News Column

AMBAC FINANCIAL GROUP INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 11, 2014

Following this summary is a discussion addressing the consolidated results of operations and financial condition of Ambac Financial Group, Inc. ("Ambac" or "the Company") for the periods indicated. This discussion should be read in conjunction with Ambac's Annual Report on Form 10-K for the year ended December 31, 2013, the CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 below and Risk Factors set forth in Part II, Item 1A of this Form 10-Q. This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") contains certain financial measures, in particular the presentation of Operating Earnings (Losses) and Adjusted Book Value, which are not presented in accordance with accounting principles generally accepted in the United States ("GAAP"). We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying profitability drivers of our business. We do not intend for these non-GAAP financial measures to be a substitute for any GAAP financial measures and they may differ from similar reporting provided by other companies. Readers of this Form 10-Q should use these non-GAAP financial measures only in conjunction with the comparable GAAP financial measures. Operating Earnings (Losses) and Adjusted Book Value are non-GAAP financial measures that adjust for the impact of certain non-recurring or non-economic GAAP accounting requirements and include the addition of certain items that the Company has or expects to realize in the future, but that are not reported under GAAP. We also provide reconciliations to the most directly comparable GAAP measures; Operating Earnings (Losses) to Net income (loss) attributable to common stockholders and Adjusted Book Value to Total Ambac Financial Group, Inc. stockholders' equity. CAUTIONARY STATEMENT PURSUANT TO THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Management has included in Parts I and II of this Quarterly Report on Form 10-Q, including this MD&A, 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 2013 Annual Report on Form 10-K and in Part II, Item 1A of this Quarterly Report on 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 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) volatility in the price of Ambac's common stock; (2) uncertainty concerning our ability to achieve value for holders of Ambac securities, whether from Ambac Assurance Corporation ("Ambac Assurance") or from new business opportunities; (3) the possible dilution of the ownership interests of our stockholders; (4) the impact on our stock price of future offerings of debt or senior equity securities; (5) our inability to achieve the financial results projected during our Chapter 11 proceeding; (6) potential of rehabilitation proceedings against Ambac Assurance; (7) decisions made by the rehabilitator of the Segregated Account of Ambac Assurance Corporation (the "Segregated Account") for the benefit of policyholders that may result in material adverse consequences for Ambac's security holders; (8) our inability to realize the expected recoveries included in our financial statements; (9) intercompany disputes or disputes with the rehabilitator of the Segregated Account; (10) material changes to the Segregated Account rehabilitation plan or to current rules and procedures governing the payment of permitted policy claims, with resulting adverse impacts; (11) decisions of the rehabilitator of the Segregated Account concerning payments of deferred claim amounts or payments on surplus notes, the timing or magnitude of which is disadvantageous to Ambac; (12) increased fiscal stress experienced by issuers of public finance obligations or an increased incidence of Chapter 9 filings by municipal issuers; (13) adverse events arising from the rehabilitation proceedings for the Segregated Account, including the failure of the injunctions issued by the Wisconsin rehabilitation court to protect the Segregated Account and Ambac Assurance from certain adverse actions; (14) adverse tax consequences or other costs resulting from the Segregated Account rehabilitation plan or from rules and procedures governing the payment of permitted policy claims; (15) credit risk throughout our business, including but not limited to credit risk related to residential mortgage-backed securities, student loan and other asset securitizations, collateralized loan obligations, public finance obligations and exposures to reinsurers; (16) risks attendant to the change in composition of securities in our investment portfolio; (17) inadequacy of reserves established for losses and loss expenses; (18) the risk that our risk management policies and practices do not anticipate certain risks and/or the magnitude of potential for loss as a result of unforeseen risks; (19) changes in prevailing interest rates; (20) factors that may influence the amount of installment premiums paid to Ambac, including the 72



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Segregated Account rehabilitation proceedings; (21) default by one or more of Ambac Assurance's portfolio investments, insured issuers or counterparties; (22) 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 transactions; (23) risks relating to determinations of amounts of impairments taken on investments; (24) credit and liquidity risks due to unscheduled and unanticipated withdrawals on investment agreements; (25) 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; (26) system security risks; (27) the effects of U.S. fiscal policies; (28) market spreads and pricing on derivative products insured or issued by Ambac or its subsidiaries; (29) the risk of volatility in income and earnings, including volatility due to the application of fair value accounting; (30) changes in accounting principles or practices that may impact Ambac's financial results, including those resulting from any further changes to the Segregated Account rehabilitation plan or decisions of the rehabilitator; (31) legislative and regulatory developments; (32) operational risks, including with respect to internal processes, risk models, systems and employees, and failures in services or products provided by third parties; (33) Ambac's financial position and the Segregated Account rehabilitation proceedings that may prompt departures of key employees and may impact our ability to attract qualified executives and employees; and (34) other risks and uncertainties that have not been identified at this time. COMPANY OVERVIEW Ambac Financial Group, Inc. ("Ambac" or the "Company"), headquartered in New York City, is a financial services holding company incorporated in the state of Delaware. On May 1, 2013 (the "Effective Date"), the Second Modified Fifth Amended Plan of Reorganization of Ambac Financial Group, Inc. (the "Reorganization Plan") became effective and Ambac emerged from bankruptcy. There are substantial restrictions on the ability to transfer Ambac's common stock set forth in Article XII of Ambac's Amended and Restated Certificate of Incorporation. In order to preserve certain tax benefits, subject to limited exceptions, any attempted transfer of common stock shall be prohibited and void to the extent that, as a result of such transfer (or any series of transfers of which such transfer is a part), either (i) any person or group of persons shall become a holder of 5% or more of the Company's common stock or (ii) the percentage stock ownership interest in Ambac of any holder of 5% or more of the Company's common stock shall be increased (a "Prohibited Transfer"). These restrictions shall not apply to an attempted transfer if the transferor or the transferee obtains the written approval of Ambac's Board of Directors to such transfer. A purported transferee of a Prohibited Transfer shall not be recognized as a stockholder of Ambac for any purpose whatsoever in respect of the securities which are the subject of the Prohibited Transfer (the "Excess Securities"). Until the Excess Securities are acquired by another person in a transfer that is not a Prohibited Transfer, the purported transferee of a Prohibited Transfer shall not be entitled with respect to such Excess Securities to any rights of stockholders of Ambac, including, without limitation, the right to vote such Excess Securities and to receive dividends or distributions, whether liquidating or otherwise, in respect thereof, if any. Once the Excess Securities have been acquired in a transfer that is not a Prohibited Transfer, the securities shall cease to be Excess Securities. If the Board determines that a transfer of securities constitutes a Prohibited Transfer then, upon written demand by Ambac, the purported transferee shall transfer or cause to be transferred any certificate or other evidence of ownership of the Excess Securities within the purported transferee's possession or control, together with any distributions paid by Ambac with respect to such Excess Securities, to an agent designated by Ambac. Such agent shall thereafter sell such Excess Securities and the proceeds of such sale shall be distributed as set forth in the Amended and Restated Certificate of Incorporation. If the purported transferee of a Prohibited Transfer has resold the Excess Securities before receiving such demand, such person shall be deemed to have sold the Excess Securities for Ambac's agent and shall be required to transfer to such agent the proceeds of such sale, which shall be distributed as set forth in the Amended and Restated Certificate of Incorporation. Ambac's primary goal is to maximize shareholder value through executing the following key strategies: Increasing the value of its investment in Ambac Assurance Corporation



("Ambac Assurance") by actively managing its assets and liabilities with a

focus on maximizing risk-adjusted investment portfolio returns and

mitigating or remediating losses on poorly performing insured transactions

through executing policy commutations, repurchasing liabilities at a

discount, pursuing recoveries of losses through litigation and the exercise

of contractual and legal rights, restructuring transactions and other means; and



Pursuing new businesses, which may include financial services businesses

such as advisory, asset servicing, asset management, and/or insurance.

Opportunities for de-risking transactions depend on market conditions, including the perception of Ambac Assurance's creditworthiness, the structure of the underlying risk and associated policy, as well as other factors. Ambac Assurance's ability

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to commute policies or purchase liabilities may be limited by available liquidity. The execution of Ambac's strategy with respect to increasing the value of its investment in Ambac Assurance is subject to the authority of the Rehabilitator (defined below) to control the management of the Segregated Account (as defined below). 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. Refer to Note 1 to the Consolidated Financial Statements located in Part II, Item 8 of Ambac's 2013 Form 10-K and to Note 1 to the Unaudited Consolidated Financial Statements located in Part I, Item I of this Form 10-Q, for more information on the Segregated Account and the contracts between Ambac Assurance and the Segregated Account. Although we are exploring new business opportunities for Ambac, no assurance can be given that we will be able to identify or execute the acquisition or development of any new business. In addition, there can be no assurance that we will be able to generate or obtain the financial and other resources that may be required to finance the acquisition or development of any new business. Moreover, it is not possible at this time to predict the operating results or prospects of any future business. Due to these factors, as well as uncertainties relating to the ability of Ambac Assurance to deliver value to Ambac, the value of our securities is speculative. For additional risks and uncertainties concerning Ambac, please refer to Part I, Item 1A of Ambac's 2013 Form 10-K and Part II, Item 1A of this Form 10-Q. Ambac has two reportable business segments: Financial Guarantee and Financial Services. Ambac's financial guarantee business segment is conducted through its primary operating subsidiary, Ambac Assurance and its wholly owned subsidiary, Ambac Assurance UK Limited ("Ambac UK"). Insurance policies insured by Ambac Assurance and Ambac UK guarantee payment when due of the principal and interest on the obligation guaranteed. Ambac Assurance also has another wholly-owned financial guarantee subsidiary, Everspan Financial Guarantee Corp. ("Everspan"), which has been in runoff since its acquisition in 1997. The deterioration of Ambac Assurance's financial condition resulting from losses in its insured portfolio since 2007 has prevented Ambac Assurance from being able to write new business. An inability to write new business has and will continue to 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 the Settlement Agreement, dated as of June 7, 2010, by and among Ambac Assurance, Ambac Credit Products LLC ("ACP"), Ambac and counterparties to credit default swaps with ACP that were guaranteed by Ambac Assurance. Ambac Assurance is also restricted in its ability to pay dividends pursuant to the terms of its Auction Market Preferred Shares. It is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future. Refer to Part I, Item 1 of Ambac's 2013 Form 10-K, "Insurance Regulatory Matters - Dividend Restrictions, Including Contractual Restrictions" and Note 9 to the Consolidated Financial Statements located in Part II, Item 8 of Ambac's 2013 Form 10-K, for more information on dividend payment restrictions. 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. Net par exposure at June 30, 2014 for policies allocated to the Segregated Account was $20,899 million. As of June 30, 2014, insurance liabilities for policies allocated to the Segregated Account were $6,136.0 million. These insurance liabilities include loss reserves and loss expense reserves, gross of remediation and reinsurance recoveries. In March 2010, the Office of the Commissioner of Insurance for the State of Wisconsin ("OCI" (which term shall be understood to refer to such office as regulator of Ambac Assurance and to the Commissioner of Insurance for the State of Wisconsin as rehabilitator of the Segregated Account (the "Rehabilitator"), as the context requires)) 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. Refer to Note 1 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's 2013 Form 10-K and to Note 1 to the Unaudited Consolidated Financial Statements in Part I, Item I of this Form 10-Q for further discussion of the Segregated Account. Ambac's financial services segment is operated by subsidiaries of Ambac Assurance. This segment provides financial and investment products, including investment agreements, funding conduits, and interest rate swaps, principally to the clients of its financial guarantee business. Ambac Assurance insures all of the obligations of its financial services subsidiaries. The financial services businesses are in active runoff, which is being effectuated by means of transaction terminations, settlements, assignments and scheduled amortization of contracts. 74



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CRITICAL ACCOUNTING POLICIES AND ESTIMATES Ambac's Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"), which require the use of estimates and assumptions. For a discussion of Ambac's critical accounting policies and estimates, see "Critical Accounting Policies and Estimates" in Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Ambac's Annual Report on Form 10-K for the year ended December 31, 2013. 75



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FINANCIAL GUARANTEES IN FORCE Financial guarantee products were sold in three principal markets: the U.S. public finance market, the U.S. structured finance and asset-backed market and the international finance market. The following table provides a breakdown of guaranteed net par outstanding by market at June 30, 2014 and December 31, 2013. Net par exposures within the U.S. public finance market include capital appreciation bonds which are reported at the par amount at the time of issuance of the insurance policy. Guaranteed net par outstanding includes the exposures of policies that insure variable interest entities ("VIEs") consolidated in accordance with the Consolidation Topic of the ASC, Consolidation. Guaranteed net par outstanding excludes the exposures of policies that insure bonds which have been refunded or pre-refunded: ($ in millions) June 30, 2014 December 31, 2013 Public Finance (1) (2) $ 108,449 $ 116,062 Structured Finance 28,907 31,412 International Finance 30,358 31,618 Total net par outstanding (3) $ 167,714 $ 179,092



(1) Includes $6,115 and $6,165 of Military Housing net par outstanding at June

30, 2014 and December 31, 2013, respectively. (2) Includes $2,485 of Puerto Rico net par outstanding at June 30, 2014 and



December 31, 2013. Components of Puerto Rico net par outstanding includes

capital appreciation bonds which are reported at the par amount at the time of issuance of the related insurance policy.



(3) Included in the above net par exposures at June 30, 2014 and December 31,

2013 are $2,203 and $2,776, respectively, of exposures that were executed

in credit derivatives form.

Ratings Distribution The following tables provide a rating distribution of net par outstanding based upon internal Ambac Assurance credit ratings at June 30, 2014 and December 31, 2013 and a distribution by bond type of Ambac Assurance's below investment grade net par exposures at June 30, 2014 and December 31, 2013. Below investment grade is defined as those exposures with an Ambac internal credit rating below BBB-: Percentage of Guaranteed Portfolio Ambac Rating (1) June 30, 2014 December 31, 2013 AAA <1% <1% AA 20 20 A 42 43 BBB 20 20 Below investment grade 18 17 Total 100 % 100 %



(1) Internal credit ratings are provided solely to indicate the underlying

credit quality of guaranteed obligations based on the view of Ambac

Assurance, and for Ambac UK related transactions, based on the view of

Ambac UK. In cases where Ambac Assurance or Ambac UK 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 Assurance and Ambac UK credit ratings are subject to

revision at any time and do not constitute investment advice. 76



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Summary of Below Investment Grade Exposure

($ in millions) June 30, 2014 December 31, 2013 Public Finance: Tax-backed (1) $ 2,660 $ 1,887 Housing (2) 843 732 General obligation (1) 584 363 Transportation 499 519 Health care 30 30 Other 1,345 1,291 Total Public Finance 5,961 4,822 Structured Finance: Residential mortgage-backed and home equity-first lien 7,545 8,092 Residential mortgage-backed and home equity-second lien 6,000 6,440 Student loans 3,880 4,223 Structured Insurance 1,645 1,648 Mortgage-backed and home equity-other 323 346 Other 546 547 Total Structured Finance 19,939 21,296 International Finance: Other 3,662 3,702 Total International Finance 3,662 3,702 Total $ 29,562 $ 29,820 (1) Tax-backed includes $2,235 and $1,430 of Puerto Rico net par at June 30, 2014 and December 31, 2013. General obligation includes $250 and $0 of



Puerto Rico net par at June 30, 2014 and December 31, 2013, respectively.

