteed obligations that have defaulted in an amount that is sufficient to cover the present value
of the anticipated defaulted debt service payments over the expected period of default, less estimated recoveries under subrogation rights (currently discounted at 5.10% as prescribed by OCI). Under U.S. GAAP, in addition to the establishment of
loss reserves for defaulted obligations, loss reserves are established (net of U.S GAAP basis unearned premium reserves) for obligations that have experienced credit deterioration, but have not yet defaulted using a risk-free discount rate,
currently at 3.02%.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Mandatory contingency reserves are required based upon the type of obligation insured, whereas U.S. GAAP does not require such a reserve. Releases of
the contingency reserves are generally subject to OCI approval and relate to a determination that the held reserves are deemed excessive.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Investment grade fixed income investments are stated at amortized cost and below investment grade fixed income investments are reported at the lower of
amortized cost or fair value. Under U.S. GAAP, all bonds are reported at fair value.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Wholly owned subsidiaries are not consolidated; rather, the equity basis of accounting is utilized and the carrying values of these investments are
subject to an admissibility test. When Ambac Assurances share of the subsidiaries losses exceeds the related carrying amounts of the wholly owned subsidiary, Ambac Assurance discontinues applying the equity method and the investment is
reduced to zero. For those subsidiaries that have insufficient claims paying resources and its obligations are guaranteed by Ambac Assurance, Ambac Assurance records an estimated impairment for probable losses which are in excess of the
subsidiaries claims paying resources. Such impairments were recorded for our credit derivative subsidiary for periods prior to June 2010. Under U.S. GAAP, credit derivatives are recorded at fair value, which is impacted by market valuations of
the exposures and includes the effect of Ambac Assurances own credit in the measurement. This mark-to-market valuation often differs significantly from the statutory measure of impairment discussed above.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Variable interest entities are not required to be assessed for consolidation. Under U.S. GAAP, a reporting entity that has both the following
characteristics is required to consolidate the VIE: a) the power to direct the activities of the VIE that most significantly impact the VIEs economic performance; and b) the obligation to absorb losses of the VIE that could potentially be
significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. With regard to issuance of a financial guarantee insurance policy, Ambac generally has the obligation to absorb losses of VIEs
that could potentially be significant to the VIE as the result of its guarantee of insured obligations issued by VIEs.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | As a result of prescribed practices by OCI, surplus notes are included in Surplus at an amount equal to par regardless of the amounts received in
consideration for issuance of the notes. Under U.S. GAAP, surplus notes are included in long-term debt obligations recorded at their estimated fair value and accrete up to face value via the effective interest method. The OCI has extended the
preceding prescribed practice related to surplus notes to the evaluation of other-than-temporary impairments for Ambac Assurance guaranteed securities held in the investment portfolio. Under both U.S. GAAP and the NAIC SAP, the present value of cash
flows expected to be collected will be equal the sum of the present value of (i) the bonds intrinsic cash flows and (ii) the estimated fair value of Ambac claim payments. Under the Segregated Account Rehabilitation Plan, future claim
payments made by Ambac Assurance on these securities would be satisfied 25% in cash and 75% in surplus notes. The Wisconsin Insurance Commissioner has directed Ambac Assurance to utilize par value rather than fair value of these surplus notes in
this computation.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Upfront premiums written are earned on a basis proportionate to the remaining scheduled debt service to the original total principal and interest
insured. Installment premiums are reflected in income pro rata over the period covered by the premium payment. Under U.S. GAAP, premium revenues for both upfront and installment premiums are earned over the life of the financial guarantee contract
in proportion to the insured principal amount outstanding at each reporting date.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Costs related to the acquisition of new business are expensed as incurred, whereas under U.S. GAAP, the related costs are expensed over the periods in
which the related premiums are earned; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Deferred tax assets are reduced by a statutory valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be
realized; any remaining net deferred tax asset is then subject to an admissibility test; whereas US GAAP only requires a valuation allowance if it is more likely than not that the deferred tax asset will not be realized.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Liquidity and Capital Resources

Ambac Financial Group, Inc. Liquidity. The matters described herein, to the extent that they relate to future events or
expectations, may be significantly affected by Ambacs Chapter 11 Bankruptcy filing. We believe the consummation of a successful restructuring under Chapter 11 of the Bankruptcy Code is critical to our continued viability and long term
liquidity. As with any judicial proceeding, there are risks of unavoidable delay with a Chapter 11 proceeding and there are risks of objections from certain stakeholders, including objections from the holders of unsecured debt that vote to reject a
plan of reorganization. Any material delay in the confirmation of a plan, or the threat of rejection of the plan by the Bankruptcy Court, would add expense as Ambac will be required to incur substantial costs for professional fees and other
expenses associated with the administration of the Chapter 11 proceedings. A prolonged continuation of the Chapter 11 proceedings may also require us to seek financing. If we require financing during the Chapter 11 proceedings and we are unable to
obtain the financing on favorable terms or at all, our chances of successfully reorganizing our businesses may be seriously jeopardized, and as a result, our assets and securities could become further devalued or worthless. While management believes
that Ambac will have sufficient liquidity to satisfy its needs until it emerges from the bankruptcy proceeding, no guarantee can be given that it will be able to pay all such expenses. If its liquidity runs out prior to emergence from bankruptcy, a
liquidation of Ambac pursuant to Chapter 7 of the Bankruptcy Code will occur.

Ambacs liquidity and solvency is largely
dependent upon: (i) Ambac Assurances ability to pay dividends; (ii) cash on hand; (iii) the level of costs associated with the reorganization; and (iv) the value of Ambac Assurance. It is highly unlikely that Ambac
Assurance will be able to make dividend payments to Ambac for the foreseeable future. Ambacs principal uses of liquidity during 2011 are for primarily the payment of fees to bankruptcy professionals, which approximated $5.5 million during
the first quarter of 2011, and operating expenses. Operating expenses, which include legal and other professional fees, director fees, and compensation costs, etc., equaled $0.5 million for the first quarter of 2011. Ambacs liquidity
requirements are being funded by cash on hand and any contingencies (e.g., an unfavorable outcome in the outstanding class action lawsuits) could cause material additional liquidity strains.

Ambac Assurance Liquidity. Ambac Assurances liquidity on a long-term basis is dependent on receipt of installment
premiums on existing financial guarantees, principal and interest cash flows from investments, and the amount of required loss and commutation payments on both insurance and credit derivative contracts. The principal sources of Ambac
Assurances liquidity are gross installment premiums on insurance and credit default swap contracts, investment coupon receipts, scheduled investment maturities, sales of investment securities, repayment of affiliate loans, claim recoveries
from reinsurers and RMBS subrogation recoveries. The principal uses of Ambac Assurances liquidity are the payment of operating expenses, loss and commutation payments on both insurance and credit derivative contracts, reinsurance premiums,
surplus notes interest payments, and additional loans to affiliates. As a result of the Segregated Account Rehabilitation Plan, claim payments on policies allocated to the



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Segregated Account will not be paid until the Segregated Account Rehabilitation Plan is declared effective.

Our ability to recover the RMBS subrogation recoveries is subject to significant uncertainty, including risks inherent in litigation, collectability of such amounts from counterparties (and/or their
respective parents and affiliates), timing of receipt of any such recoveries, regulatory intervention which could impede our ability to take actions required to realize such recoveries and uncertainty inherent in the assumptions used in estimating
such recoveries. Our current estimate considers that we will receive subrogation recoveries of $864.5 million and $1,727.8 million in 2012 and 2013, respectively. The amount of these subrogation recoveries is significant and if were unable to
recover any amounts our future available liquidity to pay claims would be reduced.

A subsidiary of Ambac Assurance 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 is required to repay all amounts drawn under the liquidity facility. At March 31, 2011 and December 31, 2010 $8.8 million
was drawn on this liquidity facility, respectively. At March 31, 2011 the undrawn balance of the liquidity facility was $351.2 million.

Ambac and its affiliates participate in leveraged lease transactions with municipalities, utilities and quasi-governmental agencies (collectively lessees), either directly or through various
affiliated companies. Assets underlying these leveraged lease transactions involve equipment and facilities used by the lessees to provide basic public services such as mass transit and utilities. Ambac and its affiliates may provided one or more of
the following financial products in these transactions: (i) credit default swaps, (ii) guarantees of the lessees termination payment obligations, (iii) loans, and (iv) investment agreements and payment agreements, both of
which serve as collateral to economically defease portions of the lessees payment obligations in respect of termination payments.

These transactions expose Ambac to the following risks:



| |  |  | Collateral posting requirements due to Ambac Assurance rating downgrade triggering events under certain agreements.
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | As a consequence of Ambac Assurances ratings downgrades, in some of the transactions the lessees are currently obligated to replace Ambac
Assurance as credit enhancer, subject to waivers granted by the lessors. Failure of the waivers to be renewed followed by a failure to replace Ambac could result in a lease event of default and the requirement for a lessee to make a termination
payment upon a demand by the lessor. Portions of any termination payments may be funded from the liquidation of the related defeasance collateral (i.e. payment agreements, investment agreements and/or other securities). To the extent a lessee fails
to make a required termination payment, Ambac may be required to make a surety bond payment, or a swap settlement, under its guarantee policy or credit default swap, as applicable. The payment required under the Ambac credit enhancement will be
based on the difference between the termination amount and the value derived from the defeasance collateral. Following a payment, Ambac would then be entitled to settle a credit default swap with the lessee or exercise its reimbursement rights
against the lessee. In such circumstances Ambac, through subrogation or ownership in the leased assets, would have the right, along with other remedies, to liquidate the leased assets.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Ambac Assurances aggregate financial enhancement exposure related to leveraged
lease transactions that contain Ambac Assurance rating downgrade triggering events at March 31, 2011 was $524 million. Ambac Assurances exposure to these termination or swap settlement payments, net of defeasance collateral, was $384
million at March 31, 2011.



