Greetings, and welcome to the Ambac Financial Group Incorporated second quarter fiscal year 2008 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Sean Leonard, Chief Financial Officer for Ambac Financial.

Thank you. Good morning, everyone. Welcome to Ambac’s second quarter conference call. I’m Sean Leonard, Chief Financial Officer of Ambac. With me today are Michael Callen, Chairman and CEO and David Wallis, Chief Risk Officer. Our earnings press release, quarterly operating supplement, and a slide presentation that follows along with this discussion are available on our website. I recommend that you view the slide presentation as we speak today. Also note that this call is being broadcast on the internet at www.ambac.com. During this conference call, we may make statements that would be regarded as forward-looking statements. These statements may relate to, among other things, management’s current expectations of future performance, future results and cash flows, and market outlook. You are cautioned not to place undue reliance on these forward-looking statements which reflect our current analysis of existing trends and information as of the date of this presentation, and there is an inherent risk that actual results, performance or achievements could differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. These differences could arise from a number of factors; information concerning factors that could actually cause results to differ materially from the information we will give you is available on our press release, and on our most recent Form 10-K and subsequently filed Form 8-Ks. You should review these materials for a complete discussion of these factors and other risks. Copies of these documents may be obtained from the SEC website. I would now like to turn it over to Mike Callen, who will comment on the current market environment and Ambac’s strategic initiatives.

Thanks, Sean and thank you, ladies and gentlemen for joining us to discuss our second quarter. After a few opening comments, I’ll return the floor to Sean to analyze the quarter’s financial results, and then, David Wallis, our Chief Risk Officer, will talk about the portfolio. From my point of view, the high points in the past three months have been several. First, we have made progress in managing the risk in the portfolio by negotiating commutations of our CDO of ABS exposures. Clearly, the bid-offer spreads in the marketplace are narrowing, so that meaningful discussions are being held and progress is evident. The transaction announced recently is the so-called AA Bespoke contract, which released a substantial amount of rating agency capital. A number of market analysts published widely distributed estimates that included this transaction as 100% impaired. In the event, of course, our payment of $850 million to a sophisticated counterparty was about 60% of that amount. Every contract is quite different, as you know, with respect to structure, asset quality and timing of cash flows. I would caution against using simplistic ratios of settlements compared to par amounts for purposes of the determining so-called good from bad deals. Our policy continues to be consummating these agreements after careful scrutiny of economic terms that benefit Ambac’s owners and policyholders. We do not conclude agreements that simply reduce the par value of the CDO portfolio. Nevertheless, we are encouraged by the significant progress that continues to be evident, as credit market participants work to resolve their exposures. A second major development this quarter was the result on the direct mortgage portfolio, primarily by means of arduous, meticulous analysis. With the assistance of outside professionals, we have managed to identify clear, egregious violations of reps and warranties that will enable us…

Thanks, Mike. I will now provide a brief overview of the financial results for the quarter. Net income was $823.1 million, or $2.80 per diluted share, up 68% on a per-diluted basis from the second quarter 2007 results. The increase was primarily driven by the net noncash mark-to-market gains in our CDO of ABS portfolio, record accelerated earned premiums resulting from refundings, and negative loss provisioning related to transaction performance of certain direct RMBS transactions exceeding our previous expectations, and estimated recoveries from our mediation efforts on the direct RMBS portfolio. Partially offsetting these positive results were other than temporary market value declines in our financial services investment portfolio. To assist users of our financial statements and analysis of our reported earnings, we also report earnings on an operating and core earnings basis. Both of these earnings measures are considered non-GAAP measures. Operating earnings excludes the net income loss impact of net gains and losses from sales of investment securities and mark-to-market gains and losses on credit, total return, and nontrading derivative contracts that are not impaired. Core earnings exclude the net income impact of accelerated premiums from refundings. Operating earnings per share in the second quarter were a loss of $1.53 per share, and core amounts to a loss of $1.83 per share. Remember that in calculating operating earnings and core earnings, we exclude the impact of unrealized gains and losses from our CDO portfolio, but do not exclude the impact of estimated credit impairment within this portfolio. In the second quarter, Ambac reported credit impairment of $1.06 billion pre-tax, or $2.45 on a per share basis. This amount is reflected in our operating and core earnings results. Normal earned premiums amounted to $166.3 million in the quarter, declining $11.7 million, primarily due to the December 2007 Assured Guaranty…