Components of Puerto Rico net par outstanding includes capital appreciation

bonds which are reported at the par amount at the time of issuance of the

related insurance policy.

(2) Includes $611 and $486 of military housing net par at June 30, 2014 and

December 31, 2013, respectively.

The slight decrease in below investment grade exposures is primarily due to (i) reductions to residential mortgage-backed securities during the year as a result of both prepayments by issuers and claims presented to Ambac Assurance and (ii) principal payments on student loans, partially offset by an increase due to deterioration in Puerto Rico and military housing exposures. 77



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RESULTS OF OPERATIONS We followed the accounting prescribed by the Reorganizations Topic of the ASC while Ambac was in reorganization proceedings under Chapter 11 of the U.S. Bankruptcy Code. On April 30, 2013, Ambac executed a closing agreement with the United States Internal Revenue Service (the "IRS") to conclude the settlement of a dispute ("IRS Settlement). On May 1, 2013 (the "Effective Date"), the Reorganization Plan became effective and Ambac emerged from bankruptcy. The IRS Settlement represented the final material contingency under the Reorganization Plan required for the adoption of fresh start financial statement reporting under the Reorganizations Topic of the ASC. As such, fresh start financial statement reporting ("Fresh Start") was adopted by the Company on April 30, 2013 ("Fresh Start Reporting Date"), incorporating, among other things, the discharge of debt obligations, issuance of new common stock, and fair value adjustments. Adopting Fresh Start resulted in a new reporting entity with no beginning retained earnings or accumulated deficit. The financial results of the Company for the periods from May 1, 2013 are referred to as "Successor Ambac" and the financial results for the periods through April 30, 2013 are referred to as "Predecessor Ambac." The 2013 Successor Period and the 2013 Predecessor Period are distinct reporting periods. The effects of the reorganization and Fresh Start adjustments were recorded in Predecessor Ambac's Consolidated Statement of Total Comprehensive Income on the Fresh Start Reporting Date. The effects of emergence and Fresh Start had a material impact on the comparability of our results of operations between these periods, as discussed below. The significant Fresh Start items that were recorded in the four months ended April 30, 2013 which impact comparability are as follows: Investment Income: As required under Fresh Start, the amortized cost basis of Ambac's fixed income securities were adjusted to fair value as of the Fresh Start Reporting Date. This resulted in an overall increase in the amortized cost of fixed income securities and offsetting decrease in Accumulated Other Comprehensive Income of $826.6 million. Premiums and discounts are amortized or accreted over the remaining term of the securities using the effective interest method. As a result of Fresh Start, the net unamortized discount in the portfolio decreased on the Fresh Start Reporting Date by the amount of the increase to amortized cost described above, which impacts the amount of premium amortization and discount accretion reflected in net investment income of Successor Ambac. Interest Expense: As required under Fresh Start, surplus notes issued by Ambac Assurance and the Segregated Account and the related accrued interest on such notes were adjusted to fair value as of the Fresh Start Reporting Date. This resulted in an overall increase in the carrying value of debt and accrued interest by $767.9 million. Discounts to the face value of debt are accreted through interest expense based on the projected cash flows of the instruments using the effective interest method. As a result of Fresh Start, the unamortized discounts on surplus notes have decreased and the future cash flows have been re-projected, both of which impacts the amount of discount accretion recognized in interest expense for Successor Ambac. Operating Expenses-Deferred Acquisition Costs: As required under Fresh Start, deferred acquisition costs have been written off as of the Fresh Start Reporting Date and accordingly amortization of such costs will not be reflected in Successor Ambac's net income. Insurance Intangible Amortization: At the Fresh Start Reporting Date, an insurance intangible asset was recorded which represented the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities. The carrying value of our financial guarantee insurance and reinsurance contracts will continue to be reported and measured in accordance with existing accounting policies; these line items primarily comprise premiums receivable, reinsurance recoverable on paid and unpaid losses, unearned premiums, deferred ceded premium, subrogation recoverable, loss and loss expense reserves, and ceded premiums payable. Subsequent to the Fresh Start Reporting Date, the insurance intangible asset shall be amortized into expense on a basis consistent with the satisfaction of financial guarantee insurance or reinsurance obligations. Goodwill: Represents the excess of the reorganization value over the fair value of identified tangible and intangible assets of Successor Ambac. Goodwill will be assessed for impairment on an annual basis, and more frequently if certain indicators of impairment exist. Refer Note 2 and Note 3 of Ambac's Annual Report on Form 10-K for the year ended December 31, 2013 for a discussion on how goodwill was determined and for the factors that are considered in the impairment assessment process. 78



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A summary of our financial results is shown below:

Successor Ambac - Predecessor Ambac - Quarterly Information ($ in Period from April 1 Period from May 1 through Period from April 1 millions) through June 30, 2014 June 30, 2013 through April 30, 2013 Revenues: Net premiums earned $ 65.0 $ 58.0 $ 29.7 Net investment income 80.1 26.2 32.2 Net other-than-temporary impairment losses (8.8 ) (2.0 ) (0.5 ) Net realized investment (losses) gains 3.1 18.5 7.3 Change in fair value of credit derivatives (1.2 ) 51.2 (73.2 ) Derivative product revenues (48.0 ) 83.7 (33.2 ) Other income 5.3 2.2 (1.1 ) (Loss) income on variable interest entities (38.1 ) 4.6 388.2 Expenses: Loss and loss expenses 175.3 (26.1 ) 13.1 Insurance intangible amortization 36.3 25.0 - Underwriting and operating expenses 24.0 16.2 10.7 Interest expense 32.0 21.1 7.9 Reorganization items 0.2 0.4 (2,747.2 ) Provision for income taxes (2.2 ) 0.5 - Less: Net income attributable to the noncontrolling interest (0.3 ) (0.4 ) (1.7 ) Net income (attributable to common shareholders) $ (207.9 ) $ 205.7 $ 3,066.7 79



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Table of Contents Successor Ambac - Predecessor Ambac -



Year-to-date information ($ in Period from January 1 Period from May 1 through Period from January 1 millions)

through June 30, 2014 June 30, 2013 through April 30, 2013 Revenues: Net premiums earned $ 147.6 $ 58.0 $ 130.0 Net investment income 150.9 26.2 116.7 Net other-than-temporary impairment losses (19.1 ) (2.0 ) (0.5 ) Net realized investment gains 19.4 18.5 53.3 Change in fair value of credit derivatives 6.2 51.2 (60.4 ) Derivative product revenues (101.8 ) 83.7 (33.7 ) Other income 7.2 2.2 8.4 (Loss) income on variable interest entities (43.7 ) 4.6 426.6 Expenses: Loss and loss expenses 35.3 (26.1 ) (38.0 ) Insurance intangible amortization 68.0 25.0 - Underwriting and operating expenses 49.8 16.2 44.6 Interest expense 64.3 21.1 31.0 Reorganization items 0.2 0.4 (2,745.2 ) Provision for income taxes 1.1 0.5 0.8 Less: Net income attributable to the noncontrolling interest (0.2 ) (0.4 ) (1.8 ) Net income (attributable to common shareholders) $ (52.0 ) $ 205.7 $ 3,349.0 The following paragraphs describe the consolidated results of operations of Ambac and subsidiaries for all periods in the three and six months ended June 30, 2014 and 2013 and its financial condition as of June 30, 2014 and December 31, 2013. Net Premiums Earned. Net premiums earned primarily represent the amortization into income of collected insurance premiums. We present accelerated premiums, which result from calls and other accelerations of insured obligations separate from other net premiums earned, herein referred to as normal net premiums earned. Ambac recognizes negative accelerations on policies when the GAAP premiums receivable for the policy exceeds the policy's unearned premium revenue at termination. Normal net premiums earned have been negatively impacted by the runoff of the insured portfolio either via transaction terminations, calls, pre-refundings and scheduled maturities. As noted above, as a result of Fresh Start, insurance and reinsurance assets and liabilities are measured using the same accounting policies for both Successor and Predecessor periods. Net premiums earned for the three and six months ended June 30, 2014 were $65.0 million and $147.6 million, respectively, a decrease of $22.8 million and $40.5 million, as compared to the three and six months ended June 30, 2013, respectively. Normal net premiums earned and accelerated premiums are reconciled to total net premiums earned in the table below and are included in the Financial Guarantee segment. The following table provides a breakdown of net premiums earned by market: Successor Ambac - Predecessor Ambac - Period from May 1 Period from April 1 through June through June 30, Period from April 1 through ($ in millions) 30, 2014 2013 April 30, 2013 Public Finance $ 26.3 $ 23.6 $ 11.8 Structured Finance 10.9 8.9 4.6 International Finance 19.8 12.5 6.2 Total normal premiums earned 57.0 45.0 22.6 Accelerated earnings 8.0 13.0 7.1 Total net premiums earned $ 65.0 $ 58.0 $ 29.7 80



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Table of Contents Successor Ambac - Predecessor Ambac - Period from May 1 Period from January 1 through June 30, Period from January 1 ($ in millions) through June 30, 2014 2013 through April 30, 2013 Public Finance $ 53.7 $ 23.6 $ 47.9 Structured Finance 21.3 8.9 20.3 International Finance 39.5 12.5 25.4 Total normal premiums earned 114.5 45.0 93.6 Accelerated earnings 33.1 13.0 36.4 Total net premiums earned $ 147.6 $ 58.0 $ 130.0



The following table provides a breakdown of accelerated earnings by market sector:

Successor Ambac - Predecessor Ambac - Period from April 1 through June 30, Period from May 1 Period from April 1 ($ in millions) 2014 through June 30, 2013 through April 30, 2013 Public Finance $ 4.9 $ 10.9 $ 6.6 Structured Finance (2.3 ) 2.9 0.5 International Finance 5.4 (0.8 ) - Total accelerated earnings 8.0 13.0 7.1 Successor Ambac - Predecessor Ambac - Period from January 1 through June 30, Period from May 1 Period from January 1 ($ in millions) 2014 through June 30, 2013 through April 30, 2013 Public Finance $ 23.7 $ 10.9 $ 32.6 Structured Finance (2.1 ) 2.9 3.8 International Finance 11.5 (0.8 ) - Total accelerated earnings 33.1 13.0 36.4 Net Investment Income. As noted above, as a result of Fresh Start, the amount of premium amortization and discount accretion reflected in net investment income for Successor Ambac have been impacted by the resetting of the amortized cost basis for fixed income securities to fair value at the Fresh Start Reporting Date. Fresh Start adjustments increased the overall amortized cost basis and decreased the effective yield of the portfolio for Successor Ambac. The following table provides details of net investment income by segment for the periods presented: Successor Ambac - Predecessor Ambac - Period from May 1 Period from April 1 through June through June 30, Period from April 1 through

($ in millions) 30, 2014 2013 April 30, 2013 Financial Guarantee $ 79.6 $ 26.0 $ 31.8 Financial Services 0.4 0.2 0.4 Corporate 0.1 - - Total net investment income 80.1 26.2 32.2 Successor Ambac - Predecessor Ambac - Period from May 1 Period from January 1 through June 30, Period from January 1 ($ in millions) through June 30, 2014 2013 through April 30, 2013 Financial Guarantee $ 150.0 $ 26.0 $ 115.1 Financial Services 0.8 0.2 1.6 Corporate 0.1 - - Total net investment income 150.9 26.2 116.7 81



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For Successor Ambac Financial Guarantee net investment income generally reflects recent market yields for securities in the portfolio, given that the amortized cost bases of securities were reset to fair value at the Fresh Start Reporting Date. Portfolio yields for Predecessor Ambac in 2013 benefited from high yielding Ambac-wrapped securities purchased as part of the company's loss remediation strategy during periods of generally higher market spreads than were prevalent at the Fresh Start Reporting Date. Financial Guarantee net investment income was $79.6 million and $150.0 million for the three and six months ended June 30, 2014, respectively, representing increases of $21.8 million and $8.9 million from the three and six months ended June 30, 2013. The increase in Financial Guarantee net investment income for the three months ended June 30, 2014 primarily reflects the continued investment in Ambac-wrapped securities as well as improved performance of such holdings. Additionally, other invested assets classified as trading produced mark-to-market gains of $3.2 million in the three months ended June 30, 2014, an increase of $5.3 million compared to the three months ended June 30, 2013. These same factors drove the increase in Financial Guarantee net investment income for the six months ended June 30, 2014 compared to the six months ended June 30, 2013, partially offset by the impact of higher yields for the first four months of 2013 preceding the Fresh Start Reporting Date. Financial Services investment income continues to decline, driven primarily by a smaller portfolio of investments in the investment agreement business. The investment portfolio continues to decrease as investment agreements runoff, or when intercompany loans from Ambac Assurance are repaid. Corporate investment income relates to the investments from Ambac's investment portfolio. Net Other-Than-Temporary Impairment Losses. Net other-than-temporary impairment losses recorded in earnings include only credit related impairment amounts to the extent management does not intend to sell and it is not more likely than not that the Company will be required to sell before recovery of the amortized cost basis. Non-credit related impairment amounts are recorded in other comprehensive income. Alternatively, non-credit related impairment is reported through earnings as part of net other-than-temporary impairment losses if management intends to sell securities or it is more likely than not that the Company will be required to sell before recovery of amortized cost less any current period credit impairment. Net other-than-temporary impairments for the three and six month periods ended June 30, 2014 and 2013 relate primarily to the company's intent to sell certain securities that were in an unrealized loss position. Additionally, other-than-temporary impairments for the three and six months ended June 30, 2014 include credit losses on certain Ambac-wrapped securities. Since commencement of the Segregated Account Rehabilitation Proceedings, changes in the estimated timing of claim payments have resulted in adverse changes in projected cash flows on certain impaired Ambac-wrapped securities. Ambac estimates the timing of such claim payment receipts, but the actual timing of such payments are at the sole discretion of the Rehabilitator. Refer to Note 1 to the Unaudited Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for information relating to the amended Segregated Account Rehabilitation Plan; increases to the percentage of permitted policy claims to be paid from 25% to 45%; and the making of certain payments on Deferred Amounts, together with interest thereon; as well as early redemptions of a portion of outstanding surplus notes (including accrued and unpaid interest thereon). Our evaluation of other-than-temporary impairments as of June 30, 2014, particularly with respect to Ambac's intent to sell securities that are in an unrealized loss position, considered the impact of increased cash outflow that would result in 2014 from the increased claim payment percentage, payment on Deferred Amounts and surplus note redemptions. Declines in the fair value of investment securities or changes in management's intent to sell securities to fund these increased cash payments could result in future recognition of other-than-temporary impairments. Additionally, further modifications to the Segregated Account Rehabilitation Plan or to the rules and guidelines promulgated thereunder, orders from the Rehabilitation Court, or actions by the Rehabilitator, with respect to the form, amount and timing of satisfying permitted policy claims, or making payments on Deferred Amounts or surplus notes, may have a material effect on the fair value of Ambac-wrapped securities and future recognition of other-than-temporary impairments. 82