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As a result of Ambac Assurances credit rating downgrades, seven lessees in these
transactions may be required to replace Ambac Assurance as financial enhancement provider if waivers granted by the lessors are not renewed. There are four additional lessees that could be required to replace Ambac Assurance as financial
enhancement provider in certain circumstances. In one case, Ambac Assurances replacement could be required upon the withdrawal of the guarantee provided by the lessees municipal owner. In another case, Ambac Assurances
replacement could be required upon the rating downgrade of the second guarantor below a threshold level. In the other two cases, Ambac Assurances replacement could be required if the lessee withdrew additional collateral it has pledged to the
lessor.

Ambac Assurances aggregate financial guarantee exposure to termination payments related to leveraged lease
transactions that contain Ambac Assurance rating downgrade triggering events at March 31, 2011 was $842 million. Ambac Assurances financial guarantee exposure to these termination payments, net of defeasance collateral was $702
million, at March 31, 2011.

Financial Services Liquidity. The principal uses of liquidity by Financial
Services subsidiaries are payments on investment and payment agreement obligations; payments on intercompany loans; payments under derivative contracts (primarily interest rate swaps, currency swaps and US Treasury futures); collateral posting; and
operating expenses. Management believes that its Financial Services short and long-term liquidity needs can be funded from net investment income; the maturity of invested assets; sales of invested assets; intercompany loans from Ambac
Assurance; and receipts from derivative contracts.

Investment agreements subject Ambac to liquidity risk associated with
unanticipated withdrawals of principal as allowed by the terms of certain contingent withdrawal investment agreements, including those issued to entities that provide credit protection with respect to collateralized debt obligations. These entities
issue credit linked-notes, invest a portion of the proceeds in the contingent withdrawal investment agreements and typically sell credit protection by issuing a credit default swap referencing specified asset-backed or corporate securities. Upon a
credit event of one of the underlying reference obligations, the issuer may need to draw on the investment agreement to pay under the terms of the credit default swap. Accordingly, these investment agreements may be drawn prior to our original
expectations, resulting in an unanticipated withdrawal. As of March 31, 2011, $487.0 million of contingent withdrawal investment agreements issued to CDOs remained outstanding, of which $7.0 million were related to CDOs with primarily RMBS
underlying collateral. To manage the liquidity risk of unscheduled withdrawals, Ambac utilizes several tools, including regular surveillance of the related transactions. This surveillance process is customized for each investment agreement
transaction and includes a review of past activity, recently issued trustee reports, reference name performance characteristics and third party tools to analyze early withdrawal risk.

Credit Ratings and Collateral. The significant rating downgrades of Ambac Assurance by Moodys and S&P resulted in
the triggering of required cure provisions in nearly all of the investment agreements issued. Most investment agreements contain multiple possible remedies, including collateral posting; a termination of the investment agreement contract, both of
which demand significant liquidity; or the designation of a replacement guarantor. In most cases Ambac had the option to select the remedy and, therefore, could either post collateral or otherwise enhance its credit, prior to an actual draw on the
investment agreement. In many cases, Ambac chose to terminate investment agreements, particularly when it was able to do so at levels that resulted in meaningful discounts to book value. In addition, Ambac has posted collateral of $746.0 million in
connection with its outstanding investment agreements, including accrued interest, at March 31, 2011.

Ambac Financial
Services (AFS) provided interest rate and currency swaps for states, municipalities, asset-backed issuers and other entities in connection with their financings. AFS hedges



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most of the related interest rate and currency risks of these instruments with standardized derivative contracts, which include collateral support agreements. Under these agreements, AFS is
required to post collateral to a swap dealer to cover unrealized losses. In addition, AFS is often required to post collateral in excess of the amounts needed to cover unrealized losses, often referred to as an independent amount. Additionally, AFS
hedges part of its interest rate risk with financial futures contracts which require it to post margin with its futures clearing merchant. All AFS derivative contracts possessing rating-based downgrade triggers that could result in collateral
posting or a termination have been triggered. If additional terminations were to occur, it would generally result in a return of collateral to AFS in the form of cash, U.S. Treasury or U.S. government agency obligations with market values
approximately equal to or in excess of market values of the swaps. In most cases, AFS will look to re-establish the hedge positions that are terminated early. This may result in additional collateral posting obligations or the use of futures
contracts or other derivative instruments which could require AFS to post margin amounts. The amount of additional collateral required or margin posted on futures contracts will depend on several variables including the degree to which
counterparties exercise their termination rights and the ability to replace these contracts with existing counterparties under existing documents and credit support arrangements. All contracts that require collateral posting are currently
collateralized. Collateral and margin posted by AFS totaled a net amount of $111.1 million, including independent amounts, under these contracts at March 31, 2011.

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

While meaningful progress has been made in unwinding the Financial Services businesses, multiple sources of risk continue to exist. These
include further deterioration in investment security market values, additional unexpected draws on outstanding investment agreements, the inability to unwind derivative hedge positions needed to settle investment agreement terminations, the
settlement of potential swap terminations, and the inability to replace or establish new hedge positions.

Balance
Sheet. In 2011, total assets decreased from $29.0 billion to $27.4 billion, driven by the deconsolidation of variable interest entities, partially offset by (i) installment premium receipts on insurance and credit derivative
transactions; and (ii) coupon payments on investment securities. As of March 31, 2011, stockholders deficit was $2.16 billion, as compared to $1.35 billion deficit at December 31, 2010. This change was primarily caused by the
net loss for the period, partially offset by improvements in fair value of investment securities during the period.

Investment Portfolio.Ambac Assurances investment objectives for the Financial Guarantee portfolio are to achieve the
highest yield on a diversified portfolio of fixed income investments while protecting claims-paying resources and satisfying liquidity needs. 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 are to (i) maintain sufficient liquidity to satisfy scheduled and unscheduled investment agreement
maturities and withdrawals, and (ii) protect Ambac Assurances claims-paying resources while maximizing investment earnings relative to the cost of liabilities. The investment portfolio is subject to internal investment guidelines. Such
guidelines set forth minimum credit rating requirements and credit risk concentration limits.



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The amortized cost and estimated fair value of investments in fixed income securities
and short-term investments, excluding VIE fixed income securities, at March 31, 2011 and December 31, 2010 were as follows:



|                                               |  |                |         |  |                     |   |         |               |  |   |                     |  |  |   |         | 
|---------------------------------------------- |  | -------------- | ------- |  | ------------------- | - | ------- | ------------- |  | - | ------------------- |  |  | - | ------- | 
|                                               |  | March 31, 2011 |         |  | December 31, 2010   |  
|($ in millions)                                |  | AmortizedCost  |         |  | EstimatedFair Value |   |         | AmortizedCost |  |   | EstimatedFair Value | 
|Fixed income securities:                       |  |                |         |  |                     |   |         |               |  |   |                     |  |  |   |         | 
|Municipal obligations                          |  | $              | 2,185.7 |  |                     | $ | 2,226.9 |               |  | $ | 2,161.6             |  |  | $ | 2,204.1 | 
|Corporate obligations                          |  |                | 943.2   |  |                     |   | 973.3   |               |  |   | 897.7               |  |  |   | 917.9   | 
|Foreign obligations                            |  |                | 93.1    |  |                     |   | 97.4    |               |  |   | 113.1               |  |  |   | 118.4   | 
|U.S. government obligations                    |  |                | 119.2   |  |                     |   | 121.9   |               |  |   | 153.6               |  |  |   | 156.9   | 
|U.S. agency obligations                        |  |                | 81.7    |  |                     |   | 87.6    |               |  |   | 81.7                |  |  |   | 88.3    | 
|Residential mortgage-backed securities         |  |                | 1,236.4 |  |                     |   | 1,563.1 |               |  |   | 1,239.1             |  |  |   | 1,498.7 | 
|Collateralized debt obligations                |  |                | 38.2    |  |                     |   | 30.6    |               |  |   | 41.0                |  |  |   | 32.3    | 
|Other asset-backed securities                  |  |                | 998.0   |  |                     |   | 982.7   |               |  |   | 1,019.9             |  |  |   | 1,004.3 | 
|Short-term                                     |  |                | 792.4   |  |                     |   | 792.4   |               |  |   | 708.8               |  |  |   | 708.8   | 
|Other                                          |  |                | 0.1     |  |                     |   | 0.1     |               |  |   | 0.1                 |  |  |   | 0.1     | 
|                                               |  |                |         |  |                     |   |         |               |  |   |                     |  |  |   |         | 
|                                               |  |                | 6,488.0 |  |                     |   | 6,876.0 |               |  |   | 6,416.6             |  |  |   | 6,729.8 | 
|                                               |  |                |         |  |                     |   |         |               |  |   |                     |  |  |   |         | 
|Fixed income securities pledged as collateral: |  |                |         |  |                     |   |         |               |  |   |                     |  |  |   |         | 
|U.S. government obligations                    |  |                | 97.1    |  |                     |   | 98.8    |               |  |   | 113.2               |  |  |   | 115.4   | 
|Residential mortgage-backed securities         |  |                | 7.8     |  |                     |   | 8.3     |               |  |   | 7.7                 |  |  |   | 8.1     | 
|                                               |  |                |         |  |                     |   |         |               |  |   |                     |  |  |   |         | 
|                                               |  |                | 104.9   |  |                     |   | 107.1   |               |  |   | 120.9               |  |  |   | 123.5   | 
|                                               |  |                |         |  |                     |   |         |               |  |   |                     |  |  |   |         | 
|Total                                          |  | $              | 6,592.9 |  |                     | $ | 6,983.1 |               |  | $ | 6,537.5             |  |  | $ | 6,853.3 | 
|                                               |  |                |         |  |                     |   |         |               |  |   |                     |  |  |   |         | 