Thanks, Sean. Good morning, everyone. As you would expect, the focus of my comments will be RMBS related, in the two areas where we have taken this exposure: the direct RMBS book and within CDOs of ABS. On the direct RMBS side, we have had three more months of seasoning to monitor trends in performance, and as our transactions mature, we consider the future outcomes become moderately more certain. In addition, given the progress of our active RMBS for mediation efforts, which I’ll summarize later, this is the first quarter where we have felt able to recognize the benefits of these efforts. On the CDO of ABS side, we continue to be disappointed with the pace of deterioration, especially as regards to CDO collateral within our transactions. However, as we have now progressively written down this constituent element of our CDO transactions, we anticipate less pain to come with respect to this important historic driver. I’m now going to review the portfolio in a manner akin to last quarter’s earnings call. This chart shows aggregate outstanding reserves and impairments for both RMBS related product constituents, further breaking out the segments of each. The left-hand side shows RMBS reserves with HELOC reserves now representing 52% of the total $896 million RMBS reserve and closed-end seconds representing 21%. Mid-prime or Alt-A exposures comprise approximately 20%. Our sub-prime exposure, as we have noted previously benefiting from very limited and almost exclusively fixed rate 2006-2007 originations, continues to be a source of only relatively moderate concern. Next, on the right-hand side, we show our CDO impairments. Having satisfactorily commuted our largest CDO-squared transaction last week, we’re essentially fully reserved for our remaining two large below-investment grade CDO-squared transactions. Some of the high grade deals in the remainder of the book were a source of…

Thanks, David. That concludes our prepared remarks. We would now like to open the call up to questions.

Our first question today is coming from the line of Andrew Wessel - JP Morgan.

A couple of questions. One on the use the implementation of FAS 157. How to think about using the market’s perception of your ability to pay your debt against the obligation you have under a CS contract to pay in the event of default? I’m having problems figuring out how that leads to a $5.2 billion write-off, when in actuality there would’ve been a $4.2 billion write-down?

What the theory is in the accounting rules and would apply for a known set of cash flows versus what we’re dealing here with is a potential contingent set of cash flows that we potentially are obligated to pay over time. But the theory is the same: in essence, that one should include a market-based discount rate. One should not just discount at, say, a risk-free rate; we actually use a portfolio rate of 4.5% to discount potential claim payments in our insurance portfolio. But the accounting period, one should utilize a market-driven rate. When one considers what a market-driven rate would be, we have chosen to look at market indicators relating to the credit spreads of Ambac Assurance, which is effectively the company that would have to make the payment. As those discount rates raise the present value or fair value of those obligations decline. That is consistent with how the market would look at our debt obligations that trade out in the market. I think it’s consistently applied amongst other market participants.

Okay, then looking at it from the perspective of, the statement’s always been made, economics aren’t affected by temporary impairment; rating agency models aren’t affected by temporary impairment. Why take this step now to change GAAP results when the focus has always been on operating results, and the focus for the rating agencies has been on the same?

Andrew, we’re required to report GAAP results and we’re required to follow FAS 157. That goes hand in hand with reporting in compliance with U.S. Generally Accepted Accounting Principles. We don’t have a choice on the GAAP. We’ve always provided operating and core earnings for these very reasons. It provides an additional analytical measure for folks to look at for these reasons, that the volatility that’s produced in fair valuation adjustments may not reflect the intrinsic value or our view of the ultimate impairment that underlies the transaction. We have not done anything different, and we did not adopt FAS 157 this quarter; we adopted it at the beginning of year, which is required to be adopted. So there’s nothing, particularly from our perspective, unusual about that. What did happen, and part of my comments and the reason for my comments, is our credit spreads did spike in June, largely due to some actions by the rating agencies in the middle of the month, and the credit spreads reflected that. They have subsequently come in and further have come in, recently based upon the announcement of our AA-Bespoke transaction. I was trying to give folks a sense in my comments for the effect of that, and we do expect that gain to reverse in July.