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Net Realized Investment Gains. The following table provides a breakdown of net realized (losses) gains for the periods presented:

Financial Financial ($ in millions) Guarantee Services Corporate Total Successor Ambac - Period from April 1 through June 30, 2014 Net gains on securities sold or called $ 7.2$ 0.2 $ - $ 7.4 Foreign exchange (losses) (4.3 ) - - (4.3 ) Total net realized gains $ 2.9$ 0.2 $ - $ 3.1 Successor Ambac-Period from May 1 through June 30, 2013 Net gains on securities sold or called $ 15.0$ 0.1 $ - $ 15.1 Foreign exchange gains 3.4 - - 3.4 Total net realized gains $ 18.4$ 0.1 $ - $ 18.5 Predecessor Ambac - Period from April 1 through April 30, 2013 Net gains on securities sold or called $ 5.9 $ - $ - $ 5.9 Foreign exchange gains 1.3 - - 1.3 Total net realized gains $ 7.2 $ - $ - $ 7.2 Successor Ambac-Period from January 1 through June 30, 2014 Net gains on securities sold or called $ 25.6$ 0.2 $ - $ 25.8 Foreign exchange (losses) (6.4 ) - - (6.4 ) Total net realized gains $ 19.2$ 0.2 $ - $ 19.4 Predecessor Ambac-Period from January 1 through April 30, 2013 Net gains on securities sold or called $ 7.2$ 39.9 $ - $ 47.1 Foreign exchange gains 6.2 - - 6.2 Total net realized gains $ 13.4$ 39.9 $ - $ 53.3 Net gains during the six months ended June 30, 2014 arose primarily from the sale of assets received pursuant to Ambac's remediation activities and net gains on securities sold in connection with investment portfolio reallocation and to raise liquidity for the anticipated payment of Deferred Amounts and surplus notes in December 2014, partially offset by net foreign exchange losses. The net gains during the four months ended April 30, 2013 were primarily the result of recoveries from the settlement of litigation associated with investment securities that were written-off in 2002 and 2003. No significant future recoveries on these securities are expected. Change in Fair Value of Credit Derivatives. The valuation of credit derivative liabilities is impacted by the market's view of Ambac Assurance's credit quality. We reflect Ambac's own credit quality in the fair value of such liabilities by including a credit valuation adjustment ("CVA") in the determination of fair value. The loss from change in fair value of credit derivatives for the three months ended June 30, 2014 was $1.2 million, a decrease of $20.7 million as compared to the loss for the three months ended June 30, 2013. The gain from change in fair value of credit derivatives for the six months ended June 30, 2014 was $6.2 million, an increase of $15.3 million as compared to the loss for the six months ended June 30, 2013. The change in fair value of credit derivatives for each of the periods presented included improvements in reference obligation prices, gains associated with runoff of the portfolio and credit derivative fees earned, which was more than offset by the impact of incorporating the Ambac CVA. The CVA changes each period are based on observed changes in the fair value of Ambac Assurance's direct and guaranteed obligations. Reductions to the CVA resulted in losses within the overall change in fair value of credit derivative liabilities of $13.0 million and $22.8 million for the three and six months ended June 30, 2014, respectively, and $14.6 million, $91.3 million and $160.9 million for the two months ended June 30, 2013, one month ended April 30, 2013 and four months ended April 30, 2013, respectively. Realized gains and other settlements on credit derivative contracts represent premiums received and accrued on such contracts. Included in the 2013 periods were fees received of $4.6 million during the two months ended June 30, 2013 associated with terminated transactions. Realized gains and other settlements for the three and six months ended June 30, 2014 included $0.1 million of fees received associated with terminated transactions. Excluding the impact of these termination fees, the declines in realized gains and other settlements are due to reduced premium receipts resulting from continued runoff of the credit derivative portfolio. There were no loss or settlement payments in the periods presented. 83



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Unrealized gains (losses) on credit derivative contracts reflect the impact of all other factors of the overall change in fair value of credit derivatives noted above. See Note 7 to the Unaudited Consolidated Financial Statements located in Part I, Item 1 of this Form 10-Q for a further description of Ambac's methodology for determining the fair value of credit derivatives. The table below indicates the impact of incorporating Ambac's own credit risk into the fair value of credit derivatives as of June 30, 2014 and December 31, 2013: ($ in millions) June 30, 2014 December 31, 2013 Mark-to-market liability of credit derivatives, excluding CVA $ 105.8 $



133.3

CVA on credit derivatives (16.1 ) (39.0 ) Net credit derivative liability at fair value $ 89.7 $



94.3

Derivative Product Revenues. The derivative products portfolio is positioned to benefit from rising rates as an economic hedge against interest rate exposure in the financial guarantee portfolio. Net losses reported in derivative product revenues for the three and six months ended June 30, 2014 were ($48.0) million and ($101.8) million, reflecting declines of $98.5 million and $151.8 million as compared to the net gains for the three and six months ended June 30, 2013. Results in derivative product revenues were primarily driven by mark-to-market (losses) gains in the portfolio caused by (falling) rising interest rates during the periods, net of the impact of credit valuation adjustments as discussed below. The fair value of derivatives includes a valuation adjustment to reflect Ambac's own credit risk when appropriate. Within the financial services derivatives portfolio, an Ambac CVA is generally applicable for uncollateralized derivative liabilities that may not be offset by derivative assets under a master netting agreement. Inclusion of an Ambac CVA in the valuation of financial services derivatives resulted in gains (losses) within derivative products revenues of ($9.9) million and ($4.5) million for the three and six months ended June 30, 2014, respectively. Inclusion of an Ambac CVA in the valuation of financial services derivatives resulted in gains (losses) within derivative products revenues of ($30.5) million, $3.4 million and ($26.7) million for the two months ended June 30, 2013, one month ended April 30, 2013 and four months ended April 30, 2013, respectively. The impact of changes to the CVA reflects the market's view of Ambac Assurance's credit quality as well as the amount of underlying liabilities, which generally decline as interest rates increase. The market's view of Ambac Assurance's credit quality improved during 2013 and 2014. The table below indicates the impact of incorporating Ambac's own credit risk into the fair value of the derivative products portfolio (excludes credit derivatives) as of June 30, 2014 and December 31, 2013: ($ in millions) June 30, 2014 December 31, 2013 Derivative products mark-to-market liability, excluding CVA $ 206.8 $



130.3

CVA on derivative products portfolio (43.9 ) (48.4 ) Net derivative products portfolio liability at fair value $ 162.9 $



81.9

Other Income. Other income is primarily comprised of non-investment related foreign exchange gains and losses, and deal structuring, commitment, consent and waiver fees. Other income for the three and six months ended June 30, 2014 was $5.3 million and $7.2 million, respectively, an increase of $4.2 million and a decrease of $3.4 million as compared to the three and six months ended June 30, 2013. Other income for the three and six months ended June 30, 2014 primarily resulted from deal related fees offset by foreign exchange losses. Other income for the three months ended June 30, 2013 primarily resulted from deal related fees. Other income for the six months ended June 30, 2013 primarily resulted from deal related fees in addition to foreign exchange gains. (Loss) Income on Variable Interest Entities. Included within (Loss) income on variable interest entities are income statement amounts relating to VIEs consolidated under the Consolidation Topic of the ASC, including gains or losses attributable to consolidating or deconsolidating VIEs during the periods reported. Generally, the Company's consolidated VIEs are entities for which Ambac has provided financial guarantees on its assets or liabilities. In consolidation, most assets and liabilities of the VIEs are reported at fair value and the related insurance assets and liabilities are eliminated. However, the amount of VIE net assets (liabilities) that remain in consolidation generally result from the net positive (negative) present value of projected cash flows from (to) the VIEs which are attributable to Ambac's insurance subsidiaries in the form of financial guarantee insurance premiums , fees and losses. In the case of VIEs with net negative projected cash flows, the net liability is generally to be funded by Ambac's insurance subsidiaries through insurance claim payments. Differences between the net carrying value of the insurance accounts under the Financial Services-Insurance Topic of the ASC and the carrying value of the consolidated VIE's net assets or liabilities are recorded through income at the time of consolidation or deconsolidation. (Loss) income on variable interest entities was $(38.1) million and $(43.7) million for the three and six months ended June 30, 2014, respectively. Results for the three and six months ended June 30, 2014 reflect decreases to the fair value of net assets primarily due to a decrease in the CVA applied to certain VIE note liabilities that include significant projected financial guarantee claims. Income on variable interest entities for the one and four months ended April 30, 2013 include the net income related to a 84



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newly consolidated VIE. Consolidation of this VIE resulted in a gain of $385.3 million, representing the difference between net assets of the VIE at fair value as of the consolidation date and the previous carrying value of Ambac's net insurance liabilities associated with the VIE. Income on variable interest entities for the four months ended April 30, 2013 includes gains associated with longer estimated lives of certain transactions and the resultant increase in projected positive net cash flows from the VIEs to Ambac in the form of financial guarantee premiums. Refer to Note 3 to the Unaudited Consolidated Financial Statements included in Part I, 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 unconsolidated VIEs. Additionally losses and loss expenses include interest on Deferred Amounts pursuant to the amended Segregated Account Rehabilitation Plan, which became effective June 12, 2014. The amendments to the Segregated Account Rehabilitation Plan primarily modified the mechanism for handling claims under the Segregated Account Rehabilitation Plan. Instead of the combination of cash payments and interest-bearing surplus notes originally contemplated by the Segregated Account Rehabilitation Plan, holders of permitted policy claims will, under the amended Segregated Account Rehabilitation Plan, receive an initial interim cash payment for a portion of such policy claim ("Interim Payment"), together with the right to receive a deferred payment equal to the balance of the unpaid policy claim ("Deferred Amount"). The amended Segregated Account Rehabilitation Plan requires that Deferred Amounts generally accrue and compound interest at an annual effective rate of 5.1%. In the case of permitted policy claims relating to transactions that pay monthly, interest will begin to accrue on Deferred Amounts from the first distribution date (under the transaction documents for the relevant bond) after the date on which the Interim Payment in respect of such permitted policy claim was made. For permitted policy claims relating to transactions that do not pay monthly, interest will begin to accrue on Deferred Amounts from the first Payment Date (as defined in the Segregated Account Rehabilitation Plan, as amended) to occur after the date on which the Interim Payment in respect of such permitted policy claim was made. Losses and loss expenses for the three months ended June 30, 2014 include interest accruals from the beginning of the accrual periods through June 30, 2014. Losses and loss expenses for the three and six months ended June 30, 2014 were a loss of $175.3 million and $35.3 million, respectively, an increase of $188.3 million and $99.5 million as compared to the three and six months ended June 30, 2013, respectively. The three and six months ended June 30, 2014 include $308.1 million of interest expense on Deferred Amounts. The following provides details for losses incurred for the periods presented: Successor Ambac - Predecessor Ambac - Period from April 1 Period from May 1 through June Period from April 1 through April ($ in millions) through June 30, 2014 30, 2013 30, 2013 RMBS $ (234.6 ) 86.8 (84.8 ) Student Loans 28.6 (19.6 ) 0.9 Domestic Public Finance 92.8 (10.4 ) 61.4 Ambac UK (21.2 ) (65.3 ) 10.7 All other Credits (12.2 ) (2.3 ) 21.1 Interest on Deferred Amounts 308.1 - - Loss Expenses 13.8 (15.3 ) 3.8 Totals $ 175.3 $ (26.1 ) $ 13.1 Successor Ambac - Predecessor Ambac - Period from January 1 Period from May 1 through June Period from January 1 through ($ in millions) through June 30, 2014 30, 2013 April 30, 2013 RMBS $ (337.5 ) $ 86.8 (241.1 ) Student Loans (54.2 ) (19.6 ) 35.4 Domestic Public Finance 99.8 (10.4 ) 45.6 Ambac UK 16.1 (65.3 ) 88.8 All other Credits (11.7 ) (2.3 ) 23.1 Interest on Deferred Amounts 308.1 - - Loss Expenses 14.7 (15.3 ) 10.1 Totals $ 35.3 $ (26.1 ) $ (38.1 ) 85



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The following table provides details of net claims recorded, net of reinsurance for the affected periods: Successor Ambac - Predecessor Ambac - Period from April 1 Period from April 1 Period from May 1 through through April 30, ($ in millions) through June 30, 2014 June 30, 2013 2013 Claims recorded (1) $ 107.0 $ 139.0 $ 90.9 Subrogation Received (169.6 ) (58.9 ) (32.6 ) Net Claims Recorded $ (62.6 ) $ 80.1 $ 58.3 Successor Ambac - Predecessor Ambac - Period from January 1 Period from May 1 through Period from January 1 through ($ in millions) through June 30, 2014 June 30, 2013 April 30, 2013 Claims recorded (1) $ 231.8 $ 139.0 $ 403.4 Subrogation Received (239.3 ) (58.9 ) (160.4 ) Net Claims Recorded $ (7.5 ) $ 80.1 $ 243.0 (1) Claims recorded include (i) claims paid and (ii) changes to claims



presented and not yet presented through the balance sheet date for policies

which were allocated to the Segregated Account. Item (ii) includes

permitted policy claims for policies allocated to the Segregated Account

that were presented and approved by the Rehabilitator of the Segregated

Account but not paid through to the balance sheet date in accordance with

the Segregated Account Rehabilitation Plan and associated rules and

guidelines as discussed in Note 1 to the Consolidated Financial Statements

in Part II, Item 8 of Ambac's 2013 Form 10-K and in Note 1 to the

Unconsolidated Financial Statements in Part I, Item 1 of this Form 10-Q.