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The following table represents the fair value of mortgage and asset-backed securities,
excluding VIE mortgage and asset-backed securities, at March 31, 2011 and December 31, 2010 by classification:



|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|---------------------------------------------- |  | ------------------ | ------- |  | ----------------- | - | ----- | --------- |  | - | ----- |  |  | - | ------- | 
|($ in millions)                                |  | FinancialGuarantee |         |  | FinancialServices |   |       | Corporate |  |   | Total | 
|March 31, 2011:                                |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Residential mortgage-backed securities:        |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|RMBS  First-lien  Alt-A                      |  | $                  | 511.3   |  |                   |   | 274.4 |           |  | $ |      |  |  | $ | 785.7   | 
|RMBS  Second Lien                             |  |                    | 354.9   |  |                   |   |      |           |  |   |      |  |  |   | 354.9   | 
|U.S. Government Sponsored Enterprise Mortgages |  |                    | 112.5   |  |                   |   | 175.6 |           |  |   |      |  |  |   | 288.1   | 
|RMBS  First Lien  Sub Prime                  |  |                    | 105.6   |  |                   |   |      |           |  |   |      |  |  |   | 105.6   | 
|Government National Mortgage Association       |  |                    | 3.6     |  |                   |   | 27.8  |           |  |   |      |  |  |   | 31.4    | 
|RMBS  First Lien  Prime                      |  |                    | 5.7     |  |                   |   |      |           |  |   |      |  |  |   | 5.7     | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Total residential mortgage-backed securities   |  |                    | 1,093.6 |  |                   |   | 477.8 |           |  |   |      |  |  |   | 1,571.4 | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Other asset-backed securities                  |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Military Housing                               |  |                    | 363.9   |  |                   |   |      |           |  |   |      |  |  |   | 363.9   | 
|Credit Cards                                   |  |                    |        |  |                   |   | 207.7 |           |  |   |      |  |  |   | 207.7   | 
|Structured Insurance                           |  |                    | 130.5   |  |                   |   |      |           |  |   |      |  |  |   | 130.5   | 
|Auto                                           |  |                    |        |  |                   |   | 98.2  |           |  |   |      |  |  |   | 98.2    | 
|Student Loans                                  |  |                    | 18.9    |  |                   |   | 28.0  |           |  |   |      |  |  |   | 46.9    | 
|Other                                          |  |                    | 115.1   |  |                   |   | 20.4  |           |  |   |      |  |  |   | 135.5   | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Total other asset-backed securities            |  |                    | 628.4   |  |                   |   | 354.3 |           |  |   |      |  |  |   | 982.7   | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Total                                          |  | $                  | 1,722.0 |  |                   | $ | 832.1 |           |  | $ |      |  |  | $ | 2,554.1 | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|December 31, 2010                              |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Residential mortgage-backed securities:        |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|RMBS  First-lien  Alt-A                      |  | $                  | 502.9   |  |                   | $ | 254.8 |           |  | $ |      |  |  | $ | 757.7   | 
|U.S. Government Sponsored Enterprise Mortgages |  |                    | 121.0   |  |                   |   | 293.2 |           |  |   |      |  |  |   | 414.2   | 
|RMBS  Second Lien                             |  |                    | 219.1   |  |                   |   |      |           |  |   |      |  |  |   | 219.1   | 
|RMBS  First Lien  Sub Prime                  |  |                    | 99.6    |  |                   |   |      |           |  |   |      |  |  |   | 99.6    | 
|Government National Mortgage Association       |  |                    | 3.8     |  |                   |   | 6.5   |           |  |   |      |  |  |   | 10.3    | 
|RMBS  First Lien  Prime                      |  |                    | 5.9     |  |                   |   |      |           |  |   |      |  |  |   | 5.9     | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Total residential mortgage-backed securities   |  |                    | 952.3   |  |                   |   | 554.5 |           |  |   |      |  |  |   | 1,506.8 | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Other asset-backed securities                  |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Military Housing                               |  |                    | 368.6   |  |                   |   |      |           |  |   |      |  |  |   | 368.6   | 
|Credit Cards                                   |  |                    |        |  |                   |   | 256.1 |           |  |   |      |  |  |   | 256.1   | 
|Structured Insurance                           |  |                    | 133.6   |  |                   |   |      |           |  |   |      |  |  |   | 133.6   | 
|Auto                                           |  |                    |        |  |                   |   | 110.8 |           |  |   |      |  |  |   | 110.8   | 
|Student Loans                                  |  |                    | 16.3    |  |                   |   | 33.0  |           |  |   |      |  |  |   | 49.3    | 
|Other                                          |  |                    | 85.9    |  |                   |   |      |           |  |   |      |  |  |   | 85.9    | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Total other asset-backed securities            |  |                    | 604.4   |  |                   |   | 399.9 |           |  |   |      |  |  |   | 1,004.3 | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 
|Total                                          |  | $                  | 1,556.7 |  |                   | $ | 954.4 |           |  | $ |      |  |  | $ | 2,511.1 | 
|                                               |  |                    |         |  |                   |   |       |           |  |   |       |  |  |   |         | 

The weighted average rating of the mortgage and asset-backed securities is BBB- and BBB, as of
March 31, 2011 and December 31, 2010, respectively.



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The following table provides the fair value of non-agency residential mortgage-backed
securities, excluding VIE non-agency residential mortgage-backed securities, by vintage and type at March 31, 2011 and December 31, 2010:



|                  |  |                 |       |  |             |   |       |                 |  |   |                     |  |  |       |       |  |  |   |         | 
|----------------- |  | --------------- | ----- |  | ----------- | - | ----- | --------------- |  | - | ------------------- |  |  | ----- | ----- |  |  | - | ------- | 
|Year of Issue     |  | First-lienAlt-A |       |  | Second-lien |   |       | First-lienPrime |  |   | First-lienSub-Prime |  |  | Total |      
|($ in millions)   |  |                 |       |  |             |   |       |                 |  |   |                     |  |  |       |       |  |  |   |         | 
|March 31, 2011    |  |                 |       |  |             |   |       |                 |  |   |                     |  |  |       |       |  |  |   |         | 
|2003 and prior    |  | $               |      |  |             | $ | 0.9   |                 |  | $ |                    |  |  | $     | 3.1   |  |  | $ | 4.0     | 
|2004              |  |                 | 26.5  |  |             |   | 6.7   |                 |  |   |                    |  |  |       | 1.6   |  |  |   | 34.8    | 
|2005              |  |                 | 205.3 |  |             |   | 57.1  |                 |  |   | 5.7                 |  |  |       | 4.2   |  |  |   | 272.3   | 
|2006              |  |                 | 226.4 |  |             |   | 230.1 |                 |  |   |                    |  |  |       | 82.3  |  |  |   | 538.8   | 
|2007              |  |                 | 327.5 |  |             |   | 60.1  |                 |  |   |                    |  |  |       | 14.4  |  |  |   | 402.0   | 
|                  |  |                 |       |  |             |   |       |                 |  |   |                     |  |  |       |       |  |  |   |         | 
|Total             |  | $               | 785.7 |  |             | $ | 354.9 |                 |  | $ | 5.7                 |  |  | $     | 105.6 |  |  | $ | 1,251.9 | 
|                  |  |                 |       |  |             |   |       |                 |  |   |                     |  |  |       |       |  |  |   |         | 
|December 31, 2010 |  |                 |       |  |             |   |       |                 |  |   |                     |  |  |       |       |  |  |   |         | 
|2003 and prior    |  | $               |      |  |             | $ | 1.0   |                 |  | $ |                    |  |  | $     | 3.2   |  |  | $ | 4.2     | 
|2004              |  |                 | 27.3  |  |             |   | 3.9   |                 |  |   |                    |  |  |       | 1.6   |  |  |   | 32.8    | 
|2005              |  |                 | 209.1 |  |             |   | 50.9  |                 |  |   | 5.9                 |  |  |       | 3.5   |  |  |   | 269.4   | 
|2006              |  |                 | 214.8 |  |             |   | 110.2 |                 |  |   |                    |  |  |       | 77.2  |  |  |   | 402.2   | 
|2007              |  |                 | 306.5 |  |             |   | 53.1  |                 |  |   |                    |  |  |       | 14.1  |  |  |   | 373.7   | 
|                  |  |                 |       |  |             |   |       |                 |  |   |                     |  |  |       |       |  |  |   |         | 
|Total             |  | $               | 757.7 |  |             | $ | 219.1 |                 |  | $ | 5.9                 |  |  | $     | 99.6  |  |  | $ | 1,082.3 | 
|                  |  |                 |       |  |             |   |       |                 |  |   |                     |  |  |       |       |  |  |   |         | 