We’re trying our best to be as transparent as we can be. And as you know, we have been publishing our mark-to-market on a monthly basis, plus whatever other information is available to us, so that you have the opportunity to put this in the context for analytical purposes that you need to put it.

Sure, and that’s definitely been helpful. Then my last question and I’ll jump back in the queue. Just the reserve release on the direct RMBS transaction: the remediation efforts I think it’s fantastic, and so will the shareholders should be very happy to hear you undertaking this effort, which is of course a ridiculous task. I can’t even imagine the labor involved. But I think from a perspective of that three-year recovery period, is that reflective of expected legal activity, expected lawsuits? I would think if it was cut and dry enough, that that would be a much shorter period of expected recovery.

I sort of agree but that for the moment, they’ve got the money and clearly, they’re not keen to open wallet. It is a protracted process. It isn’t easy to gather the data. There is a degree of, candidly, obfuscation or intransigence in terms of handing over that data. Then you’ve got to analyze it. It isn’t easy. Sometimes there are fields missing, which inhibit the sampling that you want to do to ascertain what the whole looks like. Then, obviously, you need to locate the files – each file by the way takes an hour, an hour and a half, to go through – where does the guy live; is it consistent with his social security number; where does he work; does he really work there; phone them up; what’s his income, and so on. It’s a very, very long-winded process. We have to build the case over a period of time. We’re in no rush to do that, but I can assure you we will be very diligent and very steady and unremitting in our efforts. The three-year period is our best guess, an average life-type basis, as to what it will take to bring home the gains that we’re expected.

(inaudible) significant haircuts.

And there are significant haircuts. We don’t think we’ve being overly aggressive. Clearly we’re not booking gains in any transaction in excess of the gross cumulative loss that our modeling of the mortgage securities involved project. We can’t do that. What that means in some cases is that already, in one particular case, we’ve got breaches. I think it’s in excess of three times of the reserve that we posted. Obviously what we would do is bring down that reserve to zero on a net basis, and in a sense we would have the ability, we won’t be stepping forward with this needlessly, to settle for $0.30 on the dollar or something in respect of these known, substantive and documented breaches. Hopefully that’s helpful and rounds out the comments a little.

Okay. Thank you.

Our next question is coming from the line of Steve Stelmach - FBR.

Just real quick on the FAS 157, and again, I apologize for circling back to it. But Sean, did you mention that the $961 million benefit in the quarter would have been a negative $1.3 billion mark-to-market loss as of 7/31? Did I catch that number right?

What I had said is if we had used similar maybe the July 31 spreads and pushed that back to the June 30 balances, and the state of affairs at June 30; using that market-level discount rate, yes, it would’ve reserved the gain and produced a loss of that amount.

Okay. I’m just thinking about the swing of, what, $2.3 billion? That would wipe out stated equity. Is that the right way to think about that? I know obviously the operating numbers are the more appropriate measure, and I am agreeing with that, but just from a GAAP perspective, would that ever resulted in a zero equity value?

It would have had a reducing effect on equity, and then you would need to tax effect the amounts.

So take the $2.3 billion tax effect, and then, net it against the equity?

That’s right.

Okay; all right. Mike, on Connie Lee, how much capital sits at Connie Lee today? And how much do you expect to see Connie Lee with in the fourth quarter?

We have $150 million in the vehicle at the moment. We will take down another $850 million, start with about $1 billion when we get the AAA. The portfolio today, the insurance claims are about $650 million of very high quality assets that have been there, are very mature with no loss reserves; healthcare and universities, that type of thing. We’ll be starting with a very clean slate.

Okay. Then Connie Lee, will it sit below the holding company, or will it sit below the current operating company?

It will sit below the insurance company, the operating company.