Amounts recorded for claims not yet presented and/or permitted are based on

management's judgment.

As of June 30, 2014 and December 31, 2013, respectively, $4,307.2 million and $3,904.3 million of Segregated Account claims, including accrued interest payable on Deferred Amounts of $308.1 and $0, respectively, remain unpaid. Underwriting and Operating Expenses. Underwriting and operating expenses consist of gross operating expenses plus the amortization of previously deferred insurance acquisition costs. The amortization of previously deferred underwriting expenses is included in Financial Guarantee segment results. As noted above, all deferred acquisition costs were written off in Fresh Start and accordingly no amortization is reported in Successor Ambac. The following table provides details of underwriting and operating expenses for the periods presented: Successor Ambac - Predecessor Ambac - Period from May 1 Period from April 1 through June through June 30, Period from April 1 through ($ in millions) 30, 2014 2013 April 30, 2013

Gross Operating Expenses 23.0 $ 15.6 $ 9.4 Reinsurance commissions, net 1.0 0.6 0.1 Amortization of deferred acquisition costs - - 1.2 Total $ 24.0 $ 16.2 $ 10.7 Successor Ambac - Predecessor Ambac - Period from May 1 Period from January 1 through June 30, Period from January 1 ($ in millions) through June 30, 2014 2013 through April 30, 2013 Gross Operating Expenses $ 48.9 $ 15.6 $ 37.8 Reinsurance commissions, net 0.9 0.6 0.3 Amortization of deferred acquisition costs - - 6.5 Total $ 49.8 $ 16.2 $ 44.6 86



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Gross operating expenses for the three and six months ended June 30, 2014 were $23.0 million and $48.9 million, down $2.0 million and $4.5 million as compared to the three and six months ended June 30, 2013, respectively. The decrease is primarily due to changes to the present value of premium taxes, partially offset by higher director fees. 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 the hiring of advisers. During the three and six months ended June 30, 2014 expenses incurred in connection with legal and consulting services provided for the benefit of OCI amounted to $2.3 million and $3.2 million, respectively, flat as compared to three months ended June 30, 2013 and a decrease of $0.5 million as compared to the six months ended June 30, 2013, respectively. Future expenses may include advisory costs for the benefit of OCI that are outside the control of Ambac's management. Interest Expense. Interest expense includes accrued interest on investment agreements, a secured borrowing transaction and surplus notes issued by Ambac Assurance and the Segregated Account. Additionally, interest expense includes discount accretion on surplus notes as their carrying value is at a discount to par. As noted above, as a result of Fresh Start, the unamortized discounts on surplus notes have decreased by resetting the carrying value to fair value at the Fresh Start Reporting Date and future cash flows on the surplus notes have been re-projected. Both of these items have impacted the amount of discount accretion recognized in interest expense for Successor Ambac. Accretion of surplus note discounts included within overall interest expense was $12.2 million and $24.9 million for the three and six months ended June 30, 2014, as compared to $8.3 million, $1.4 million and $5.1 million for the two months ended June 30, 2013, and for the one and four months ended April 30, 2013, respectively. The following table provides details by type of obligation for the periods presented: Successor Ambac - Predecessor Ambac - Period from May 1 Period from April 1 through June through June 30, Period from April 1 ($ in millions) 30, 2014 2013 through April 30, 2013 Interest expense: Surplus notes $ 31.5 $ 20.7 $ 7.5 Investment agreements 0.5 0.3 0.3 Secured borrowing - 0.1 0.1 Total $ 32.0 $ 21.1 $ 7.9 Successor Ambac - Predecessor Ambac - Period from May 1 Period from January 1 through June through June 30, Period from January 1 ($ in millions) 30, 2014 2013 through April 30, 2013 Interest expense: Surplus notes $ 63.4 $ 20.7 $ 29.5 Investment agreements 0.9 0.3 1.3 Secured borrowing - 0.1 0.2 Total $ 64.3 $ 21.1 $ 31.0 Ambac Assurance and the Segregated Account have not paid any interest on surplus notes since their issuance. Surplus note interest payments require the approval of OCI. Annually from 2011 through 2014, OCI issued its disapproval of the requests of Ambac Assurance and the Rehabilitator of the Segregated Account, acting for and on behalf of the Segregated Account, to pay interest on outstanding surplus notes issued by Ambac and the Segregated Account on the annual scheduled interest payment date of June 7th. As a result of this disapproval, total unapproved interest for surplus notes outstanding to third parties (excluding junior surplus notes) was $277.7 million at the scheduled interest payment date of June 7, 2014. OCI has also not approved any payment on any junior surplus notes since their issuance. The disapproved interest was accrued for and Ambac is accruing interest on the disapproved interest amounts following each scheduled interest payment date. As described in Note 1 to the Unaudited Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q, the Rehabilitator will redeem certain Segregated Account surplus notes (other than junior surplus notes) on December 22, 2014 at a redemption price that includes an amount equal to accrued interest on such redeemed surplus notes. Such redemption will also trigger similar proportionate redemption payments on Ambac Assurance's surplus notes. The redemption of surplus notes will result in a charge representing the accelerated recognition of the unamortized discount on the redeemed surplus notes. As of June 30, 2014, the unamortized discount on the portion of Segregated Account and General Account surplus notes expected to be redeemed is $79.3 million. 87



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Reorganization Items. Reorganization items are primarily expenses directly attributed to our Chapter 11 reorganization process. The following table presents reorganization fees for all periods presented:

Successor Ambac - Predecessor Ambac - Period from May 1 Period from April 1 through June through June 30, Period from April 1 ($ in millions) 30, 2014 2013 through April 30, 2013 Reorganization items: Professional advisory fees $ 0.2 $ 0.4 $ 2.4 Gain from cancellation and satisfaction of Predecessor Ambac debt - - (1,521.4 ) Fresh Start reporting adjustments - - (1,228.2 ) Total $ 0.2 $ 0.4 $ (2,747.2 ) Successor Ambac - Predecessor Ambac - Period from May 1 Period from January 1 through June through June 30, Period from January 1 ($ in millions) 30, 2014 2013 through April 30, 2013 Reorganization items: Professional advisory fees $ 0.2 $ 0.4 $ 4.4 Gain from cancellation and satisfaction of Predecessor Ambac debt - - (1,521.4 ) Fresh Start reporting adjustments - - (1,228.2 ) Total $ 0.2 $ 0.4 $ (2,745.2 ) Provision for Income Taxes. The provision for income taxes for the three and six months ended June 30, 2014 was $(2.1) million and $1.1 million, decreased by $2.8 million and $0.2 million as compared to the three and six months ended June 30, 2013. The income tax for the three and six months ended June 30, 2014 includes a provision of $0.0 million and $0.0 million for Federal alternative minimum tax obligations, respectively. For both periods, the income tax expense also includes a provision for pre-tax profits in Ambac UK's Italian branch, which cannot be offset by losses in other jurisdictions. The income tax for the four months ended April 30, 2013 also includes a provision for New York State/New York City alternative minimum tax obligations. At June 30, 2014 the Company had $5.4 billion of U.S. Federal net ordinary operating loss carryforwards, including $1.4 billion at Ambac Financial Group and $4.0 billion at Ambac Assurance. Ambac Assurance Statutory Basis Financial Results Ambac Assurance's and the Segregated Account's statutory financial statements are prepared on the basis of accounting practices prescribed or permitted by the OCI. OCI recognizes only statutory accounting practices prescribed or permitted by the State of Wisconsin ("SAP") 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. OCI has prescribed or permitted additional accounting practices for Ambac Assurance and the Segregated Account which are described in Note 9 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's 2013 Form 10-K. As a result of the amended Segregated Account Rehabilitation Plan becoming effective on June 12, 2014, the previously disclosed OCI prescribed practice relating to other than temporarily impaired investment securities is no longer effective. Ambac has received a new prescribed practice from OCI with regard to the carrying value of investments in Ambac-insured securities with policies that were allocated to the Segregated Account. The new permitted practice exempts Ambac Assurance from evaluating such investments for other than temporary impairments and requires all such investments be reported at amortized cost regardless of its NAIC risk designation. This accounting determination is intended to recognize that Ambac Assurance continues to maintain statutory loss reserves without adjustment for the economic effects of its ownership of the insured investment securities, improve transparency to the users of the statutory financial statements and to minimize operational risks. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Ambac's 2013 Form 10-K for additional information on the significant differences between U.S. GAAP and SAP. 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 within Ambac Assurance's statutory basis financial statements. Accordingly, Ambac 88



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Assurance's statutory financial statements include the results of Ambac Assurance's general account and, to the extent allowable under a prescribed accounting practice by OCI, the Segregated Account. Pursuant to this prescribed practice, the results of the Segregated Account are not fully included in Ambac Assurance's statutory financial statements if Ambac Assurance's surplus is (or would be) less than $100 million ("Minimum Surplus Amount"). Please refer to Note 1 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's 2013 Form 10-K and Note 1 to the Unconsolidated Financial Statements in Part I, Item 1 of this Form 10-Q for additional information on the establishment of the Segregated Account as well as the operative documents between Ambac Assurance and the Segregated Account. Ambac Assurance's statutory policyholder surplus and qualified statutory capital (defined as the sum of policyholders surplus and mandatory contingency reserves) were $945.7 million and $1,052.4 million at June 30, 2014, respectively, as compared to $840.3 million and $905.1 million at December 31, 2013, respectively. The Segregated Account's statutory policyholder surplus amount, which is included in Ambac Assurance's policyholder surplus, was $442.0 million and $442.6 million as of June 30, 2014 and December 31, 2013, respectively. In the event that Ambac Assurance does not maintain surplus in excess of the Minimum Surplus Amount, the Segregated Account would experience a shortfall in funds available to pay its liabilities to the extent that such liabilities exceed amounts available under the Reinsurance Agreement and Cooperation Agreement (each as defined in Note 1 to the Unaudited Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q). Any such shortfall would be a consideration for the Rehabilitator in the determination of whether any changes to the Segregated Account Rehabilitation Plan and/or the amount of partial policy claim payments are necessary or appropriate or whether to institute general rehabilitation proceedings against Ambac Assurance. Ambac Assurance's decrease in policyholder surplus was primarily due to the accrual of $308.1 million of interest on Deferred Amounts pursuant to the amended Segregated Account Rehabilitation Plan in addition to contributions to contingency reserves. Statutory net loss was primarily due to additional losses incurred related to the accrual of interest on Deferred Amounts partially offset by positive loss development on RMBS policies, premium income and investment income recognized during 2014. Ambac Assurance's statutory policyholder surplus includes $1,641.9 million surplus notes and junior surplus notes issued to various parties (including $350 million of junior surplus notes held by Ambac). These surplus notes and junior surplus notes, as well as preferred stock issued by Ambac Assurance, are obligations of Ambac Assurance that must be satisfied prior to Ambac realizing residual value from Ambac Assurance. Ambac Assurance's statutory surplus is sensitive to multiple factors, including: (i) loss reserve development (inclusive of Segregated Account reserves and interest on Deferred Amounts), (ii) approval by OCI of principal and/or interest payments on existing surplus notes issued by Ambac Assurance or the Segregated Account, (iii) deterioration in the financial position of Ambac Assurance subsidiaries that have their obligations guaranteed by Ambac Assurance, (iv) first time payment defaults of insured obligations, which increases statutory loss reserves, (v) commutations of insurance policies or credit derivative contracts at amounts that differ from the amount of liabilities recorded, (vi) reinsurance contract terminations at amounts that differ from net assets recorded, (vii) changes to the fair value of investments carried at fair value, (viii) settlements of representation and warranty breach claims at amounts that differ from amounts recorded, including failures to collect such amounts, (ix) realized gains and losses, including losses arising from other than temporary impairments of investment securities, and (x) future changes to prescribed SAP practices by the OCI. Ambac UK Financial Results under UK Accounting Principles Ambac UK is required to prepare financial statements under the provisions of The Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 relating to insurance companies, and in accordance with the Statement of Recommended Practice on Accounting for Insurance Business issued by the Association of British Insurers dated December 2005 (as amended in December 2006) (collectively referred to as "UK GAAP"). Ambac UK is also required to prepare financial statements pursuant to the Accounts and Statements Rules set out in Part I and Part IV of Chapter 9 to IPRU(INS) the Interim Prudential Sourcebook for Insurers, GENPRU the General Prudential Sourcebook and INSPRU the Insurance Prudential Sourcebook ("the Rules") made by the Prudential Regulatory Authority under section 138 of the Financial Services and Markets Act 2000 ("UK Regulatory"). Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in Ambac's 2013 Form 10-K for additional information on the significant differences between these accounting bases and U.S. GAAP. The deficit in Ambac UK's shareholder funds under UK GAAP was 112.0 million at June 30, 2014 as compared to a deficit of 165.4 million at December 31, 2013. Ambac UK's improvement in shareholders' funds was primarily due to net income. Notwithstanding the deficit in shareholders' funds, the directors remain satisfied that Ambac UK has adequate resources to meet its obligations as they fall due and that Ambac UK remains a going concern. At June 30, 2014, the carrying value of cash and investments was 316.1 million, an increase from 297.2 million at December 31, 2013. The increase in cash and investments is due to the continued receipt of premium income and investment coupons from AmbacUK's investment portfolio. The deficit in Ambac UK's shareholder funds under UK Regulatory was 400.4 million at June 30, 2014 as compared to a deficit of 458.1 million 89



