2007 Annual Report Financial Peace of Mind New York I London I Sydney I Tokyo I Milan I Mexico City Ambac Financial Group, Inc., headquartered in New York City, is a holding company whose affiliates provide financial guarantees to clients in both the public and private sectors around the world. Ambac’s principal operating subsidiary, Ambac Assurance Corporation, a guarantor of public finance and structured finance obligations, has earned triple-A ratings from Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services; and a double-A rating from Fitch, Inc. Moody’s, Standard & Poor’s and Fitch all maintain a “negative outlook.” Ambac Financial Group, Inc. common stock is listed on the New York Stock Exchange (ticker symbol ABK). Page 1 Employee Photo (l to r): Back row: Andrew Kuyk, Wes Kirchhoff, Dean Scarano, Steven Saporito, Effie Michailidis, David Murelli, Jennifer Schimmel, Douglas Frankel, Richard Leblanc Front row: Watcharee Thitibordin, Aracelis Ocasio, Kalpana David, Diane Marolla, Michael Callen, Patricia LoCascio, Yanira Vergara, Denise Tauriello Ambac Financial Group, Inc. 1 2007 Annual Report Dear Fellow Stockholders We dedicate this book to all of our employees who went the extra mile during this unprecedented year. (see inside front cover for names) Ambac and the financial guarantee industry RAISING CAPITAL AND faced historic challenges in 2007 and into 2008. MAINTAINING OUR RATINGS The global credit market distress, the swift Restoring market confidence and maintaining collapse of the subprime mortgage market midway our important triple-A ratings with Moody’s and through the year, and the subsequent rating agency Standard & Poor’s has been our top priority. In downgrades of various mortgage-backed securities, early March 2008, we announced a $1.5 billion made 2007 the most difficult period in our common stock and equity unit offering that was 37-year history. This reality is reflected in our successfully executed in a difficult environment. financial results, which include the first reported As a result, our capital position has been strength- financial loss for Ambac. Most notably, these events ened and our triple-A franchise has been preserved. undermined confidence in Ambac’s business Our professionals continue to be focused on model and in our ratings outlook. actively meeting the needs of issuers and investors, improving financings with our valuable guarantee. Ambac Financial Group, Inc. 2 2007 Annual Report The successful resolution of our capital issue was testimony to the dedication of my Ambac colleagues and to the support received from the Board of Directors, stockholders, policyholders and clients. Throughout the capital enhancement process, REFOCUSING OUR BUSINESS many parties offered us alternatives. Yet, as I have The capital raise, combined with our strategic said publicly, their terms were unacceptably high. review of all aspects of Ambac’s business, will Let me emphasize this important point: solvency improve the quality of our portfolio, dampen has never been an issue. Ambac has adequate earnings volatility, and reduce ratings uncertainty. capital, a strong balance sheet and a steady stream In February 2008, we announced a six-month of future earnings assured through our unearned suspension of new structured finance business in premiums. It is inconceivable that any investor support of further strengthening our capital holding an Ambac-insured bond will miss a single position. We have focused our new business principal or interest payment. We are proud that, generation efforts on lower risk and lower ultimately, we addressed our capital issues with a volatility sectors, particularly in the U.S. municipal market-based solution that balanced the interests business, as well as utilities, infrastructure and of all our stockholders. health care in the U.S. and around the world. The successful resolution of our capital issue Diversity of our portfolio strengthens Ambac, was testimony to the dedication of my Ambac as acknowledged by the rating agencies, and colleagues and to the support received from the our future business will encompass more than Board of Directors, stockholders, policyholders U.S. public finance. We will, however, concentrate and clients. I would also like to thank the govern- on general obligation transactions and transactions ment officials, particularly Sean Dilweg and his involving projects essential in nature. We will staff at the Wisconsin Office of the Commissioner also further sharpen our ability to examine of Insurance, and Eric Dinallo and the New York the profitability of individual transactions to State Insurance Department, for their valuable realize adequate compensation for the risks we perspective and guidance. are assuming. Ambac Financial