It would still have to go through OpCo up to HoldCo, from Connie Lee, to OpCo to HoldCo…

Remember we have a prohibition built into the plan of any dividends for at least three years.

Got it. Okay. Then on the legislative front, there’s been obviously a push for corporate-equivalent ratings on the muni side, and then the rating agencies themselves have begun to migrate that way. Could you just give us some color on the business outlook there?

We’ve got Bob Shoback here; probably knows as much about public finance as anybody. Let me ask him to comment on that.

Sure.

With regard to the corporate-equivalent ratings, there’s been pushes in that direction for a number of years. One or more of the rating agencies have implemented that to some degree in the past, and at that point in time, we didn’t really see a significant decrease in the utilization of insurance as a result of those efforts on their part.

Okay; great. Thank you.

Our next question is coming from the line of Geoffrey Dunn - Dowling & Partners. Geoffrey Dunn - Dowling & Partners : Sean, first of all, can you give us the net capital benefit from the commutation of the AA deal?

It’s different between the two agencies based upon the process that they undertake. In the case of Moody’s results, Moody’s does not tax effect. One thing they don’t do is tax effect any stress losses or any theoretical losses that they have in their model. They have just gross numbers, and then compare that against our claims paying resources. Moody’s had a very low view of that transaction, and particularly combined with the nature in which they calculate their theoretical losses, utilizing a 30% margin, so they calculate at a 1.3 times level. With that in mind, coupled with the tax impacts of that transaction, the estimate of the capital relief just on that transaction is about $800 million. Relating to Standard & Poor’s, they include an element for taxes and theoretical losses in their calculations, so you don’t have that differential, and they don’t have a similar construct, even though they do require a margin of safety of 1.25 times. But effectively, we think that is probably between $50 and $100 million. Geoffrey Dunn - Dowling & Partners : Okay. Then probably for Mike, with the structure of Connie Lee under AAC, how are you making it such that that is walled off, and the market perceives that as a clean $1 billion of capital?

We will have a separate board. The separate by-laws, the legal structure will be such. The regulators, remember, in Wisconsin and for that matter in New York, will be involved in this. We have asked our external counsel in building this plan that we want this subsidiary to be totally independent, which they claim to have found unusual, but were happy to accommodate us. In the documents that the agencies and the regulators are reviewing, I think it makes it very clear there will be at least seven directors, four of whom will have nothing to do with Ambac. Certain things will require a super majority vote. There are all sorts of restrictions being placed on the vehicle, including agreements on multiyear termination of dividends, or no dividends to be upstreamed, and so forth. I don’t think in terms of the separateness, as we call it, that we have expanded on we have had any doubts from the constituencies we have to satisfy. Geoffrey Dunn - Dowling & Partners : Okay. Last question for David. Understanding all your comments, it seems like you’re starting to get your hands around the RMBS. But each quarter for the last couple, we’ve seen significant impairments on the CDOs. How can you get ahead of this issue? How can we get to a point where the impairments are declining significantly, rather being surprised by an incremental billion dollars each quarter? Is it purely getting ahead of the ratings, the internal collateral, or is there something else where we can gain confidence that the worst is behind us, and now we’re facing an improving result from here on out?