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at December 31, 2013, an improvement primarily due to net income offset by an increase in inadmissible assets. The deficit at June 30, 2014 and December 31, 2013 are in comparison to a regulatory capital requirement of 21.6 million for both periods whereby Ambac UK is deficient in terms of compliance with applicable regulatory capital requirements with a regulatory capital shortfall of 422.0 million and 479.7 million at June 30, 2014 and December 2013, respectively. The regulators are aware of this deficiency and dialogue between Ambac UK management and its regulators remains ongoing with respect to options for addressing the shortcoming, although such options remain few. LIQUIDITY AND CAPITAL RESOURCES Ambac Financial Group, Inc. Liquidity. Ambac's liquidity is dependent on its current cash and investments, expense sharing and other arrangements with Ambac Assurance as described below and value to be realized from junior surplus notes issued to Ambac by the Segregated Account of Ambac Assurance. Pursuant to the Mediation Agreement, Amended TSA and Cost Allocation Agreement (as each such term is defined in Note 1 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's 2013 Form 10-K), Ambac Assurance is required, under certain circumstances, to make payments to Ambac with respect to the utilization of net operating loss carry-forwards ("NOLs") and to reimburse certain costs and expenses. Any expected receipts with regard to the utilization of NOLs will only occur after Ambac Assurance utilizes NOLs generated after September 30, 2011, which amount to approximately $346.1 million and $270.3 million as of June 30, 2014 and December 31, 2013, respectively. It is also uncertain whether and to what extent Ambac will realize value from the junior surplus note issued to it by the Segregated Account. See Note 1 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's Form 10-K for descriptions of the Mediation Agreement, the Amended TSA, the Cost Allocation Agreement and the junior surplus note. It is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future and therefore the aforementioned payments will be Ambac's principal source of funds in the near term. Refer to Part I, Item 1, "Insurance Regulatory Matters - Dividend Restrictions, Including Contractual Restrictions" and Note 9 to the Consolidated Financial Statements located in Part II, Item 8, of Ambac's 2013 Form 10-K for more information on dividend payment restrictions. The principal use of liquidity is the payment of operating expenses. Contingencies could cause material liquidity strains. Ambac Assurance Liquidity. Ambac Assurance's liquidity is dependent on the balance of liquid investments and, over time, the net impact of sources and uses of funds. The principal sources of Ambac Assurance's liquidity are gross installment premiums on insurance and credit default swap contracts, principal and interest payments from investments, sales of investments, proceeds from repayment of affiliate loans, recoveries on claim payments and reinsurance recoveries. Termination of installment premium policies on an accelerated basis may adversely impact Ambac Assurance's liquidity. The principal uses of Ambac Assurance's liquidity are the payment of operating expenses, claim and commutation payments on both insurance and credit derivative contracts, ceded reinsurance premiums, surplus note principal and interest payments and additional loans to affiliates. Interest and principal payments on surplus notes are subject to the approval of OCI, which has full discretion over payments regardless of the liquidity position of Ambac Assurance. The level of claims paid by the Segregated Account is subject to the sole discretion of the Rehabilitator, subject to any required approval of the Rehabilitation Court. Ambac Assurance manages its liquidity risk by maintaining a comprehensive analysis of projected cash flows. Additionally, the financial guarantee business maintains a specified level of cash and short-term investments at all times. Pursuant to the injunctions issued by the Rehabilitation Court, claims on policies allocated to the Segregated Account were not permitted to be paid during the Segregated Account Rehabilitation Proceedings until approved by the Rehabilitator. As further described in Note 1 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's 2013 Form 10-K, on or about September 20, 2012, the Segregated Account was permitted to pay, and commenced paying, 25% of each permitted policy claim that arose since the commencement of the Segregated Account Rehabilitation Proceedings. As further described in Note 1 to the Unaudited Financial Statements in Part I, Item 1 of this Form 10-Q, the Segregated Account is, and was, obliged to make Interim Payments of 45% of each permitted policy claim to be paid on or after July 21, 2014 in accordance with the Segregated Account Rehabilitation Plan and associated rules and guidelines. In addition, as described in Note 1 to the Consolidated Financial Statements in Part II, Item 8 of Ambac's 2013 Form 10-K and in Note 12 to the Unaudited Financial Statements in Part I, Item 1 of this Form 10-Q, the Rehabilitator has sought and received approval from the Rehabilitation Court to make Supplemental Payments and Special Policy Payments with respect to certain insured securities. During the three and six months ended June 30, 2014, the Segregated Account made total cash payments of $39.9 million and $106.9 million, respectively, of which $8.5 million for the three months ended June 30, 2014 and $52.4 million for the six months ended June 30, 2014 related to Supplemental Payments and Special Policy Payments in respect of permitted policy claims. Permitted policy claims, including Deferred Amounts together with interest thereon, will be material uses of future liquidity. 90



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As described in Note 1, under the Segregated Account Rehabilitation Plan, as amended, surplus notes will not be issued with respect to the unpaid balance of permitted policy claims, and such unpaid balances (as adjusted from time to time pursuant to the amended Segregated Account Rehabilitation Plan) will instead be recorded by the Segregated Account as Deferred Amounts. The Deferred Amounts will accrue interest (i) in the case of permitted policy claims relating to transactions that pay monthly, from the first distribution date (under the transaction documents for the relevant bond) after the date on which the Interim Payment in respect of such permitted policy claim was made until such outstanding policy obligations are paid in full or (ii) for permitted policy claims relating to transactions that do not pay monthly, from the first Payment Date (as defined in the Segregated Account Rehabilitation Plan, as amended) to occur after the date on which the Interim Payment in respect of such permitted policy claim was made until such outstanding policy obligations are paid in full. Interest on the Deferred Amounts will accrue generally at an effective rate of 5.1%, compounded annually. In the case of insured bonds whose outstanding principal balance is not reduced by the unpaid portion of permitted policy claims (such bonds, "Undercollateralized Bonds"), the 5.1% effective annual interest rate on the Deferred Amount will be reduced by the bond interest rate applicable to such Undercollateralized Bonds. The Segregated Account is responsible for accrued interest of $308.1 million through June 30, 2014. Furthermore, as more fully described in Note 1, on December 22, 2014, the Rehabilitator will make equalizing payments of 26.67% of Deferred Amounts, together with interest thereon, outstanding as of July 20, 2014 and will early redeem a portion of the surplus notes issued by the Segregated Account, together with interest thereon, which will result in a proportionate redemption by Ambac Assurance of its surplus notes. Using the balance of Deferred Amounts at June 30, 2014, the aggregate amount of equalizing payments for Deferred Amounts is estimated to be approximately $1,139 million. The early redemption of Segregated Account and Ambac Assurance surplus notes owned by third parties, including accrued interest, is estimated to be approximately $413.6 million in the aggregate. In addition, as described in Note 1 to the Unaudited Financial Statements in Part 1, Item 1 of this Form 10-Q, the Segregated Account will establish Junior Deferred Amounts in respect of general claims, instead of issuing junior surplus notes as originally contemplated. Junior Deferred Amounts will generally accrue and compound interest at an annual effective rate of 5.1% and will be payable, as and when determined by the Rehabilitator, in his sole and absolute discretion. If approved by the Rehabilitator, payment of these Junior Deferred Amounts, together with interest thereon, will be a use of future liquidity. Ambac Assurance is limited in its ability to pay dividends pursuant to the terms of its Auction Market Preferred Shares ("AMPS"), which state that dividends may not be paid on the common stock of Ambac Assurance unless all accrued and unpaid dividends on the AMPS for the then current dividend period have been paid, provided that dividends on the common stock may be made at all times for the purpose of, and only in such amounts as are necessary for enabling Ambac (i) to service its indebtedness for borrowed money as such payments become due or (ii) to pay its operating expenses. If dividends are paid on the common stock for such purposes, dividends on the AMPS become cumulative until the date that all accumulated and unpaid dividends have been paid on the AMPS. Ambac Assurance has not paid dividends on the AMPS since 2010. Refer to Part I, Item 1, "Insurance Regulatory Matters - Dividend Restrictions, Including Contractual Restrictions" and Note 9 to the Consolidated Financial Statements located in Part II, Item 8, of Ambac's 2013 Form 10-K for more information on dividend payment restrictions. Our ability to recover RMBS subrogation recoveries and other 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. 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 materially. Ambac Assurance received subrogation of $170.7 million and $240.9 million during the three and six months ended June 30, 2014, respectively. A wholly-owned subsidiary of Ambac Assurance is a party to credit default swaps ("CDS") with various commercial counterparties. Ambac Assurance guarantees its subsidiary's payment obligations under such CDS. The terms of such CDS include events of default or termination events based on the occurrence of certain events, or the existence of certain circumstances, relating to the financial condition of Ambac Assurance, including the commencement of an insolvency, rehabilitation or like proceeding. If such an event of default or termination event were to occur, the CDS counterparties could claim the contractual right to terminate the CDS and require Ambac Assurance, as financial guarantor, to make termination payments. Ambac Assurance estimates that such potential termination payments amount to $170.6 million as of June 30, 2014. However, the Rehabilitation Court has issued an injunction barring the early termination of contracts based on the occurrence of events or the existence of circumstances like those described above. As a result, Ambac Assurance does not expect to make early termination payments in respect of CDS where such amounts are claimed based on the occurrence of events, or the existence of circumstances, relating to the financial condition of Ambac Assurance. Financial Services Liquidity. The principal uses of liquidity by Financial Services subsidiaries are payments on investment agreement obligations, payments on intercompany loans, payments under derivative contracts (primarily interest rate 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 coupon receipts; the maturity of invested assets; sales of invested assets; intercompany loans from Ambac Assurance; and receipts from derivative contracts. 91



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While meaningful progress has been made in unwinding the Financial Services businesses, multiple sources of risk continue to exist. These include deterioration in investment security market values, additional unexpected draws on outstanding investment agreements, potential swap terminations and the inability to replace or establish new hedge positions and interest rate volatility. Investment agreements subject Ambac to liquidity risk associated with unanticipated withdrawals of principal as allowed by the terms of contingent withdrawal provisions within all remaining outstanding investment agreements. Investment agreements outstanding as of June 30, 2014 were issued in connection with either municipal bonds or structured credit-linked notes ("CLNs"). The investment agreements contain contingent withdrawal risk in the event of either an early redemption of the related bond issue or certain credit events pertaining to the underlying borrower. As of June 30, 2014, Ambac had $124.4 million of contingent withdrawal investment agreements related to CLNs and $45.7 million related to municipal bonds. The investment agreement business manages liquidity risk by closely matching the maturity schedules of its invested assets with the maturity schedules of its investment agreement liabilities. Additionally, management performs 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. Liquidity risk also exists in the derivative contract and investment agreement portfolios due to contract provisions which may require collateral posting or early termination of contracts. Both the investment agreement and swap businesses borrow cash and securities from Ambac Assurance to meet liquidity needs when such borrowing is determined to be most economically beneficial to Ambac Assurance. Intercompany loans are made under established lending agreements with defined borrowing limits that have received non-disapproval from OCI. Cash Flow Statement Discussion. Net cash provided by (used in) operating activities was $172.3 million, $39.6 million and ($0.7) million during the six months ended June 30, 2014, two months ended June 30, 2013, the four months ended April 30, 2013, respectively. The principal sources of Ambac's operating cash flows are gross installment premiums on insurance contracts and fees on credit default swap contracts, investment coupon receipts, claim and reinsurance recoveries and RMBS subrogation recoveries. The principal uses of Ambac's liquidity are the payment of operating expenses, claim and commutation payments on both insurance and credit derivative contracts, ceded reinsurance premiums and tax payments. During the six months ended June 30, 2014, Ambac had net loss and loss expense recoveries of $73.2 million. Ambac had net loss and loss expense recoveries of $3.8 million and $20.4 million in the two months ended June 30, 2013 and the four months ended April 30, 2013, respectively. In addition, premium collection and credit derivative receipts by Ambac were down approximately $8.0 million. In connection with the Settlement Agreement with the IRS, Ambac paid $101.9 million to the US Treasury in April 2013. Future operating cash flows will primarily 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 Deferred Amounts and interest thereon), including payments under credit default swap contracts. As discussed above in Ambac Assurance Liquidity, the Segregated Account Rehabilitation Plan, as amended, will have adverse consequences to Ambac's future cash flows as the percentage of the initial cash Interim Payment for permitted policy claims increased from 25% to 45% as of July 21, 2014. Additionally, operating cash flows will be impacted by the expected payment, on December 22, 2014, for both equalizing payments of Deferred Amounts and the early redemption of a portion of the surplus notes issued by the Segregated Account and Ambac Assurance. Total net cash outflows associated with the payment of Deferred Amounts and the redemption of surplus notes specified above are expected to exceed $1.5 billion. Net cash used in financing activities was ($190.0) million, ($3.3) million and ($5.5) million during the six months ended June 30, 2014, two months ended June 30, 2013, the four months ended April 30, 2013, respectively. Financing activities for the six months ended June 30, 2014 included payments for investment agreement draws of $190.0 million. Financing activities for the two months ended June 30, 2013 and the four months ended April 30, 2013 included paydowns on a variable interest entity secured borrowing of $3.3 million and $5.5 million, respectively. Net cash provided by (used) in investing activities was $14.8 million, ($168.7) million and $112.3 million for the six months ended June 30, 2014, two months ended June 30, 2013 and the four months ended April 30, 2013, respectively. Credit Ratings and Collateral. Ambac Assurance is no longer rated by Moody's and S&P, which resulted in the triggering of required cure provisions in nearly all of the investment agreements issued. 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, at June 30, 2014Ambac posted collateral of $168.2 million in connection with its outstanding investment agreements. Ambac Financial Services, LLC ("AFS") provided interest rate and currency swaps for states, municipalities, asset-backed issuers and other entities in connection with their financings. AFS hedges its interest rate risk of these instruments, as well as a portion of the interest rate risk in the financial guarantee portfolio, with standardized derivative contracts, including financial futures contracts, which contain collateral or margin requirements. Under these hedge agreements, AFS is required to post collateral or margin to its counterparties and futures commission merchants to cover unrealized losses. In addition, AFS is required to post 92