Group, Inc. 3 2007 Annual Report The newly-created Chief Risk Officer position will help us improve capital management and ensure we remain a top-rated financial guarantor. We recently implemented significant changes instruments and securities structures available in to our underwriting and risk management systems. the market. Since founding the financial guarantee Specifically, we created the position of Chief industry 37 years ago, a balance between growth Risk Officer reporting directly to the Board of and safety has kept Ambac’s business on the Directors to ensure that we build a culture that right track. The events of the last 12 months is grounded upon a fundamental view towards have helped put this balance in the forefront of underwriting and managing risk in our portfolio. everything that we will do. We believe the financial David Wallis, who has done an outstanding job stress we experienced is limited to a small portion leading our surveillance operations, is now our of our portfolio and does not invalidate the Chief Risk Officer, responsible for three principal business model. areas: Capital and Risk Analysis, Portfolio Risk Lost amidst the noise of worldwide credit Management, and Credit Risk Management. market distress and Ambac’s strategic refinements This organizational change increases emphasis on was Ambac’s strong pace and quality of new fundamental risk management and places stricter business developed in the first half of 2007. limits on transaction size and capital usage for In fact, 2007 was the company’s second best large transactions. These strategy adjustments year in terms of credit enhancement production. will enable us to improve capital management We believe this demonstrates the essential nature and will ensure we remain a top-rated source of of our business and serves as an indicator of the financial peace of mind for issuers and investors. enduring strength of our franchise. Global new business activity reflected the expertise and REINVIGORATING OUR teamwork of professionals across all business lines: LEADERSHIP POSITION Public Finance, Structured Finance and Global Since 2007, we have learned valuable lessons about Infrastructure Finance. the complexity and correlation of the financial Ambac Financial Group, Inc. 4 2007 Annual Report We are optimistic about Ambac and about our industry. We believe the fundamental strengths of our business model remain intact. RESTORING CONFIDENCE All of us at Ambac are working hard to FOR FUTURE GROWTH rebuild confidence and we are committed to Early in 2008, Robert Genader made a personal continuing to provide a high level of transparency decision to retire as Chairman, President and as we seek to restore our stable ratings outlook. CEO. At the Board’s request, I stepped into that We believe that this clear-sighted goal and our role on an interim basis. I would like to thank return-to-basics approach will enable Ambac to Bob for his 20 years of dedicated service to regain its position as a leading financial guarantee Ambac and our clients. company in the years ahead, assisting issuers, pro- In my short tenure as CEO, the most gratify- tecting bondholders and rewarding stockholders. ing factor for me has been the commitment and excellence of Ambac’s people. All of our employees Thank you for your continued confidence. have dedicated themselves to applying their impres- sive array of skills to address the tasks at hand. Their willingness to go the extra mile throughout this Sincerely, unprecedented time has been greatly appreciated. On behalf of all our stockholders, I extend my thanks to each one of them. We are optimistic about Ambac and about our industry. We believe the fundamental strengths of our business model remain intact. Indeed, today’s environment is an opportunity for Ambac as current pricing is likely to provide the best Michael A. Callen risk-adjusted returns we have seen in many years. Chairman, President & CEO Ambac Financial Group, Inc. 5 2007 Annual Report CREDIT ENHANCEMENT NET PREMIUM/ENHANCEMENT PRODUCTION 1 FEES EARNED (in millions) (in millions) $1,489 $918 $1,414 $866 $871 $1,299 $1,288 $1,295 $1,249 $765 $667 $974 $500 $711 $652 $400 $323 $486 $268 $213 98 99 00 0102 03 04 05 06 07 98 99 00 0102 03 04 05 06 07 EXPENSE CLAIMS-PAYING RATIO 2 RESOURCES (in millions) 21.9% $14,512 $13,101 18.2% $11,970 17.1% 17.0% $11,213 15.3% 15.3%15.2% 13.9% $9,586 13.8% 13.6% $8,150 $6,937 $5,946 $5,210 $4,168 98 99 00 0102 03 04 05 06 07 98 99 00 0102 03 04 05 06 07 1 Credit Enhancement Production is defined as gross (direct and assumed) up-front premiums written plus the present value of estimated installment premiums written on insurance policies, structured credit derivatives and other credit enhancement products issued in the period.