That’s a good question. I think it’s a combination of things. As I tried to get through, what has really been damning as the first change in the credits of these deals has been the degradation in the CDO buckets. A high-grade deal has X percent RMBS, but sometimes there’s significant CDO buckets, and sometimes buckets in excess of the subordination of the deal. When that really degrades, that’s an immediate first order effect. The salutary fact there is that we’ve progressively been writing off – and the details of this are on our website in respect with each individual transaction – the portions, in some cases very large portions, of these CDOs. We hope and believe that we’re through the worst there. The other component to the credit of these deals is obviously the RMBS collateral, and as I intimated in the prepared remarks, what we really are reliant upon now in terms of looking at these things is cash flow modeling. I think we’ve convinced ourselves, and probably others share this view that some of the CDO models that we’ve used historically in addition to cash flows are somewhat flawed. What that’s about is obviously running through all the CUSIPs of all the RMBS, and in all the different vintages, using different assumptions, taking account of the fact that there’re different points in their loss curves, at the cash flows through all the deals. What that depends upon in terms of outcome is the assumptions that you use, and have you got the process right. We believe we’ve got the process right; we have hired an external party, and done an apples-and-apples type comparison in relation to the results using similar assumptions. So, we feel good about that. What that leaves you with in terms of variables, is the assumptions that you use. We believe our assumptions are reasonable. We do believe, as a general statement, Mike’s comment re: pig in the python earlier, that loss curves are very front ended. Therefore, there will be an amelioration in the rate of decline in terms of cumulative loss, and so on. We think we are applying reasonable cash flow assumptions; we think that we have progressively degraded the first order problems, which is the CDO buckets and therefore, in terms of the environment and the assumptions we’re using, we are hopeful that we won’t have this kind of volatility going forward.

And Geoff, let me reiterate an observation I made at the beginning; it’s a very good question by the way. The ability to have meaningful conversations with counterparties, now versus, let’s say, at the end of the year, or at the end of the first quarter, has improved significantly. I want to be broad in my comments here. That is quite encouraging. As we have announced, the Bespoke transaction, frankly, at the end of the year, probably at the end of the first quarter, the consummation of that transaction would not have been possible. But counterparties’ positions, counting positions, perceptions change and as I’ve said, if anybody asks me to express one comment I made in my opening remarks, it’s that clearly, the bid-offer spread on these possibilities is closing down, which is a sign of more liquidity in the market. We have a number of efforts underway, which have been underway for some time. I think that’s going to have impact, too. Geoffrey Dunn - Dowling & Partners : Great, all very helpful, thanks.

Our next question is coming from the line of Darin Arita - Deutsche Bank.

A question on Connie Lee, in terms of getting this transaction done, what are the key hurdles?

The major hurdle is the AAA stable. Our conversations with the rating agencies have probably reached their second step, with – I’m going to guess – three or four more steps to go. In great rigorous detail, they are putting us through the ringer, but I quite honestly believe that we are up to meeting that test. We have developed a plan with appendices to it that we needed to rent several mules to get over to them. They look at this is a project; they’re working it very hard; they have a lot of very good questions. They want to know what Plan Bs are in the event that our initial plan in terms of risk profile are not good. I cannot speak for the rating agencies, I wouldn’t dare, but I can say that every criteria that we know of, including the restriction to public finance, which is going to be in the by-laws, has been incorporated. The test and the questions that they’re putting us through in the models are only going to be helpful. I am encouraged in both of the major rating agencies in the sense that our discussions have been very serious; they have not had any negative attitudes on display, just quite in-depth questions. But clearly, the hurdle is the AAA stable. Some think that the issue is going to be market acceptance. We have put that to the test as much as we can do, by putting on our roadshow and then leaving the room and getting feedback through our investment bankers and so forth, and there is nothing I’ve seen that says that’s going to be a problem. Perhaps Bob Shoback could comment on that if you need some elaboration.

I think we’ve gone out to a lot of the institutional investors, and our client base, and have received indications from all parties that the need has never been greater at this point in time. The capacity that is left in municipal markets is the vast majority of what has been there, 75% or more of past capital and past market share. The need is still great, so there’s a huge imbalance between supply and demand. The investors, the issuers, want this product and need it.

In terms of the ratings, would you be willing to have this rated AA or split-rated?

We’re not even thinking about that at this point. I don’t think it’s a bridge we’ll come to; I’m quite encouraged. I should stop there, but as my mouth has never been disciplined, I’ll tell you if it ever came to that, would we go forward and prove that this is an AAA vehicle that can do business effectively? Absolutely. There has just been enormous effort put into this. And when we put our underwriters on display, as we have, I think it just strengthens the case all the more.

Great. That’s helpful, and then, in terms of the second lien RMBS, the analysis on breaches of reps and warranties, of the 1800 loans that were analyzed, David, you mentioned that some were randomly selected. How many of these were randomly selected?