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collateral or margin in excess of the amounts needed to cover unrealized losses. All AFS derivative contracts containing ratings-based downgrade triggers that could result in collateral or margin posting or a termination have been triggered. If terminations were to occur, AFS would be required to make termination payments but would also receive a return of collateral or margin in the form of cash, U.S. Treasury or U.S. government agency obligations with market values equal to or in excess of market values of the swaps and futures contracts. In most cases, AFS will look to re-establish hedge positions that are terminated early. This may result in additional collateral or margin obligations. The amount of additional collateral or margin posted on derivatives contracts will depend on several variables including the degree to which counterparties exercise their termination rights (or agreements terminate automatically) and the terms on which hedges can be replaced. All collateral and margin obligations are currently met. Collateral and margin posted by AFS totaled a net amount of $160.1 million, including independent amounts, under these contracts at June 30, 2014. Ambac Credit Products ("ACP") entered into credit derivative contracts. ACP is not required to post collateral under any of its contracts. BALANCE SHEET Fresh start accounting prescribed by the Reorganizations Topic of the ASC was adopted upon our emergence from Chapter 11 proceedings on April 30, 2013 (the "Effective Date"). As a result of the application of fresh start accounting, Successor Ambac remeasured all tangible and intangible assets and all liabilities, other than deferred taxes and liabilities associated with post-retirement benefits, at fair value, and recorded goodwill representing the excess of reorganization value of Successor Ambac over the fair value of net assets being re-measured. Thus, the post-emergence consolidated financial statements reflect the new basis of accounting. Total assets increased by approximately $631 million from December 31, 2013 to $27.7 billion at June 30, 2014, primarily due to an increase in both the non-VIE and VIE investment portfolios partially offset by lower insurance intangible assets and premium receivables from the runoff of the insured portfolio. Total liabilities increased by approximately $386 million from December 31, 2013 to $26.5 billion as of June 30, 2014 , primarily as a result of (i) higher variable interest entity liabilities; (ii) higher loss and loss expense reserves (primarily from the accrual of interest on Deferred Amounts of $308.1 million during 2014) and (iii) higher derivative liabilities; partially offset by (i) lower unearned premium reserves and (ii) lower investment agreement liabilities. As of June 30, 2014 total stockholders' equity was $1,223 million, compared with total stockholders' equity of $978.4 million at December 31, 2013. This increase was primarily due comprehensive income earned during the period, which includes appreciation of non-VIE investment fair values partially offset by the net loss for the six months ended June 30, 2014. Investment Portfolio. Ambac Assurance's non-VIE investment objective is to achieve the highest after-tax yield on a diversified portfolio of primarily fixed income investments while employing asset/liability management practices to satisfy all operating and strategic liquidity needs. Ambac Assurance's investment portfolio is subject to internal investment guidelines and is subject to limits on types and quality of investments imposed by the insurance laws and regulations of the States of Wisconsin and New York. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits. Within these guidelines, Ambac Assurance opportunistically purchases Ambac Assurance insured securities in the open market given their relative risk/reward characteristics. Ambac Assurance's investment policies are subject to oversight by the Rehabilitator of the Segregated Account pursuant to contracts entered into between Ambac Assurance and the Segregated Account. Ambac UK's non-VIE investment policy is designed with the primary objective of ensuring that Ambac UK is able to meet its financial obligations as they fall due, in particular with respect to policyholder claims. Ambac UK's investment portfolio is primarily fixed income investments and pooled investment funds with diversified holdings. The portfolio is subject to internal investment guidelines and may be subject to limits on types and quality of investments imposed by the PRA as regulator of Ambac UK. Ambac UK's investment policy sets forth minimum credit rating requirements and concentration limits, among other restrictions. The Board of Directors of Ambac UK approves any changes or exceptions to AmbacUK's investment policy. The Financial Services non-VIE investment portfolio consists primarily of assets funded with proceeds from the issuance of investment agreement liabilities. The primary investment objective is to invest in a diversified portfolio of high-grade securities that produce sufficient cash flow to satisfy all investment agreement liabilities and their collateral requirements. The investment portfolio is subject to internal investment guidelines. Such guidelines set forth minimum credit rating requirements and credit risk concentration limits. 93



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The following table summarizes the composition of Ambac's investment portfolio, excluding VIE investments, at fair value by segment at June 30, 2014 and December 31, 2013:

Financial Financial ($ in millions) Guarantee Services Corporate Total Successor Ambac-June 30, 2014: Fixed income securities: Municipal obligations (1) $ 981.1 $ - $ - $ 981.1 Corporate obligations 1,891.8 - - 1,891.8 Foreign obligations 144.1 - - 144.1 U.S. government obligations 32.6 45.0 - 77.6 U.S. agency obligations 30.2 - - 30.2 Residential mortgage-backed securities (2) 1,853.4 - - 1,853.4 Collateralized debt obligations 144.4 - - 144.4 Other asset-backed securities 826.3 119.3 32.2 977.8 5,903.9 164.3 32.2 6,100.4 Short-term (1) 335.2 4.1 4.9 344.2 Other investments 256.5 - - 256.5 6,495.6 168.4 37.1 6,701.1 Fixed income securities pledged as collateral: U.S. government obligations 65.0 - - 65.0 65.0 - - 65.0 Total investments $ 6,560.6$ 168.4$ 37.1$ 6,766.1 Percent total 97.0 % 2.5 % 0.5 % 100 % Financial Financial ($ in millions) Guarantee Services Corporate Total Successor Ambac-December 31, 2013: Fixed income securities: Municipal obligations (1) $ 1,377.7 $ - $ - $ 1,377.7 Corporate obligations 1,489.4 - - 1,489.4 Foreign obligations 124.9 - - 124.9 U.S. government obligations 89.1 37.2 - 126.3 U.S. agency obligations 32.1 - - 32.1 Residential mortgage-backed securities (2) 1,547.8 10.8 - 1,558.6 Collateralized debt obligations 176.2 7.7 - 183.9 Other asset-backed securities 649.9 314.4 28.1 992.4 5,487.1 370.1 28.1 5,885.3 Short-term (1) 262.3 - 8.8 271.1 Other investments 241.1 - - 241.1 5,990.5 370.1 36.9 6,397.5 Fixed income securities pledged as collateral: U.S. government obligations 126.2 - - 126.2 126.2 - - 126.2 Total investments $ 6,116.7$ 370.1$ 36.9$ 6,523.7 Percent total 93.7 % 5.7 % 0.6 % 100.0 %



(1) Includes taxable and tax exempt securities.

(2) Includes RMBS insured by Ambac Assurance.

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The following table represents the fair value of mortgage and asset-backed securities at June 30, 2014 and December 31, 2013 by classification:

Financial Financial ($ in millions) Guarantee Services Corporate Total Successor Ambac-June 30, 2014: Residential mortgage-backed securities: RMBS-Second Lien $ 860.0 $ - $ - $ 860.0 RMBS-First-lien-Alt-A 544.6 - - 544.6 RMBS-First Lien-Sub Prime 287.2 - - 287.2 RMBS-First Lien-Prime 122.7 - - 122.7 U.S. Government Sponsored Enterprise Mortgages 37.8 - - 37.8 Government National Mortgage Association 1.1 - - 1.1 Total residential mortgage-backed securities 1,853.4 - - 1,853.4 Other asset-backed securities Military Housing 227.4 - - 227.4 Credit Cards 55.4 114.8 9.0 179.2 Auto 156.0 4.5 23.2 183.7 Student Loans 237.7 - - 237.7 Structured Insurance 51.4 - - 51.4 Other 98.4 - - 98.4 Total other asset-backed securities 826.3 119.3 32.2 977.8 Total $ 2,679.7$ 119.3$ 32.2$ 2,831.2 Successor Ambac-December 31, 2013: Residential mortgage-backed securities: RMBS-Second Lien $ 702.1 $ - $ - $ 702.1 RMBS-First-lien-Alt-A 468.8 - - 468.8 RMBS-First Lien-Sub Prime 246.0 - - 246.0 RMBS-First Lien-Prime 86.7 - - 86.7 U.S. Government Sponsored Enterprise Mortgages 42.9 10.8 - 53.7 Government National Mortgage Association 1.3 - - 1.3 Total residential mortgage-backed securities 1,547.8 10.8 - 1,558.6 Other asset-backed securities Military Housing 344.1 - - 344.1 Credit Cards 20.7 235.3 8.0 264.0 Auto 122.5 79.1 17.8 219.4 Student Loans 14.0 - - 14.0 Structured Insurance 50.9 - - 50.9 Other 97.7 - 2.3 100.0 Total other asset-backed securities 649.9 314.4 28.1 992.4 Total $ 2,197.7$ 325.2$ 28.1$ 2,551.0 The weighted average rating, which is based on the lower of Standard & Poor's or Moody's ratings, of the mortgage and asset-backed securities is CC and BB as of June 30, 2014, and CCC- and BBB+ as of December 31, 2013, respectively. Ambac's fixed income portfolio includes securities covered by guarantees issued by Ambac Assurance and other financial guarantors ("insured securities"). The published rating agency 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. In the event these underlying ratings are not available from the rating agencies, Ambac will 95



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assign an internal rating. Refer to Note 8 to the Unaudited Financial Statements included in Part 1, Item 1 of this Form 10-Q for further details on securities insured by Ambac Assurance. The following table provides the ratings distribution of the fixed income investment portfolio based on market value at June 30, 2014 and December 31, 2013 by segment: Rating (1): Financial Guarantee Financial (2) Services Corporate Combined Successor Ambac-June 30, 2014: AAA 12 % 71 % 100 % 15 % AA 14 29 - 13 A 18 - - 17 BBB 17 - - 17 Below investment grade 34 - - 33 Not rated 5 - - 5 100 % 100 % 100 % 100 % Successor Ambac-December 31, 2013: AAA 12 % 87 % 100 % 16 % AA 24 13 - 23 A 19 - - 18 BBB 14 - - 13 Below investment grade 26 - - 25 Not rated 5 - - 5 100 % 100 % 100 % 100 %



(1) Ratings are based on the lower of Moody's or S&P ratings. If guaranteed,

rating represents the higher of the underlying or guarantor's financial

strength rating. (2) Below investment grade insured bonds purchased as part of the loss



remediation strategy represent 29% and 21% of the 2014 and 2013 Financial

Guarantee portfolio, respectively.

The increase in the percentage of below investment grade holdings since December 31, 2013 is driven by additional purchases of and increased prices on insured bonds held under Ambac's loss remediation strategy. 96



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The following table summarizes, for all available-for-sale securities in an unrealized loss position as of June 30, 2014 and December 31, 2013, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position:

June 30, 2014 (2) December 31, 2013 Gross Gross Estimated Unrealized Estimated Unrealized ($ in millions) Fair Value (1) Losses Fair Value (1) Losses Municipal obligations in continuous unrealized loss for: Less than 12 months $ 49.6 $ 0.2 $ 437.7 $ 28.4 Greater than 12 months 205.6 7.8 - - 255.2 8.0 437.7 28.4 Corporate obligations in continuous unrealized loss for: Less than 12 months 213.1 1.6 877.4 23.9 Greater than 12 months 243.0 5.9 - - 456.1 7.5 877.4 23.9 Foreign government obligations in continuous unrealized loss for: Less than 12 months 50.4 1.3 117.9 6.9 Greater than 12 months 61.6 3.9 - - 112.0 5.2 117.9 6.9 U.S. government obligations in continuous unrealized loss for: Less than 12 months 15.3 0.8 70.0 2.2 Greater than 12 months 15.8 1.1 - - 31.1 1.9 70.0 2.2 U.S. agency obligations in continuous unrealized loss for: Less than 12 months - - 5.8 0.1 Greater than 12 months 4.5 - - - 4.5 - 5.8 0.1 Residential mortgage-backed securities in continuous unrealized loss for: Less than 12 months 167.5 7.2 644.5 18.1 Greater than 12 months 10.1 0.2 - - 177.6 7.4 644.5 18.1 Collateralized debt obligations in continuous unrealized loss for: Less than 12 months 10.1 0.3 137.7 0.4 Greater than 12 months - - - - 10.1 0.3 137.7 0.4 Other asset-backed securities in continuous unrealized loss for: Less than 12 months 33.0 - 630.0 36.6 Greater than 12 months - - - - 33.0 - 630.0 36.6 Short term securities in continuous unrealized loss for: Less than 12 months 4.0 - - - Greater than 12 months - - - - 4.0 - - - Total $ 1,083.6$ 30.3$ 2,921.0$ 116.6



(1) Since the table is presented in millions, securities with market values and

unrealized losses that are less than $0.1 will be shown as zero. (2) As a result of the implementation of Fresh Start, amortized cost for available for sale securities was set to equal fair value on April 30,



2013. Accordingly, at December 31, 2013, Ambac does not have any gross

unrealized losses that have been in a continuous unrealized loss position

for greater than 12 months.

Management has determined that the unrealized losses in available-for-sale securities at June 30, 2014 are primarily driven by the increases in interest rates and market shifts in risk and liquidity premiums demanded by fixed income investors between the Fresh Start Reporting Date of April 30, 2013 and June 30, 2014. Ambac has concluded that unrealized losses reflected in the table above are temporary in nature based upon (a) there being no unexpected principal and interest payment defaults on these securities; (b) an analysis of the creditworthiness of the issuer and financial guarantor, as applicable, and analysis of projected defaults on the underlying collateral; (c) management having no intent to sell these securities; and (d) it being not more likely than not that Ambac will be required to sell these debt securities before the anticipated recovery of its amortized cost basis. 97



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The following table summarizes amortized cost and fair value for all available-for-sale securities in an unrealized loss position as of June 30, 2014 and December 31, 2013, by contractual maturity date:

June 30, 2014 (2) December 31, 2013 Amortized Estimated Amortized Estimated ($ in millions) Cost Fair Value Cost Fair Value Municipal obligations: Due in one year or less $ - $ - $ - $ - Due after one year through five years 20.6 20.5 74.8 73.1 Due after five years through ten years 148.2 143.6 313.7 294.1 Due after ten years 94.4 91.1 77.6 70.5 263.2 255.2 466.1 437.7 Corporate obligations: Due in one year or less 2.0 2.0 25.5 25.5 Due after one year through five years 171.5 169.7 357.5 353.7 Due after five years through ten years 276.6 271.2 475.9 457.8 Due after ten years 13.5 13.2 42.4 40.4 463.6 456.1 901.3 877.4 Foreign government obligations: Due in one year or less 2.5 2.3 - - Due after one year through five years 44.4 43.3 51.7 50.4 Due after five years through ten years 66.7 63.0 67.6 62.8 Due after ten years 3.6 3.4 5.5 4.7 117.2 112.0 124.8 117.9 U.S. government obligations: Due in one year or less 5.1 4.7 0.4 0.4 Due after one year through five years 17.9 17.1 51.3 50.3 Due after five years through ten years 10.0 9.3 17.8 16.7 Due after ten years - - 2.7 2.6 33.0 31.1 72.2 70.0 U.S. agency obligations: Due in one year or less - - 1.3 1.3 Due after one year through five years 4.5 4.5 4.6 4.5 Due after five years through ten years - - - - Due after ten years - - - - 4.5 4.5 5.9 5.8 Residential mortgage-backed securities 185.0 177.6 662.6 644.5 Collateralized debt obligations 10.4 10.1 138.1 137.7 Other asset-backed securities 33.0 33.0 666.6 630.0 Short term securities 4.0 4.0 - - Total $ 1,113.9$ 1,083.6$ 3,037.6$ 2,921.0 98