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The following table summarizes, for all securities in an unrealized loss position as of
March 31, 2011 and December 31, 2010, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position:



|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|---------------------------------------------------------------------------- |  | ------------------ | ------- |  | --------------------- | - | ----- | ------------------ |  | - | --------------------- |  |  | - | ----- | 
|                                                                             |  | March 31, 2011     |         |  | December 31, 2010     |  
|($ in millions)                                                              |  | EstimatedFairValue |         |  | GrossUnrealizedLosses |   |       | EstimatedFairValue |  |   | GrossUnrealizedLosses | 
|Municipal obligations in continuous unrealized loss for:                     |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|0  6 months                                                                 |  | $                  | 296.2   |  |                       | $ | 7.5   |                    |  | $ | 281.8                 |  |  | $ | 7.6   | 
|7  12 months                                                                |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|Greater than 12 months                                                       |  |                    | 35.9    |  |                       |   | 2.4   |                    |  |   | 33.9                  |  |  |   | 4.0   | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|                                                                             |  |                    | 332.1   |  |                       |   | 9.9   |                    |  |   | 315.7                 |  |  |   | 11.6  | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|Corporate obligations in continuous unrealized loss for:                     |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|0  6 months                                                                 |  |                    | 65.5    |  |                       |   | 1.4   |                    |  |   | 51.8                  |  |  |   | 1.7   | 
|7  12 months                                                                |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|Greater than 12 months                                                       |  |                    | 201.0   |  |                       |   | 13.6  |                    |  |   | 212.4                 |  |  |   | 22.1  | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|                                                                             |  |                    | 266.5   |  |                       |   | 15.0  |                    |  |   | 264.2                 |  |  |   | 23.8  | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|U.S. treasury obligations in continuous unrealized loss for:                 |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|0  6 months                                                                 |  |                    | 5.0     |  |                       |   | 0.1   |                    |  |   | 5.0                   |  |  |   |      | 
|7  12 months                                                                |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|Greater than 12 months                                                       |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|                                                                             |  |                    | 5.0     |  |                       |   | 0.1   |                    |  |   | 5.0                   |  |  |   |      | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|U.S. agency obligations in continuous unrealized loss for:                   |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|0  6 months                                                                 |  |                    | 1.2     |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|7  12 months                                                                |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|Greater than 12 months                                                       |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|                                                                             |  |                    | 1.2     |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|Residential mortgage-backed securities in continuous unrealized loss for:    |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|0  6 months                                                                 |  |                    | 121.1   |  |                       |   | 5.0   |                    |  |   | 22.2                  |  |  |   | 0.5   | 
|7  12 months                                                                |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|Greater than 12 months                                                       |  |                    | 121.1   |  |                       |   | 38.0  |                    |  |   | 127.8                 |  |  |   | 40.2  | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|                                                                             |  |                    | 242.2   |  |                       |   | 43.0  |                    |  |   | 150.0                 |  |  |   | 40.7  | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|Collateralized debt obligation securities in continuous unrealized loss for: |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|0  6 months                                                                 |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|7  12 months                                                                |  |                    |        |  |                       |   |      |                    |  |   |                      |  |  |   |      | 
|Greater than 12 months                                                       |  |                    | 30.0    |  |                       |   | 7.6   |                    |  |   | 30.4                  |  |  |   | 9.1   | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|                                                                             |  |                    | 30.0    |  |                       |   | 7.6   |                    |  |   | 30.4                  |  |  |   | 9.1   | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|Other asset-backed securities in continuous unrealized loss for:             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|0  6 months                                                                 |  |                    | 145.7   |  |                       |   | 2.5   |                    |  |   | 97.3                  |  |  |   | 1.5   | 
|7  12 months                                                                |  |                    | 3.4     |  |                       |   |      |                    |  |   | 4.7                   |  |  |   |      | 
|Greater than 12 months                                                       |  |                    | 306.0   |  |                       |   | 34.7  |                    |  |   | 440.7                 |  |  |   | 42.4  | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|                                                                             |  |                    | 455.1   |  |                       |   | 37.2  |                    |  |   | 542.7                 |  |  |   | 43.9  | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 
|Totals                                                                       |  | $                  | 1,332.1 |  |                       | $ | 112.8 |                    |  | $ | 1,308.0               |  |  | $ | 129.1 | 
|                                                                             |  |                    |         |  |                       |   |       |                    |  |   |                       |  |  |   |       | 

Management has determined that the unrealized losses in fixed income securities at March 31, 2011 are
primarily driven by the uncertainty in the structured finance market, primarily with respect to non-agency residential mortgage backed securities and a general increase in risk and liquidity premiums demanded by fixed income investors. Ambac has
concluded that unrealized losses reflected in the table above are temporary in nature based upon (a) no unexpected principal and interest payment defaults on these securities; (b) analysis of the creditworthiness of the issuer and analysis
of projected defaults on the underlying collateral; and (c) Ambacs ability and current intent to hold these securities until a recovery in fair value or maturity. Of the $1,332.1 million that were in a gross unrealized loss position at
March 31, 2011, below investment grade securities and non-rated securities had a fair value of $207.6 million and



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unrealized loss of $34.5 million, which represented 15.6% of the total fair value, and 30.6% of the unrealized loss as shown in the table above. Of the $1,308.0 million that were in a gross
unrealized loss position at December 31, 2010, below investment grade securities and non-rated securities had a fair value of $110.1 million and an unrealized loss of $31.5 million, which represented 8.4% of the total fair value and 24.4% of
the unrealized loss as shown in the above table.

During the three months ended March 31, 2011 and 2010, there were
other-than-temporary impairment write-downs of $1.7 million and $31.3 million, respectively, in the Financial Guarantee investment portfolios. Other-than-temporary impairment charges to earnings in the three months ended March 31, 2011 were due
to credit losses on securities guaranteed by Ambac Assurance and other asset-backed securities believed to be credit impaired. As a result of the rehabilitation of the Segregated Account, financial guarantee payments on securities guaranteed by
Ambac Assurance which have been placed in the Segregated Account are no longer under the control of Ambac management. Additionally, other-than-temporary impairments for the three months ended March 31, 2010 included charges of $13.3 to
write-down the amortized cost basis of tax-exempt municipal bonds and student loan securities to fair value at their respective impairment dates as a result of managements intent to sell securities in connection with plans to reposition the
investment portfolio and meet general liquidity needs. As of March 31, 2011, management has not asserted an intent to sell any securities from its portfolio. Future changes in our estimated liquidity needs could result in a determination that
Ambac no longer has the ability to hold such securities, which could result in other-than-temporary impairment charges.

The
following table provides the ratings distribution of the fixed income investment portfolio, excluding VIE fixed-income investments, at March 31, 2011 and December 31, 2010:



|                       |  |                    |     |   |                   |  |     |          |  |  |     |  
|---------------------- |  | ------------------ | --- | - | ----------------- |  | --- | -------- |  |  | --- | -
|Rating(1)              |  | FinancialGuarantee |     |   | FinancialServices |  |     | Combined | 
|March 31, 2011:        |  |                    |     |   |                   |  |     |          |  |  |     |  
|AAA                    |  |                    | 30  | % |                   |  | 60  | %        |  |  | 34  | %
|AA                     |  |                    | 31  |   |                   |  | 16  |          |  |  | 29  |  
|A                      |  |                    | 17  |   |                   |  | <1  |          |  |  | 14  |  
|BBB                    |  |                    | 9   |   |                   |  | 5   |          |  |  | 9   |  
|Below investment grade |  |                    | 13  |   |                   |  | 19  |          |  |  | 14  |  
|Not Rated              |  |                    | <1  |   |                   |  |    |          |  |  | <1  |  
|                       |  |                    |     |   |                   |  |     |          |  |  |     |  
|                       |  |                    | 100 | % |                   |  | 100 | %        |  |  | 100 | %
|                       |  |                    |     |   |                   |  |     |          |  |  |     |  
|December 31, 2010:     |  |                    |     |   |                   |  |     |          |  |  |     |  
|AAA                    |  |                    | 30  | % |                   |  | 65  | %        |  |  | 36  | %
|AA                     |  |                    | 32  |   |                   |  | 14  |          |  |  | 29  |  
|A                      |  |                    | 16  |   |                   |  | 2   |          |  |  | 13  |  
|BBB                    |  |                    | 10  |   |                   |  | 2   |          |  |  | 9   |  
|Below investment grade |  |                    | 12  |   |                   |  | 17  |          |  |  | 13  |  
|Not Rated              |  |                    | <1  |   |                   |  |    |          |  |  | <1  |  
|                       |  |                    |     |   |                   |  |     |          |  |  |     |  
|                       |  |                    | 100 | % |                   |  | 100 | %        |  |  | 100 | %
|                       |  |                    |     |   |                   |  |     |          |  |  |     |  



|(1) | Ratings are based on the lower of Standard & Poors or Moodys ratings. If guaranteed, rating represents the higher of the underlying or
guarantors financial strength rating.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Ambacs fixed income portfolio includes securities covered by
guarantees issued by Ambac Assurance and other financial guarantors (insured securities). The published Moodys and S&P ratings on these securities reflect the higher of the financial strength rating of the financial guarantor
or the rating of the underlying issuer. Rating agencies do not always publish separate underlying ratings (those ratings excluding the insurance by the financial guarantor) because the insurance cannot be legally separated from the underlying
security by the insurer. Ambac obtains underlying ratings through ongoing dialogue with rating agencies and other sources. In the event these underlying ratings are not available from the



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rating agencies, Ambac will assign an internal rating. Since the insurance cannot be legally separated from the underlying security, the fair value of the insured securities in the investment
portfolio includes the value of any financial guarantee embedded in such securities, including guarantees written by Ambac Assurance. In addition, a hypothetical fair value assuming the absence of the insurance is not readily available from our
independent pricing sources.