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Reinsurance Recoverables. Ambac Assurance has reinsurance in place pursuant to surplus share treaty and facultative agreements. To minimize its exposure to losses from reinsurers, Ambac Assurance (i) monitors the financial condition of its reinsurers; (ii) is entitled to receive collateral from its reinsurance counterparties in certain reinsurance contracts; and (iii) has certain cancellation rights that can be exercised by Ambac Assurance in the event of rating agency downgrades of a reinsurer (among other events and circumstances). Ambac Assurance held letters of credit and collateral amounting to approximately $157.6 million from its reinsurers at June 30, 2014. As of June 30, 2014, the aggregate amount of insured par ceded by Ambac Assurance to reinsurers under reinsurance agreements was $17,576 million, with the largest reinsurer accounting for $15,756 million or 8.5% of gross par outstanding at June 30, 2014. The following table represents the percentage ceded to reinsurers and reinsurance recoverable at June 30, 2014 and the reinsurers' rating levels as of August 5, 2014: Net unsecured reinsurance Moody's Moody's Percentage recoverable Reinsurers Rating Outlook ceded Par (in thousands) (1) Assured Guaranty Re Ltd Baa1 Negative 89.7 % $ 36,077 Sompo Japan Insurance Inc A1 Stable 6.0 % - Assured Guaranty Corporation A3 Negative 4.3 % 6,362 Total 100.0 % $ 42,439



(1) Represents reinsurance recoverables on paid and unpaid losses and deferred

ceded premiums, net of ceded premium payables due to reinsurers, letters of

credit, and collateral posted for the benefit of Ambac Assurance. Insurance Intangible Asset. At the Fresh Start Reporting Date, an insurance intangible asset was recorded which represented the difference between the fair value and aggregate carrying value of the financial guarantee insurance and reinsurance assets and liabilities. As of June 30, 2014 and December 31, 2013, the insurance intangible asset was $1,549 million and $1,598 million, respectively. The change in the intangible asset during the six months ended June 30, 2014 was primarily due to amortization of $68.0 million. Accumulated amortization was equal to $169 million and $101 million at June 30, 2014 and December 31, 2013, respectively. Goodwill. At the Fresh Start Reporting Date, goodwill of $515 million was recorded which represented the excess reorganization value which could not be attributed to the fair value of specific identified tangible and intangible assets. As of June 30, 2014 we concluded goodwill was not impaired and the asset remains at $515 million. Derivative Liabilities. The valuation of derivative liabilities (credit derivatives and interest rate swaps) is impacted by the market's view of Ambac Assurance's credit quality. We reflect Ambac's credit quality in the fair value of such liabilities by including a CVA in the determination of fair value, whereas a lower (higher) CVA, in isolation, would result in an increase (decrease) in the liability. Successor Ambac reduced its derivative liabilities by $60.0 million at June 30, 2014 and $87.4 million at December 31, 2013 to incorporate the market's view of Ambac's credit quality. The lower CVA as of June 30, 2014 is a function of (i) changes to the underlying derivative liabilities before considering Ambac credit quality and (ii) the market's view that Ambac's credit quality improved during the six months ended June 30, 2014. Loss and Loss Expense Reserves. Losses and loss expenses are based upon estimates of the ultimate aggregate losses inherent in the financial guarantee portfolio for insurance policies issued to beneficiaries, including unconsolidated VIEs as of the reporting date. Additionally, loss and loss expense reserves include the unpaid portion of interest accrued on Deferred Amounts. The loss and loss expense reserves for financial guarantee insurance discussed herein relates only to Ambac's non-derivative insurance business for insurance policies for which we do not consolidate the VIE. The evaluation process for determining the level of reserves is subject to certain estimates and judgments. The loss and loss expense reserves, before reinsurance as of June 30, 2014 and December 31, 2013 were $5,588.2 million and $5,470.2 million, respectively. As of June 30, 2014 and December 31, 2013, respectively, $4,307.2 million and $3,904.3 million of Segregated Account claims remain unpaid, including unpaid accrued interest on Deferred Amounts of $308.1 million and $0, respectively. 99



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Loss and loss expense reserves are included in the Consolidated Balance Sheets as follows: June 30, 2014 Present Value of Expected Net ($ in millions) Unpaid Claims Cash Flows Balance Sheet Line Accrued Claims and Unearned Premium Gross Loss and Loss Item Claims Interest Loss Expenses Recoveries (1) Revenue Expense Reserves Loss and loss expense reserves $ 3,184$ 238$ 4,542$ (1,416 )$ (476 ) $ 6,072 Subrogation recoverable 815 70 235 (1,604 ) - (484 ) Totals $ 3,999$ 308$ 4,777$ (3,020 )$ (476 ) $ 5,588 December 31, 2013 Present Value of Expected Net ($ in millions) Unpaid Claims Cash Flows Balance Sheet Line Claims and Unearned Premium Gross Loss and Loss Item Claims Accrued Interest Loss Expenses Recoveries (1) Revenue Expense Reserves Loss and loss expense reserves $ 3,374 $ - $ 4,895$ (1,798 )$ (503 ) $ 5,968 Subrogation recoverable 530 - 136 (1,164 ) - (498 ) Totals $ 3,904 $ - $ 5,031$ (2,962 )$ (503 ) $ 5,470



(1) Present value of future recoveries include RMBS representation and warranty

recoveries of $2,284 and $2,207 at June 30, 2014 and December 31, 2013,

respectively.

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 certain bond types, it is reasonably possible that a material change in actual loss severities and defaults could occur over time. In the future, our experience may differ with respect to the types of guaranteed bonds affected or the magnitude of the effect. The bond types that have experienced significant claims and loss reserves are residential mortgage-backed securities ("RMBS") and student loan securities. These two bond types represent 94% of our ever-to-date insurance claims recorded with RMBS comprising 90% of our ever-to-date claims payments. The table below indicates gross par outstanding and the components of gross loss and loss expense reserves related to policies in Ambac's loss reserves at June 30, 2014 and December 31, 2013: June 30, 2014 Present Value of Expected Net Unpaid Claims Cash Flows Gross Loss and ($ in Gross par Accrued Claims and Unearned Premium Loss Expense millions) outstanding (1) Claims interest Loss Expenses Recoveries Revenue Reserves (1) (2) RMBS $ 10,941 $ 3,981$ 307$ 2,034$ (2,866 )$ (48 ) $ 3,408 Student Loans 2,214 - - 1,014 (35 ) (59 ) 920 Domestic Public Finance 5,185 18 1 580 (114 ) (76 ) 409 Ambac UK 1,879 918 (5 ) (241 ) 672 All other credits 1,262 - - 134 - (52 ) 82 Loss expenses - - - 97 - - 97 Totals $ 21,481 $ 3,999$ 308$ 4,777$ (3,020 )$ (476 ) $ 5,588 100



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Present Value of Expected Net

Unpaid Claims Cash Flows Gross Loss and ($ in Gross par Claims and Unearned Premium Loss Expense millions) outstanding (1) Claims Accrued interest Loss Expenses Recoveries Revenue Reserves (1) (2) RMBS $ 11,683 $ 3,891 $ - $ 2,312$ (2,821 )$ (70 ) $ 3,312 Student Loans 2,352 - - 1,078 (37 ) (59 ) 982 Domestic Public Finance 5,019 13 - 500 (97 ) (78 ) 338 Ambac UK 1,844 - - 882 (7 ) (242 ) 633 All other credits 1,309 - - 148 - (54 ) 94 Loss expenses - - - 111 - - 111 Totals $ 22,207 $ 3,904 $ - $ 5,031$ (2,962 )$ (503 ) $ 5,470 (1) Ceded Par Outstanding and ceded loss and loss expense reserves at June 30, 2014 and December 31, 2013, are $1,285 and $109 and $901 and $121, respectively. Ceded loss and loss expense reserves are included in Reinsurance recoverable on paid and unpaid losses.



(2) Loss reserves are included in the balance sheet as Loss and loss expense

reserves or Subrogation recoverable dependent on if a policy is in a net

liability or net recoverable position.

RMBS

Ambac insures RMBS transactions collateralized by first-lien mortgages. Ambac classifies its insured first-lien RMBS exposure principally into two broad credit risk classes: mid-prime (including Alt-A, interest only, and negative amortization) and sub-prime. Mid-prime loans were typically made to borrowers who had stronger credit profiles relative to sub-prime loans, but weaker than prime loans. Compared with mid-prime 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. Ambac has also insured RMBS transactions collateralized predominantly by 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 Representation and Warranty Subrogation Recoveries Ambac records subrogation recoveries as a component of its loss reserve estimate, related to securitized loans in RMBS transactions that breached certain representations and warranties described herein. Generally, the sponsor of an RMBS transaction provided representations and warranties with respect to the securitized loans, including representations with respect to the loan characteristics, the absence of fraud or other misconduct in the origination process, and attesting to the compliance of loans with the prevailing underwriting policies. In such cases, the sponsor of the transaction is contractually obligated to repurchase, cure or substitute collateral for any loan that breaches the representations and warranties. Ambac or its counsel engaged consultants with significant mortgage underwriting experience to review the underwriting documentation for mortgage loans underlying certain insured RMBS transactions. Transactions which 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) high levels of early payment defaults, (ii) significant number of loan liquidations or charge-offs and resulting high levels of losses, and (iii) rapid elimination of credit protections inherent in the transactions' structures. Clause (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 actions to recover against the collateral, and the securitization has incurred losses to the extent such actions did not result in full repayment of the borrower's obligations. Refer to Note 2 and Note 8 of the Consolidated Financial Statements included in 101



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Part II, Item 8 of Ambac's 2013 Form 10-K for more information regarding the estimation process for representation and warranty subrogation recoveries.

The table below distinguishes between RMBS credits for which we have not established a representation and warranty subrogation recovery and those for which we have, providing in both cases the gross par outstanding, gross loss and loss expense reserves before subrogation recoveries, subrogation recoveries, and gross loss and loss expense reserves net of subrogation for all RMBS exposures for which Ambac established reserves at June 30, 2014 and December 31, 2013: June 30, 2014 Gross loss and loss Gross loss and loss expense reserves expense before reserve net of representation and



Representation and representation and

Gross par warranty subrogation warranty subrogation warranty subrogation ($ in millions) outstanding recoveries recoveries recoveries Second-lien $ 1,997 $ 534 $ - $ 534 First-lien Mid-prime 3,444 2,084 - 2,084 First-lien Sub-prime 1,259 159 - 159 Other 245 179 - 179 Total Credits Without Subrogation 6,945 2,956 - 2,956 Second-lien 2,172 1,287 (1,678 ) (391 ) First-lien Mid-prime 149 610 (150 ) 460 First-lien Sub-prime 1,675 839 (456 ) 383 Total Credits With Subrogation 3,996 2,736 (2,284 ) 452 Total $ 10,941 $ 5,692 $ (2,284 ) $ 3,408 December 31, 2013 Gross loss and loss Gross loss and loss expense expense reserves reserves net of before representation and Representation and representation and Gross par warranty subrogation warranty subrogation warranty subrogation ($ in millions) outstanding recoveries recoveries recoveries Second-lien $ 2,127 $ 502 $ - $ 502 First-lien-Mid-prime 2,590 1,523 - 1,523 First-lien-Sub-prime 1,386 181 - 181 Other 262 149 - 149 Total Credits Without Subrogation 6,365 2,355 - 2,355 Second-lien 2,408 1,291 (1,411 ) (120 ) First-lien Mid-prime 1,139 1,026 (430 ) 596 First-lien Sub-prime 1,771 847 (366 ) 481 Total Credits With Subrogation 5,318 3,164 (2,207 ) 957 Total $ 11,683 $ 5,519 $ (2,207 ) $ 3,312 STUDENT LOANS 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. Default data has shown a significant deterioration in the performance of private student loans underlying many of our transactions. Additionally, due to the failure of the auction rate markets, and the subsequent downgrade of the Auction Rate Securities ("ARS"), the interest rates on our insured ARS have increased significantly to punitive levels pursuant to the auction rate transaction terms. 102



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The combined increase in defaults and the penalty rate on the ARS continue to erode the collateralization levels in many of the trusts we insure. Trusts which are currently under-collateralized will see an accelerated deterioration of parity over time as there is not enough excess spread from the assets to cover current obligations.



Total student loan gross loss and loss expense reserves and related gross par outstanding on Ambac insured obligations were as follows:

June 30, 2014 December 31, 2013 Gross Loss and Loss Gross Loss and Loss Gross Par Expense Gross Par Expense Issuer Type ($ in millions) Outstanding Reserves Outstanding Reserves For-Profit Issuers $ 1,883 $ 843 $ 1,951 $ 921 Not-For-Profit Issuers 331 77 401 61 Total $ 2,214 $ 920 $ 2,352 $ 982 Collateral for the For-Profit Issuers consists of private loans which do not have any federal guarantee as to defaulted principal and interest. Collateral for the Not-For-Profit Issuers consists of both FFELP and private student loans. Approximately 30% of the collateral backing the Not-For-Profit Issuers consists of FFELP loans while the remaining 70% consists of private loans. Private loan defaults have been on the rise since the credit crisis in 2008 began. Elevated unemployment rates, combined with high student loan debt levels will continue to put pressure on borrower's ability to pay their loans. REASONABLY POSSIBLE ADDITIONAL NET CASH FLOWS Ambac's management believes that the reserves for loss and loss expenses and unearned premium reserves are adequate to cover claims presented, but reserves for loss and loss expenses are based on estimates and there can be no assurance that the ultimate liability will not exceed such estimates. As discussed in Note 6 to the Unaudited Financial Statements in Part I, Item 1 of this Form 10-Q, reserves for loss and loss expenses include unpaid claims for insurance policies allocated to the Segregated Account. These unpaid claims are measured based on the estimated cost of settling the claims, which is principal plus accrued interest. The following reasonably possible additional net cash flows exclude changes to such amounts since they are unrelated to the likelihood of issuer default and potential recoveries and they will only be settled at the sole and absolute discretion of the Rehabilitator. It is possible that our loss estimate assumptions for insurance policies discussed above could be understated. We have attempted to identify reasonably possible cash flows using more stressful assumptions. The reasonably possible net cash flows consider the highest stress scenario that was utilized in the development of our probability-weighted expected loss at June 30, 2014 and assumes an inability to execute commutation transactions with issuers and/or investors. Such stress scenarios are developed based on management's view about all possible outcomes. In arriving at such view, management makes considerable judgments about the possibility of various future events. Such judgments may not conform to outcomes considered possible by others. Although we do not believe it is reasonably possible to have worst case outcomes in all cases, it is reasonably possible we could have worst case outcomes in some or even many cases. Similarly, it is also reasonably possible we will achieve better outcomes than our recorded probability weighted loss reserve. RMBS Changes to assumptions that could make our reserves under-estimated include deterioration in housing prices, poor servicing, the effects of a weakened economy marked by growing unemployment and wage pressures, and/or illiquidity of the mortgage market. Additionally, our actual subrogation recoveries could be significantly lower than our estimate of $2.3 billion, before reinsurance, as of June 30, 2014 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. In the case of both first and second-lien exposures, the reasonably possible stress case assumes a significantly harsher HPA projection, which in turn drives higher defaults and severities. Using this approach, the reasonably possible increase in loss reserves for RMBS credits for which we have an estimate of expected loss at June 30, 2014 could be approximately $171 million. 103



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Student Loans Changes to assumptions that could make our reserves under-estimated include but are 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. For student loan credits for which we have an estimate of expected loss at June 30, 2014, the reasonably possible increase in loss reserves could be approximately $636 million. Public Finance It is possible our loss reserves for public finance credits may be materially under-estimated because most credits and the portfolio as a whole have possible outcomes more adverse than our recorded loss reserves. For public finance credits with loss reserves at June 30, 2014, the sum of all losses in the highest stress case used in our current loss reserving process is $1,755 million greater than the current probability weighted loss reserve. In our past experience, losses in the public finance portfolio have been contained, with most of our adversely classified credits resolving without loss to Ambac. For example, we have entered into settlements with two municipalities in bankruptcy that do not require us to suffer permanent losses if our settlements are confirmed and the cities' plans are adopted. We have a small exposure to another city in bankruptcy and have not yet resolved the treatment of our exposure in their plan. While an unfavorable outcome in this case would not be material financially, all adverse precedents are concerning to the extent they may influence the behavior of other stressed municipalities. Our recent experience with the city of Detroit in its bankruptcy proceeding has not been favorable and renders future outcomes with other issuers even more difficult to predict and may increase the risk that we may suffer losses that could be sizable. We agreed to settlements regarding our insured Detroit general obligation bonds that provide better treatment of our exposures than the city planned to include in its plan, but nevertheless require us to incur a loss for a significant portion of our par exposure. Our settlements are also contingent upon the city's successful plan adoption such that we remain exposed to worse outcomes should it be unable to exit bankruptcy as planned. An additional troubling precedent in the Detroit case is the preferential treatment of certain creditor classes, especially the city pensions. The cost of pensions is often a key driver of municipal stress and less severe treatment of pension obligations in bankruptcy may lead to worse outcomes for traditional debt creditors. In addition, cities may be more inclined to use bankruptcy to resolve their financial stresses if they believe preferred outcomes for various creditor groups can be achieved. We currently consider high severity outcomes to be outlying and therefore implicitly assign low or remote probabilities to such outcomes into our current loss reserves unless the situation develops adversely. We expect municipal bankruptcies and defaults to continue to be challenging to project given their complexity and long duration as well as their relative infrequency and the uniqueness of each case, particularly with regard to policy and political issues. Another potentially adverse development that could cause the loss reserves on our public finance credits to be underestimated is deterioration in the municipal bond market that deprives issuers' access to funding necessary to avoid defaulting on their obligations. While our loss reserves consider our judgment regarding issuers' financial flexibility to adapt to adverse markets, they may not adequately capture sudden, unexpected or protracted market volatility that closes markets. Our exposures to the Commonwealth of Puerto Rico are under stress arising from the Commonwealth's poor financial condition, low ratings and limited access to capital. The Commonwealth's announced plans to improve its financial position and prospects include the restructuring of debt obligations, and while terms are unknown, and the targets of their restructuring may change, we believe there is a chance of incurring a loss that could be higher than our current reserves. Our loss reserves include scenarios designed to cover a range of possible outcomes but the possible outcomes could shift quickly and materially as this volatile situation unfolds. Other Credits, including Ambac UK It is possible our loss reserves on other types of credits, including Ambac UK, may be materially under-estimated because most credits have possible outcomes more adverse than the recorded loss reserve. For all other credits, including Ambac UK, for which we have an expected loss, the sum of all the highest stress case loss scenarios is $918 million greater than the current loss reserve at June 30, 2014. 104



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Table of Contents SPECIAL PURPOSE AND VARIABLE INTEREST ENTITIES Please refer to Note 3, "Special Purpose Entities, Including Variable Interest Entities" of the Unaudited Consolidated Financial Statements, located in Item 1 of this Form 10-Q, for information regarding special purpose and variable interest entities. ACCOUNTING STANDARDS Please refer to Note 14 of the Unaudited Consolidated Financial Statements located in Part I, Item 1 of this Form 10-Q for a discussion of the impact of recent accounting pronouncements on Ambac's financial condition and results of operations. NON-GAAP FINANCIAL MEASURES In addition to reporting the Company's quarterly financial results in accordance with GAAP, the Company reports two non-GAAP financial measures: Operating Earnings (Losses) and Adjusted Book Value. A non-GAAP financial measure is a numerical measure of financial performance or financial position that excludes (or includes) amounts that are included in (or excluded from) the most directly comparable measure calculated and presented in accordance with GAAP. We are presenting these non-GAAP financial measures because they provide greater transparency and enhanced visibility into the underlying profitability drivers of our business and the impact of certain items that the Company believes will reverse from GAAP book value over time through the GAAP statements of comprehensive income. Operating Earnings (Losses) and Adjusted Book Value are not substitutes for the Company's GAAP reporting, should not be viewed in isolation and may differ from similar reporting provided by other companies, which may define non-GAAP measures differently. The following paragraphs define each non-GAAP financial measure and describe why it is useful. A reconciliation of the non-GAAP financial measure and the most directly comparable GAAP financial measure is also presented below. Operating Earnings (Losses). Operating Earnings (Losses) eliminates the impact of certain GAAP accounting requirements and includes certain items that the Company has realized or expects to realize in the future, but that are not reported under GAAP. Operating Earnings (Losses) is defined as net income attributable to common shareholders, as reported under GAAP, adjusted on an after-tax basis for the following: Elimination of the non-credit impairment fair value gains (losses) on



credit derivatives, which is the amount in excess of the present value of

the expected estimated credit losses. Such fair value adjustments are

heavily affected by, and in part fluctuate with, changes in market factors

such as interest rates and credit spreads, including the market's perception of Ambac's credit risk ("Ambac CVA"), and are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee segment contracts to be accounted for consistent with the Financial Services - Insurance Topic of ASC, whether or not they are subject to derivative accounting rules.



Elimination of the effects of VIEs that were consolidated as a result of

being insured by Ambac. These adjustments eliminate the VIE consolidation

and ensure that all financial guarantee segment contracts are accounted for

consistent with the provisions of the Financial Services - Insurance Topic

of the ASC, whether or not they are subject to consolidation accounting

rules.

Elimination of the amortization of the financial guarantee insurance

intangible asset and impairment of goodwill that arose as a result of

Ambac's emergence from bankruptcy and the implementation of Fresh Start

reporting. The amount reported in net income attributable to common

shareholders represents the amortization of Fresh Start adjustments

relating to financial guarantee contracts. These adjustments ensure that

all financial guarantee segment contracts are accounted for consistent with

the provisions of the Financial Services - Insurance Topic of the ASC.



Elimination of the foreign exchange gains (losses) on re-measurement of net

premium receivables and loss and loss expense reserves. Long-duration

receivables constitute a significant portion of the net premium receivable

balance and represent the present value of future contractual or expected

collections. Therefore, the current period's foreign exchange

re-measurement gains (losses) are not necessarily indicative of the total

foreign exchange gains (losses) that Ambac will ultimately recognize.



Elimination of the gains (losses) relating to Ambac's CVA on derivative

contracts other than credit derivatives. Similar to credit derivatives,

fair values include the market's perception of Ambac's credit risk and this

adjustment only allows for such gain or loss when realized. 105



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Elimination of the gains (losses) on call options on certain surplus notes

of Ambac Assurance. Under GAAP accounting, Ambac recorded only a portion of

its call options as derivatives. This adjustment allows for all such call

options to be accounted for consistently. All call options were either

exercised or expired in June 2012. Gains (losses) on call option exercises

are not being adjusted for within Operating Earnings (Losses), consistent

with other gains and losses.

Elimination of non-recurring GAAP Fresh Start reporting adjustments.

The following table reconciles net income attributable to common shareholders to the non-GAAP measure, Operating Earnings (Losses), for all periods presented: Successor Ambac - Predecessor Ambac - Period from April 1 through June 30, Period from May 1 through Period from April 1 (Dollars in Millions) 2014 June 30, 2013 through April 30, 2013 Net (loss) income attributable to common shareholders $ (207.9 ) $ 205.7 $ 3,066.8



Adjustments:

Non-credit impairment fair value (gain) loss on credit derivatives 2.3 (50.1 ) 77.5 Effect of consolidating financial guarantee VIEs 52.9 (15.3 ) (386.6 ) Insurance intangible amortization 36.3 25.0 - Foreign exchange (gain) loss from re-measurement of premium receivables and loss and loss expense reserves (6.8 ) 7.3 (6.7 ) Fair value (gain) loss on derivatives from Ambac CVA 9.9 30.5 (3.4 ) Fresh Start accounting adjustments - - (2,749.7 ) Operating Earnings (Losses) $ (113.3 ) $ 203.1 $ (2.1 ) Successor Ambac - Predecessor Ambac - Period from January 1 through June 30, Period from May 1 through Period from January 1 (Dollars in Millions) 2014 June 30, 2013 through April 30, 2013 Net (loss) income attributable to common shareholders $ (52.0 ) $ 205.7 $ 3,349.0



Adjustments:

Non-credit impairment fair value (gain) loss on credit derivatives (1.9 ) (50.1 ) 71.6 Effect of consolidating financial guarantee VIEs 53.2 (15.3 ) (413.7 ) Insurance intangible amortization 68.0 25.0 - Foreign exchange (gain) loss from re-measurement of premium receivables and loss and loss expense reserves (8.5 ) 7.3 11.3 Fair value loss on derivative products from Ambac CVA 4.5 30.5 26.7 Fresh Start accounting adjustments - - (2,749.7 ) Operating Earnings (Losses) $ 63.3 $ 203.1 $ 295.2 The effects of Ambac's emergence from bankruptcy and Fresh Start had a material impact on the comparability of Operating Earnings (Losses) between the periods presented. Refer above for discussion of the significant Fresh Start items impacting comparability. Adjusted Book Value. Adjusted Book Value eliminates the impact of certain GAAP accounting requirements and includes the addition of certain items that the Company has realized or expects to realize in the future, but that are not reported under GAAP. Adjusted Book Value is defined as Total Ambac Financial Group, Inc. stockholders' equity as reported under GAAP, adjusted for after-tax impact of the following: Elimination of the non-credit impairment fair value loss on credit derivatives, which is the amount in excess of the present value of the expected estimated economic credit loss. GAAP Fair values are heavily affected by, and in part fluctuate with, changes in market factors such as interest rates, credit spreads, including Ambac's CVA that are not expected to result in an economic gain or loss. These adjustments allow for all financial guarantee segment contracts 106



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to be accounted for within Adjusted Book Value consistent with the provisions of the Financial Services-Insurance Topic of the ASC, whether or not they are subject to derivative accounting rules. Elimination of the effects of VIEs that were consolidated as a result of



being insured by Ambac. These adjustments eliminate VIE consolidation

and ensure that all financial guarantee segment contracts are accounted

for within Adjusted Book Value consistent with the provisions of the Financial Services-Insurance Topic of the ASC, whether or not they are subject to consolidation accounting rules.



Elimination of the financial guarantee insurance intangible asset and

goodwill that arose as a result of Ambac's emergence from bankruptcy and

the implementation of Fresh Start reporting. These adjustments ensure that all financial guarantee segment contracts are accounted for within



Adjusted Book Value consistent with the provisions of the Financial

Services-Insurance Topic of the ASC. Elimination of the gain relating to Ambac's CVA embedded in the fair



value of derivative contracts other than credit derivatives. Similar to

credit derivatives, fair values include the market's perception of Ambac's credit risk and this adjustment only allows for such gain when realized.



Addition of the value of the unearned premium reserve on financial

guarantee contracts and fees on credit derivative contracts in excess of

expected loss to be expensed, net of reinsurance. This amount represents

the expected future net earned premiums and credit derivative fees, net

of expected losses to be expensed, which are not reflected in GAAP equity. Elimination of the unrealized gains and losses on the Company's investments that are recorded as a component of accumulated other comprehensive income ("AOCI"). The AOCI component of the fair value adjustment on the investment portfolio will differ materially from



realized gains and losses ultimately recognized by the Company based on

the Company's investment strategy. This adjustment only allows for such gains and losses in Adjusted Book Value when realized. Ambac has a significant tax net operating loss ("NOL") that is offset by a full valuation allowance in the GAAP consolidated financial statements. As a result, for purposes of Adjusted Book Value, we utilized a 0% effective tax rate. We maintain a full valuation allowance against our deferred tax asset and recognition of the value of the NOL would be reflected in Adjusted Book Value considering all the facts and circumstances as of the relevant reporting date. The following table reconciles Total Ambac Financial Group, Inc. stockholders' equity to the non-GAAP measure Adjusted Book Value for all periods presented: (Dollars in Millions) June 30, 2014 December 31, 2013 Total Ambac Financial Group, Inc. stockholders' equity $ 948.1 $



703.0

Adjustments:

Non-credit impairment fair value losses on credit derivatives 70.9



72.8

Effect of consolidating financial guarantee variable interest entities (324.6 ) (372.7 ) Insurance intangible asset and goodwill (2,063.9 ) (2,112.5 ) Ambac CVA on derivative product liabilities (excluding credit derivatives) (43.9 ) (48.4 ) Net unearned premiums and fees in excess of expected losses 1,293.9



1,435.2

Net unrealized investment (gains) losses in Accumulated Other Comprehensive Income (232.0 ) 41.9 Adjusted Book Value $ (351.5 ) $ (280.7 ) Factors that impact changes to Adjusted Book Value include many of the same factors that impact Operating Earnings (Losses), including the majority of revenues and expenses but exclude components of premium earnings since they are embedded in prior period's Adjusted Book Value through the net unearned premiums and fees in excess of expected losses adjustment. Net unearned premiums and fees in excess of expected losses will affect Adjusted Book Value for (i) changes to future premium assumptions (e.g. expected term, interest rates, foreign exchange rates, time passage) and (ii) changes to expected losses for policies which do not exceed their related unearned premiums. The Adjusted Book Value decrease from December 31, 2013 to June 30, 2014 of $70.8 million was primarily driven by a reduction in net unearned premiums and fees in excess of expected losses partially offset by Operating Earnings. 107



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