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The following table represents the fair value, including the value of the financial
guarantee, and weighted-average underlying rating, excluding the financial guarantee, of the insured securities, excluding VIE guaranteed securities, at March 31, 2011 and December 31, 2010:



|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|--------------------------------------------- |  | -------------------- | ------- |  | -------------------- | - | ----- | ---------------------------------- |  | - | ------- |  |  | ---------------------------------- | ------- |  |  | ----
|($ in millions)                               |  | Municipalobligations |         |  | Corporateobligations |   |       | Mortgageand asset-backedsecurities |  |   | Total   |  |  | WeightedAverageUnderlyingRating(1)
|March 31, 2011                                |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Financial Guarantee                           |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|National Public Finance Guarantee Corporation |  | $                    | 811.9   |  |                      | $ | 79.5  |                                    |  | $ |        |  |  | $                                  | 891.4   |  |  | AA- 
|Ambac Assurance Corporation                   |  |                      | 57.3    |  |                      |   | 4.5   |                                    |  |   | 975.1   |  |  |                                    | 1,036.9 |  |  | B+  
|Assured Guaranty Municipal Corporation        |  |                      | 416.6   |  |                      |   | 97.8  |                                    |  |   | 25.6    |  |  |                                    | 540.0   |  |  | A+  
|Financial Guarantee Insurance Corporation     |  |                      | 16.4    |  |                      |   |      |                                    |  |   | 10.9    |  |  |                                    | 27.3    |  |  | BBB 
|MBIA Insurance Corporation                    |  |                      |        |  |                      |   | 20.0  |                                    |  |   | 5.3     |  |  |                                    | 25.3    |  |  | BBB-
|Assured Guaranty Corporation                  |  |                      |        |  |                      |   |      |                                    |  |   | 15.0    |  |  |                                    | 15.0    |  |  | D   
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Total                                         |  | $                    | 1,302.2 |  |                      | $ | 201.8 |                                    |  | $ | 1,031.9 |  |  | $                                  | 2,535.9 |  |  | BBB 
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Financial Services                            |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Assured Guaranty Municipal Corporation        |  | $                    |        |  |                      | $ | 61.8  |                                    |  | $ |        |  |  | $                                  | 61.8    |  |  | BBB 
|Assured Guaranty Corporation                  |  |                      |        |  |                      |   |      |                                    |  |   | 29.5    |  |  |                                    | 29.5    |  |  | BB  
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Total                                         |  | $                    |        |  |                      | $ | 61.8  |                                    |  | $ | 29.5    |  |  | $                                  | 91.3    |  |  | BBB-
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Corporate                                     |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Assured Guaranty Municipal Corporation        |  | $                    | 22.5    |  |                      | $ |      |                                    |  | $ |        |  |  |                                    | 22.5    |  |  | AA- 
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Total                                         |  | $                    | 22.5    |  |                      | $ |      |                                    |  | $ |        |  |  | $                                  | 22.5    |  |  | AA- 
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|December 31, 2010                             |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Financial Guarantee                           |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|National Public Finance Guarantee Corporation |  | $                    | 815.8   |  |                      | $ | 80.9  |                                    |  | $ |        |  |  | $                                  | 896.7   |  |  | AA- 
|Ambac Assurance Corporation                   |  |                      | 55.8    |  |                      |   | 4.6   |                                    |  |   | 840.2   |  |  |                                    | 900.6   |  |  | BB  
|Assured Guaranty Municipal Corporation        |  |                      | 399.4   |  |                      |   | 93.2  |                                    |  |   | 25.8    |  |  |                                    | 518.4   |  |  | A+  
|Financial Guarantee Insurance Corporation     |  |                      | 16.4    |  |                      |   |      |                                    |  |   | 11.8    |  |  |                                    | 28.2    |  |  | BBB+
|MBIA Insurance Corporation                    |  |                      |        |  |                      |   | 19.6  |                                    |  |   | 5.6     |  |  |                                    | 25.2    |  |  | BBB-
|Assured Guaranty Corporation                  |  |                      |        |  |                      |   |      |                                    |  |   | 16.4    |  |  |                                    | 16.4    |  |  | D   
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Total                                         |  | $                    | 1,287.4 |  |                      | $ | 198.3 |                                    |  | $ | 899.8   |  |  | $                                  | 2,385.5 |  |  | BBB+
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Financial Services                            |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Assured Guaranty Municipal Corporation        |  | $                    |        |  |                      | $ | 57.9  |                                    |  | $ |        |  |  | $                                  | 57.9    |  |  | BBB 
|Assured Guaranty Corporation                  |  |                      |        |  |                      |   |      |                                    |  |   | 28.7    |  |  |                                    | 28.7    |  |  | BB  
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Total                                         |  | $                    |        |  |                      | $ | 57.9  |                                    |  | $ | 28.7    |  |  | $                                  | 86.6    |  |  | BBB-
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Corporate                                     |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Assured Guaranty Municipal Corporation        |  | $                    | 22.5    |  |                      | $ |      |                                    |  | $ |        |  |  | $                                  | 22.5    |  |  | AA- 
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     
|Total                                         |  | $                    | 22.5    |  |                      | $ |      |                                    |  | $ |        |  |  | $                                  | 22.5    |  |  | AA- 
|                                              |  |                      |         |  |                      |   |       |                                    |  |   |         |  |  |                                    |         |  |  |     



|(1) | Ratings represent the lower underlying rating assigned by S&P or Moodys. If unavailable, Ambacs internal rating is used.
|--- | --------------------------------------------------------------------------------------------------------------------------



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Cash Flows. Net cash provided by operating activities was $82.8 million
and $427.1 million during the three months ended March 31, 2011 and 2010, respectively. Operating cash flows decreased in the first quarter 2011 primarily due to the federal tax refund of $443.9 million received in the first quarter of 2010,
partially offset by lower loss payments in 2011 as a result of the claims moratorium imposed on the Segregated Account by OCI Future net cash provided by operating activities will be impacted by the level of premium collections, surplus note
interest payments (subject to approval by OCI) and claim payments (including the ultimate payment of presented but unpaid claims as a result of the claim moratorium), including payments under credit default swap contracts.

Net cash used in financing activities was ($92.1) million and ($30.8) million during the three months ended March 31, 2011 and 2010,
respectively. Financing activities for the three months ended March 31, 2011 and 2010 included repayments of investment and payment agreements of $89.7 million and $31.1 million, respectively

Net cash provided by (used in) investing activities was $7.4 million and ($393.6) million during the three months ended March 31,
2011 and 2010, respectively. These investing activities were primarily from sales and maturities of fixed income securities to meet operating cash flow needs, partially offset by purchases of investments.

Special Purpose and Variable Interest Entities.Please refer to Note 4, Special Purpose Entities,
including Variable Interest to the Unaudited Consolidated Financial Statements in Part 1, Item 1 on this Form 10-Q for information regarding special purpose and variable interest entities. Ambac does not have any other off-balance sheet
arrangements.



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Risk Management. Ambacs principal business strategy going forward is to increase the residual value of its financial guarantee business by mitigating losses on poorly performing
transactions (including through the pursuit of recoveries in respect of paid claims, commutations of policies and repurchases of surplus notes issued in respect of claims) and maximizing the return on its investment portfolio. The Risk Management
group is primarily responsible for the development, implementation and oversight of loss mitigation strategy. As a consequence of the Segregated Account Rehabilitation Proceedings, the rehabilitator retains operational control and
decision-making authority with respect to all matters related to the Segregated Account, including surveillance, remediation and loss mitigation. Similarly, by virtue of the contracts executed between Ambac Assurance and the Segregated Account
in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the rehabilitator retains the discretion to oversee and approve certain actions taken by Ambac Assurance in respect of assets and liabilities which
remain in Ambac Assurance. As such, Ambacs risk management practices are qualified by reference to the rehabilitators exercise of its discretion to alter or eliminate any of these risk management practices. By virtue of a
management services contract executed between Ambac Assurance and the Segregated Account in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the Risk Management group is responsible for all surveillance,
remediation and mitigation services provided to the Segregated Account under the supervision of the Office of the Commissioner of Insurance of the State of Wisconsin (OCI). Please refer to Risk Management located in Part I,
Item 1: Business of this Form 10-K for further discussion of our Risk Management Group.

Credit Risk. Ambac
is exposed to credit risk in various capacities including as an issuer of financial guarantees, including credit default swaps, as counterparty to reinsurers and derivative and other financial contracts and as a holder of investment securities.

Financial GuaranteesRisk Managements focus is on surveillance, remediation, loss mitigation and risk
reduction. Surveillance analysts review, on a regular and ad hoc basis, credits in the financial guarantee book of business. Risk-adjusted surveillance strategies have been developed for each bond type. The monitoring activities are designed to
detect deterioration in credit quality or changes in the economic, regulatory or political environment which could adversely impact the portfolio. Active surveillance enables Portfolio Risk Management to track single credit migration and industry
credit trends. In some cases, Portfolio Risk Management will engage workout experts, attorneys and other consultants with appropriate expertise in the targeted loss mitigation to assist management in examining the underlying contracts or collateral,
providing industry specific advice and/or executing strategies.

Investment SecuritiesAmbac manages credit risk
associated with its investment portfolio through adherence to specific investment guidelines. These guidelines establish limits based upon single risk concentration, asset type limits and minimum credit rating standards. Additionally, senior credit
personnel monitor the portfolio on a continuous basis. Credit monitoring of the investment portfolio includes procedures on residential mortgage backed securities consistent with these utilized to assign the risk of our insured RMBS exposures.

DerivativesCredit risks relating to derivative positions (other than credit derivatives) primarily concern the
default of a counterparty. 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. Derivative contracts entered into with financial guarantee customers are not subject to collateral posting agreements. Credit risk associated with such customer derivatives is managed
through the financial guarantee portfolio risk management processes described above.

ReinsuranceTo
minimize its exposure to significant losses from reinsurer insolvencies, Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain
reinsurance contracts; and (iii) has certain cancellation rights that can



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be exercised by Ambac Assurance in the event of rating agency downgrades of a reinsurer. At the inception of each reinsurance contract, Ambac Assurance requires collateral from certain reinsurers
primarily to (i) receive statutory credit for the reinsurance for foreign reinsurers, and (ii) provide liquidity to Ambac Assurance in the event of claims on the reinsured exposures. Ambac Assurance held letters of credit and collateral
amounting to approximately $314 million from its reinsurers at March 31, 2011. The largest reinsurer accounted for 6.5% of gross par outstanding at March 31, 2011.

Market Risk. Market risk represents the potential for losses that may result from changes in the value of a financial instrument as a result of changes in market conditions. The primary
market risks that would impact the value of Ambacs financial instruments are interest rate risk, basis risk (e.g., taxable index rates relative to issue specific or tax-exempt index rates) 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 Management group are responsible for monitoring risk limits and applying risk measurement methodologies. The estimation of potential losses arising
from adverse changes in market conditions is a key element in managing market risk. Ambac utilizes various systems, models and stress test scenarios to monitor and manage market risk. This process includes frequent analyses of both parallel and
non-parallel shifts in the benchmark interest rate curve and Value-at-Risk (VaR) measures. 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.

Ambac Financial
Services (AFS) manages its swaps business with the goal of being market neutral to changes in benchmark interest rates while retaining some basis risk and some excess interest rate sensitivity as an economic hedge against the effects of
rising interest rates elsewhere in the Company, including on Ambacs financial guarantee exposures (the Macro Hedge). Basis risk in the portfolio arises from (i) variability in the ratio of benchmark tax-exempt to taxable
interest rates, (ii) potential changes in municipal issuers bond-specific variable rates relative to taxable interest rates, and (iii) variability between Treasury and swap rates. If actual or projected benchmark tax-exempt interest
rates increase or decrease in a parallel shift by 1 basis point in relation to taxable interest rates, Ambac would experience a mark-to-market gain or loss of $0.2 million and $0.2 million at March 31, 2011 and December 31, 2010,
respectively. For a 1 basis point parallel shift in USD Libor interest rates versus the US Treasury rate Ambac would experience a mark-to-market gain or loss of $0.01 million and $0.01 million at March 31, 2011 and December 31, 2010,
respectively. Each of the amounts above is presenting sensitivity (gain or loss) under the assumption that everything else remains unchanged. Actual changes in tax-exempt interest rates, and US Libor vs. US Treasury, as well as changes in Libor
curves for different currencies themselves are correlated. This correlation is taken into account when we produce VaR numbers based on historical changes of all interest rate risk components as discussed below. The incremental interest rate
sensitivity of the interest rate swap portfolio attributable to the Macro Hedge position would produce mark-to-market gains or losses of approximately $2 million for a 1 basis point parallel shift in USD Libor rates up or down at March 31,
2011.

The estimation of potential losses arising from adverse changes in market relationships, known as VaR, is a key element
in managements monitoring of basis risk for the municipal interest rate swap portfolio. Ambac has developed a VaR methodology to estimate potential losses using a one day time horizon and a 99% confidence level. This means that Ambac would
expect to incur losses greater than that predicted by VaR estimates only once in every 100 trading days, or about 2.5 times a year. Ambacs methodology estimates VaR using a 300-day historical look back period. This means that
changes in market values are simulated using market inputs from the past 300 days. For the three months ended March 31, 2011 and the year ended December 31, 2010, Ambacs VaR, for its core interest rate swap portfolio (which excludes
the Macro Hedge) averaged approximately $2.8 million and $3.7 million, respectively. Ambacs VaR ranged from a high of $4.8 million to a low of $1.5 million in the first quarter



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of 2011 and from a high of $6.5 million to a low of $1.9 million in 2010. Ambac supplements its VaR methodology, which it believes 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 benchmark interest rate curve and (ii) immediate changes in normal basis
relationships, such as those between taxable and tax-exempt markets.

The municipal interest rate swaps we provide require AFS
to receive a fixed rate and pay either a tax-exempt index rate or an issue-specific bond rate on a variable-rate municipal bond. Beginning 2008, dislocation in the credit markets and rating agency actions on Ambac Assurance led to increases in
Ambacs payments under interest rate swaps where Ambac pays an issue-specific rate, resulting in losses on those swaps. These swaps contain provisions that are designed to protect against certain forms of basis risk or tax reform. Such
provisions include the ability of AFS to convert the rate from the underlying issue-specific bond rate to an alternative floating rate that is a tax-exempt index rate or a fixed percentage of a taxable index rate in the event that the interest rate
on the bond is adversely affected due to a credit downgrade or in the event the bonds are put to a liquidity provider under a liquidity facility. Since 2008, Ambac has (i) terminated the vast majority of these swaps, (ii) converted others
to an alternative floating rate; or (iii) purchased the variable rate bonds for inclusion in the investment portfolio. As a result of these actions, the remaining notional value of affected variable-rate municipal bond swaps is $36.8 million as
of March 31, 2011.

Financial instruments that may be adversely affected by changes in credit spreads include
Ambacs outstanding credit derivative contracts and invested assets. Changes in credit spreads are generally caused by changes in the markets perception of the credit quality of the underlying obligations. Market liquidity and prevailing
risk premiums demanded by market participants are also reflected in credit spreads and impact valuations.

Ambac, through its
subsidiary Ambac Credit Products (ACP), entered into credit derivative contracts. These contracts require ACP to make payments upon the occurrence of certain defined credit events relating to an underlying obligation (generally a fixed
income obligation). If credit spreads of the underlying obligations change, the market value of the related credit derivative changes. As such, ACP could experience mark-to-market gains or losses.

The following table summarizes the net par exposure outstanding (notional values) and net derivative asset (liability) balance related to
credit derivatives as of March 31, 2011 and December 31, 2010 by asset type:



|                         |  |     |        |   |       |   |       |       |  |   |        |  
|------------------------ |  | --- | ------ | - | ----- | - | ----- | ----- |  | - | ------ | -
|($ in millions)          |  | CLO |        |   | Other |   |       | Total | 
|March 31, 2011:          |  |     |        |   |       |   |       |       |  |   |        |  
|Net par outstanding      |  | $   | 11,426 |   |       | $ | 6,847 |       |  | $ | 18,273 |  
|Net liability fair value |  |     | (70    | ) |       |   | (166  | )     |  |   | (236   | )
|                         |  |     |       
|December 31, 2010:       |  |     |        |   |       |   |       |       |  |   |        |  
|Net par outstanding      |  | $   | 11,593 |   |       | $ | 7,173 |       |  | $ | 18,766 |  
|Net liability fair value |  |     | (71    | ) |       |   | (151  | )     |  |   | (222   | )



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The following table summarizes the estimated change in fair values on the net balance
of Ambacs net credit derivative contracts assuming immediate parallel shifts in reference obligation spreads at March 31, 2011 and December 31, 2010:



|                             |  |     |      |   |       |   |      |       |  |   |                                      |   |  |   |      |  
|---------------------------- |  | --- | ---- | - | ----- | - | ---- | ----- |  | - | ------------------------------------ | - |  | - | ---- | -
|($ in millions)              |  |     |      |   |       |   |      |       |  |   |                                      |  
|Change in Underlying Spreads |  | CLO |      |   | Other |   |      | Total |  |   | Total EstimatedUnrealizedGain/(Loss) |  
|March 31, 2011:              |  |     |      |   |       |   |      |       |  |   |                                      |   |  |   |      |  
|500 basis point widening     |  | $   | (157 | ) |       | $ | (156 | )     |  | $ | (313                                 | ) |  | $ | (549 | )
|250 basis point widening     |  |     | (79  | ) |       |   | (77  | )     |  |   | (156                                 | ) |  |   | (392 | )
|50 basis point widening      |  |     | (16  | ) |       |   | (15  | )     |  |   | (31                                  | ) |  |   | (267 | )
|Base scenario                |  |     |     |   |       |   |     |       |  |   |                                     |   |  |   | (236 | )
|50 basis point narrowing     |  |     | 16   |   |       |   | 14   |       |  |   | 30                                   |   |  |   | (206 | )
|250 basis point narrowing    |  |     | 63   |   |       |   | 61   |       |  |   | 124                                  |   |  |   | (112 | )
|500 basis point narrowing    |  |     | 69   |   |       |   | 96   |       |  |   | 165                                  |   |  |   | (71  | )
|                             |  |     |      |  
|December 31, 2010:           |  |     |      |   |       |   |      |       |  |   |                                      |   |  |   |      |  
|500 basis point widening     |  |     | (130 | ) |       |   | (126 | )     |  |   | (256                                 | ) |  |   | (478 | )
|250 basis point widening     |  |     | (65  | ) |       |   | (63  | )     |  |   | (128                                 | ) |  |   | (350 | )
|50 basis point widening      |  |     | (13  | ) |       |   | (12  | )     |  |   | (25                                  | ) |  |   | (247 | )
|Base scenario                |  |     |     |   |       |   |     |       |  |   |                                     |   |  |   | (222 | )
|50 basis point narrowing     |  |     | 13   |   |       |   | 12   |       |  |   | 25                                   |   |  |   | (197 | )
|250 basis point narrowing    |  |     | 58   |   |       |   | 52   |       |  |   | 110                                  |   |  |   | (112 | )
|500 basis point narrowing    |  |     | 69   |   |       |   | 83   |       |  |   | 152                                  |   |  |   | (70  | )

Also included in the fair
value of credit derivative liabilities is the effect of Ambacs creditworthiness, which reflects market perception of Ambacs ability to meet its obligations. Incorporating estimates of Ambacs credit valuation adjustment into the
determination of fair value has resulted in a $707.7 million and $886.7 million reduction to the credit derivatives liability as of March 31, 2011 and December 31, 2010, respectively. At March 31, 2011 and December 31, 2010 the
credit valuation adjustment was calculated as 75% and 80%, respectively, of the credit derivative liability as measured before considering Ambac credit risk.



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|Item 4. | Controls and Procedures
|------- | -----------------------

In connection with the preparation of this First Quarter Form 10-Q, an evaluation was carried out by Ambacs management, with the
participation of Ambacs Chief Executive Officer and Chief Financial Officer, of the effectiveness of Ambacs disclosure controls and procedures (as defined in rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934
(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.

Disclosure
controls and procedures are designed to ensure that the information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and
forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures. Based on its evaluation, and as a result of
the previously identified material weakness in internal control relating to the accuracy of inputs to a non-RMBS loss reserve model as described in the 2010 Annual Report on Form 10-K, Ambacs Chief Executive Officer and Chief Financial Officer
have concluded that, as of March 31, 2011, Ambacs disclosure controls and procedures were ineffective.

Notwithstanding the existence of this material weakness in internal control over financial reporting, Ambac believes that the
consolidated financial statements in this Quarterly Report on Form 10-Q fairly present, in all material respects, Ambacs consolidated financial condition as of March 31, 2011 and December 31, 2010 and consolidated results of
operations for the three month periods ended March 31, 2011 and 2010 and consolidated cash flows for the three-month periods ended March 31, 2011 and 2010, in conformity with U.S. generally accepted accounting principles (GAAP). In
addition, there has been no change in Ambacs internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended March 31, 2011 that has materially affected, or is
reasonably likely to materially affect, Ambacs internal control over financial reporting.

Ambac management is committed
to maintaining an effective internal control environment over financial reporting and has been actively addressing the above noted material weakness. Managements remediation strategy involves critical assessments of non-RMBS loss reserve
models to ensure that key controls over the models design and application are operating effectively. Key controls include, but are not limited to model security and managements review over data inputs to and output from each model.



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|Item 1. | Legal Proceedings.
|------- | ------------------

Please refer to Note 12 Commitments and Contingencies to the Unaudited Consolidated Financial Statements located in Part I,
Item 1 in this Form 10-Q for a discussion on Legal Proceedings against Ambac and its subsidiaries.

Item 1A  Risk Factors

There is significant uncertainty as to how Ambacs debtholders will be treated under any plan of reorganization.

To date, Ambac has been unable to agree to terms with the Creditors Committee in order to restructure its outstanding debt through a consensual plan of reorganization. However, Ambac has agreed to a
non-binding term sheet that continues to serve as a basis for negotiations with the Creditors Committee. No assurances can be given that a deal will be consummated. However, if the ongoing negotiations with respect to the term sheet produce an
agreement, that result would facilitate a more successful reorganization plan and result in a better outcome for Ambac debtholders than would likely be the case if negotiations do not produce an agreement. Because a plan of reorganization has not
yet been agreed to, there is significant uncertainty as to how holders of Ambacs securities will be treated under any reorganization plan. It is likely, however, that Ambacs debtholders and creditors will receive all of the equity in the
company.

Our lack of ratings could trigger adverse consequences.

On April 7, 2011 Ambac Assurance requested that Moodys withdraw its ratings of Ambac Assurance and each of its affiliates, and
Moodys did withdraw such ratings. As a result, Ambac Assurance is no longer rated by any of the independent rating agencies. Ambac and its subsidiaries may be participants in transactions where the absence of a rating by one or more of the
independent rating agencies could result in a default in, or early termination of, one or more such transactions. While we are not aware of any such defaults or termination events, the existence of such provisions could have a material adverse
impact on our financial condition.

Characterization of losses on Ambac Assurances CDS portfolio as capital losses
for U.S. federal tax purposes could result in a material assessment for federal income taxes.

Ambac Assurances
CDS portfolio experienced significant losses. The majority of these CDS contracts are on a pay as you go basis, and we believe that they are properly characterized as notional principal contracts for U.S. federal income tax purposes.
Generally, losses on notional principal contracts are ordinary losses. However, the federal income tax treatment of credit default swaps is an unsettled area of the tax law. As part of the ongoing audit of Ambacs 2007-2009 federal income tax
returns and refund claims, the IRS has recently proposed to disallow Ambac Assurances deductions of CDS losses as ordinary losses, effectively taking the position that they were more properly characterized as capital losses. As of
March 31, 2011, Ambac had NOLs amounting to approximately $7.2 billion for federal income tax purposes. Although Ambac Assurance believes these contracts are properly characterized as notional principal contracts, if the Internal Revenue
Service were to successfully assert the proposed disallowance resulting from its examination, Ambac Assurance would be subject to both a substantial reduction in its net operating loss carryforwards and would suffer a material assessment for federal
income taxes. Such assessments and reductions in net operating loss carryforwards would have a material adverse impact on our financial condition. Such assessments related to the tentative refunds, which amount to approximately $700 million, may be
made by the



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Internal Revenue Service at any time and, without prior notice to Ambac, pursuant to section 6213(b) of the Internal Revenue Code of 1986, as amended. Subject to applicable law and existing court
orders, the Internal Revenue Service may then file a lien that attaches to Ambacs property interests, including the property interests of any member of the consolidated tax group, and commence collection efforts. If these events occur, the
rehabilitation plan for the Segregated Account may be materially impacted and Ambacs ability to effectively reorganize may be seriously jeopardized.

Certain adverse tax consequences could result from the rehabilitation plan and, as such, the rehabilitator is considering substantial amendments to the rehabilitation plan and/or the initiation of
rehabilitation proceedings against Ambac Assurance. Such amendments and/or the initiation of rehabilitation proceedings against Ambac Assurance would likely have adverse consequences to holders of Ambac securities and may have adverse consequences
to holders of securities insured by Ambac Assurance.

As described elsewhere herein, the issuance of surplus notes by
the General Account and the issuance of surplus notes by the Segregated Account as contemplated by the rehabilitation plan could subject Ambac Assurance to the risk of deconsolidation from Ambac for U.S. federal income tax purposes and of having to
recognize significant cancellation of indebtedness income (CODI). Deconsolidation or the recognition of substantial CODI would likely have a material adverse effect on the financial condition of Ambac Assurance and the Segregated
Account. As such, the rehabilitator is considering substantial amendments to the rehabilitation plan and/or the initiation of rehabilitation proceedings with respect to Ambac Assurance. Such amendments to the rehabilitation plan (and, presumably,
any rehabilitation plan with respect to Ambac Assurance) could include the elimination of the issuance of surplus notes by the Segregated Account and/or the imposition of transfer restrictions on any surplus notes issued by the Segregated Account.

Any such amendments to the rehabilitation plan could adversely affect the interests of Ambac security holders and holders of
securities insured by Ambac Assurance, as such amendments could reduce the likelihood of consummation of an agreement between Ambac and Ambac Assurance with respect to the ongoing term sheet negotiations. The parties failure to consummate such
a transaction would increase the likelihood that Ambacs bankruptcy case will convert to a Chapter 7 liquidation proceeding, with attendant adverse consequences to Ambac security holders and holders of securities insured by Ambac Assurance
(including, without limitation, the loss of NOLs). Additionally, the initiation of rehabilitation proceedings with respect to Ambac Assurance would result in the assumption of control by the rehabilitator of all of Ambac Assurances assets and
management of Ambac Assurance. In exercising control, the rehabilitator will act for the benefit of policyholders, and will not take into account the interests of security holders of Ambac; such actions may result in material adverse consequences
for Ambacs security holders. In addition, the initiation of delinquency proceedings against Ambac Assurance would further decrease the likelihood that OCI will permit Ambac Assurance to make future dividend payments to Ambac. Finally,
notwithstanding that amendments to the rehabilitation plan and/or the initiation of rehabilitation proceedings would be designed to preserve tax attributes for the ultimate benefit of policyholders, such amendments might have other adverse impacts
on holders of securities insured by Ambac Assurance, including, without limitation, delays in receipt of cash in respect of claims, absence of surplus notes in respect of claims and/or the imposition of trading restrictions on surplus notes received
in respect of claims.

Historical financial information may not be comparable.

Following confirmation of a Reorganization Plan and the transactions contemplated thereby, our financial condition and results of
operations from and after the effective date of the Reorganization Plan may not be comparable to the financial condition or results of operations reflected in our historical



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financial statements. In addition, any amendments to the rehabilitation plan could have a significant impact on our financial statements, such that financial statements following such amendments
may not be comparable to the financial condition or results of operations reflected in our historical financial statements.

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

Loss reserves established with respect to our non-derivative financial guarantee insurance
business are based upon estimates and judgments by management, including estimates and judgments with respect to the probability of default, the severity of loss upon default and estimated remediation recoveries for, among other things, breaches by
the issuer of representations and warranties. Loss reserves are established when management has observed credit deterioration, in most cases, when the underlying credit is considered below investment grade. Furthermore, the objective of establishing
loss reserve estimates is not to reflect the worst possible outcome. As such, there can be no assurance that the actual losses in our financial guarantee insurance portfolio will not exceed our loss reserves. A further description of our
accounting for loss and loss expenses can be found in Note 6 of the Notes to the Unaudited Consolidated Financial Statements included in Item 1 of this Form 10-Q.

Additionally, inherent in our estimates of loss severities and remediation recoveries is the assumption that we will retain control rights in respect of our insured portfolio. However, we are subject to
the loss of control rights in many insured transactions, in the event that we are the subject of delinquency proceedings and/or other regulatory actions which could result from our deteriorated financial position. In the event that we lose control
rights, our ability to mitigate loss severities and realize remediation recoveries will be compromised, and actual ultimate losses in our insured portfolio could exceed our loss reserves. The rehabilitation court issued an injunction effective until
further order of the court enjoining certain actions by holders of policies in the Segregated Account and other counterparties, including the loss of control rights. If this injunction were successfully challenged, Ambac Assurance could lose its
control rights with respect to policies in the Segregated Account.

We also rely on internally and externally developed
complex financial models, including a recently licensed statistical regression model related to RMBS, which we used for the first time in connection with the preparation of our first quarter 2011 results, to project performance of our insured
obligations. Differences in the models that we employ, and/or flaws in these financial models and/or faulty assumptions used by these financial models, could lead to increased losses and loss reserves. Uncertainty with respect to the ultimate
performance of certain of our insured exposures may result in substantial changes in loss reserves and/or actual losses. Correspondingly, such changes to loss reserves would affect our reported earnings. If we do not have sufficient liquidity to
meet the increase in actual losses, our insurance operating subsidiaries may become subject to delinquency proceedings.

The determination of the amount of impairments taken on our investments is highly subjective and could materially impact our
results of operations or financial position.

The determination of the amount of impairments on our investments vary by
investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available.
Management updates its evaluations regularly and reflects changes in impairments in operations as such evaluations are revised. There can be no assurance that our management has accurately assessed the level of impairments taken in our financial
statements. Furthermore, additional impairments may need to be taken in the future. Historical trends may not be indicative of future impairments. We use internally and externally developed financial models



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(including a recently licensed statistical regression model which we employed for the first time in connection with the preparation of our first quarter 2011 results) to project impairments with
respect to RMBS held in our investment portfolio. Differences in the models we employ and/or flaws in these models and/or faulty assumptions used by these models, could lead to increased impairments with respect to RMBS in our investment portfolio.

We are subject to dispute risk in connection with our reinsurance agreements.

In addition to having credit exposure to our reinsurance counterparties, reinsurance counterparties have disputed their obligations to
make payments required by applicable reinsurance agreements, including scheduled payments and payments due in connection with the commutation of financial guarantee insurance policies. These disputes, and any other similar dispute with other
reinsurers, could result in our being unable to collect all amounts due from reinsurers and/or collecting such amounts after potentially lengthy dispute resolution processes.

Surplus notes issued by either Ambac Assurance or the Segregated Account may be characterized as equity of Ambac Assurance and, as a result, Ambac Assurance may no longer be a member of the U.S.
federal income tax consolidated group of which the Company is the common parent.

It is possible surplus notes issued
by either Ambac Assurance or the Segregated Account may be characterized as equity of Ambac Assurance for U.S. federal income tax purposes. If the surplus notes are characterized as equity of Ambac Assurance and it is determined the surplus notes
represented more than twenty (20) percent of the total value of the stock of Ambac Assurance, Ambac Assurance may no longer be characterized as an includable corporation that is affiliated with the Company. As a result, Ambac Assurance may no
longer be characterized as a member of the U.S. federal income tax consolidated group of which the Company is the common parent (the Company Consolidated Tax Group) and Ambac Assurance would be required to file a separate consolidated
tax return as the common parent of a new U.S. federal income tax consolidated group including Ambac Assurance as the new common parent and Ambac Assurances affiliated subsidiaries (the AAC Consolidated Tax Group).

To the extent Ambac Assurance is no longer a member of the Company Consolidated Tax Group, Ambac Assurances NOLs (and certain other
available tax attributes of Ambac Assurance and the other members of the AAC Consolidated Tax Group) may no longer be available for use by the AAC Consolidated Tax Group or any of the remaining members of the AAC Consolidated Tax Group to reduce the
U.S. federal income tax liabilities of the AAC Consolidated Tax Group. This could result in a material increase in the tax liabilities of the AAC Consolidated Tax Group, reducing the cash available to pay third party obligations or dividends. In
addition, certain other benefits resulting from U.S. federal income tax consolidation may no longer be available to the Company Consolidated Tax Group including certain favorable rules relating to transactions occurring between members of the
Company Consolidated Tax Group and members of the AAC Consolidated Tax Group.

The AAC Consolidated Tax Group may not be
permitted to reconsolidate with the Company Consolidated Tax Group for a period of five years following the issuance of the Surplus Notes and the Ambac Assurance NOL (and certain other tax attributes or tax benefits of the AAC Consolidated Tax
Group) may be subject to limitation including the limitation provided by Code Section 382 following any permitted reconsolidation.

To the extent Ambac Assurance is no longer characterized as a member of the Company Consolidated Tax Group, the AAC Consolidated Tax Group may not reconsolidate with the Company Consolidated Tax Group for
a period of five years following such event even if the Company were to be



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characterized as reacquiring or owning eighty (80) percent or more of the stock of the AAC Consolidated Tax Group following any deconsolidation. In addition, depending upon certain facts
related to the potential deconsolidation of the AAC Consolidated Tax Group and any reconsolidation with the Company Consolidated Tax Group, the acquisition by the Company Consolidated Tax Group of additional value with respect to the stock of the
AAC Consolidated Tax Group may also result in the imposition of a Code Section 382 limitation with respect to the AAC Consolidated Tax Groups NOL reducing or eliminating (if there is a second ownership change within two years of the
confirmation of a Bankruptcy or a rehabilitation plan) the potential tax benefit of the NOLs to the Company Consolidated Tax Group. The potential limit on reconsolidation and the potential Code Section 382 limitation with respect to the Ambac
Assurance NOL could result in a material increase in the U.S. federal income tax liability of the AAC Consolidated Tax Group and/or the Company Consolidated Tax Group and materially reduce cash available to be pay third party obligations or
dividends.

If the surplus notes are characterized as equity of Ambac Assurance, the Ambac Assurance NOL (and certain
other tax attributes or tax benefits of the Company Consolidated Tax Group) may be subject to limitation under Section 382 of the Code.

It is possible the surplus notes may be characterized as equity of Ambac Assurance for U.S. federal income tax purposes. As a result, transfers of the surplus notes by holders or to holders of more than 5
percent of the surplus notes may result in an ownership change of Ambac Assurance for purposes of section 382 of the Code. If such an ownership change were to occur, the value and amount of the Ambac Assurance NOL would be substantially
impaired.

Issuance of the surplus notes may cause Ambac Assurance to recognize CODI, which could significantly reduce
the Ambac Assurance NOL.

If either the surplus notes or the claims for which the surplus notes are exchanged are
publicly traded for purposes of section 1273 of the Code and applicable Treasury Regulations thereunder, Ambac Assurance will be treated as having satisfied the policyholders claims against Ambac Assurance for an amount equal to
the fair market value of the surplus notes (plus any other consideration transferred). Although the preceding analysis related to whether the surplus notes or claims are publicly traded is not clear and there is little authority
addressing this issue, determining that either the surplus notes or claims are publicly traded could cause Ambac Assurance to recognize a potentially significant amount of CODI, which would reduce the Ambac Assurance NOL by the amount of
such CODI. The reduction in the Ambac Assurance NOL could impair Ambac Assurances ability to satisfy claims asserted against the Segregated Account. In addition, holders of the surplus notes may recognize interest income pursuant to the
original issue discount rules prior to receipt of interest payments on the surplus notes.

Deductions with respect to
interest accruing on the surplus notes may be eliminated or deferred until payment.

To the extent the surplus notes
are characterized as equity for U.S. federal income tax purposes, accrued interest will not be deductible by Ambac Assurance. In addition, even if the surplus notes are characterized as debt for U.S. federal income tax purposes, the deduction of
interest accruing on the surplus notes may be deferred until paid or eliminated in part depending upon (i) the terms of any deferral and payment provisions provided in the surplus notes, (ii) whether the surplus notes have
significant original issue discount and (iii) the yield to maturity of the surplus notes. To the extent deductions with respect to interest is eliminated or deferred, the U.S. federal income tax of the members of the Company
Consolidated Tax Group or the members of the AAC Consolidated Tax Group, as the



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case maybe, could be materially increased reducing the amount of cash available to pay third party obligations or dividends.

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 guidelines. The following table summarizes Ambacs repurchase program during the
first quarter of 2011 and shares available at March 31, 2011:



|         |  |                           |         |  |                             |   |      |                                                                     |  |  |                                                                |  |  |  |           | 
|-------- |  | ------------------------- | ------- |  | --------------------------- | - | ---- | ------------------------------------------------------------------- |  |  | -------------------------------------------------------------- |  |  |  | --------- | 
|         |  | Total 
SharesPurchased(1) |         |  | Average PricePaid Per Share |   |      | Total Number ofShares Purchased asPart of PubliclyAnnounced Plan(1) |  |  | Maximum Numberof Shares That MayYet Be PurchasedUnder the
Plan | 
|January  |  |                           |        |  |                             | $ |     |                                                                     |  |  |                                                               |  |  |  | 3,050,326 | 
|February |  |                           | 199,701 |  |                             | $ | 0.18 |                                                                     |  |  | 35,487                                                         |  |  |  | 2,850,625 | 
|March    |  |                           |        |  |                             | $ |     |                                                                     |  |  |                                                               |  |  |  | 2,850,625 | 
|         |  |                           |         |  |                             |   |      |                                                                     |  |  |                                                                |  |  |  |           | 
|         |  |                           | 199,701 |  |                             | $ | 0.18 |                                                                     |  |  | 35,487                                                         |  |  |  | 2,850,625 | 
|         |  |                           |         |  |                             |   |      |                                                                     |  |  |                                                                |  |  |  |           | 



|(1) | Shares repurchased during the first quarter 2011 were for the settlement of tax withholding amounts due for settling awards under Ambacs long-term incentive
plans.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

From April 1, 2011 through May 9, 2011, Ambac did not repurchase any shares of its Common
Stock in the open market under its stock repurchase program.





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Item 6  Exhibits

The following are annexed as exhibits:



|               |  |                                                                                                                                             
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
Number |  | Description                                                                                                                                 
|               | 
|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.              



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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: May 10, 2011 |  |  |  | By:                                      |  | /S/    DAVID
TRICK                                                                                                       
|                    |  |  |  |                                          |  | David Trick                                                                                                              
|                    |  |  |  |                                          |  | Senior Managing Director, Chief
Financial Officer and Treasurer (Principal Financial Officer and Duly Authorized
Officer)



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INDEX TO EXHIBITS



|               |  |                                                                                                                                             
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
Number |  | Description                                                                                                                                 
|               | 
|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.              



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