I haven’t got the numbers in front of me. What we did for the purposes of trying to figure out which deals, candidly, to go after first is initially, in some cases look at 60-day delinquencies, especially where those buckets were large. On any reasonable hit rate, we would get meaningful results, we believe, in relation to our reserve. It’s a mix; I haven’t got the precise statistics. I can come back to you on that. If there’s a takeaway in all this stuff, is that there’s 85,000 loans we haven’t looked at, and the results show that many thousands of loans, I think, will go forward in the crosshairs of rep and warranty breaches.

That would be helpful, David, if we could have that, because the 85% hit rate on the 1800 loans. I thought that was very high, but I was curious, what was the hit rate on the randomly selected loans?

Much less, and I think it was in the 30s. But obviously, then you’re looking at the entire transaction, not just a bucket. But I’ll come back to you.

All right, great. Thanks very much.

Our next question is coming from line of Arun Kumar - JPMorgan.

Good morning. Just a couple of quick questions on your statutory numbers. If you could quickly walk us through how you arrived at a statutory gain after you took the $1 billion credit impairment charge; what percentage of the credit impairment charge actually walked through your statutory numbers? And secondly, I know a lot has been asked about Connie Lee, but just one quick one on that end. Given that you’re on stage two of what you anticipate to be three to four stages on the ratings process, when do you expect that to conclude, given that you’ve stated that by October 1, you’d like to get into the business?

Nothing that I have encountered in this process would cause me to change the October 1 date in terms of doing business. If that changes for some reason that I can’t foresee, we’ll try to communicate that fact. I said in my remarks the fourth quarter. That’s a loftily prepared statement. But October 1 is still what we have in our minds around here for planning purposes.

Dealing with the statutory numbers, as you’re probably aware, statutory accounting requires the recording of loss reserves for defaulted items, so case reserves. We have recorded case reserves in the second quarter, and that’s reflected in the second quarter in numbers of approximately $170 million. What also is going on there is the premium revenue recognition pattern on the statutory accounting is a much slower revenue recognition pattern. When we have refundings, particularly heavy in the public finance area, what happens is the accelerated premiums are much higher under statutory than under our GAAP results. There’s an impact there as well. What also you have is, you’re right, we are recording impairments to our statutory results. There are some unique aspects of some of the contracts that would only require a recognition upon default. We haven’t recognized the entirety of the $1 billion of impairment in the quarter, but a substantial part of that. The last thing that’s going on is there’s some tax benefits for the impairments that are running through the quarter. When you combined all those together, that’s how you come up with the income results. You do see on page 31, which is perhaps what you’re looking at in the slide deck, some of the details of the accounts. You can see that the actual surplus from the end of the first quarter to the end of the second quarter has declined slightly, but obviously, that includes a substantial amount of impairments already in that number, with a very sizable policyholders’ surplus amount. What you don’t see in these numbers is we also are required to establish a contingency reserve, and that number is sizable as well. At the end of the quarter, the contingency reserve is $3.26 billion, which is a loss reserve, in a sense, that reduces policyholders’ surplus. You have a substantial amount of reserves built into the policyholders’ surplus number.

Fair enough. Sean, just a quick question on the holding company cash, you said you’re going to be at about $210 million at the end of the year. But are we right in assuming that if you do some of the share buyback in the second half of the year, the $50 million that you’ve discussed, that $210 million would then be down by that amount, or to whatever extent you do the buyback?

Yes, absolutely. In page 32 in the slide deck provides a very in-depth reconciliation, if you will, on how we arrived at our numbers, and you can see all the elements in there. We provide the debt service coverage and the like on that particular slide.

Great. Thank you. Very helpful.

Our next question will be coming from the line of Scott Frost - HSBC.

Just a couple of things. I had some housekeeping stuff, the notional amount of FAS 133 liabilities outstanding that are included in the $487 billion of total notional – I might’ve overlooked that. Could you also remind us of the cumulative amount of true credit impairments included in the derivative liabilities, if I overlooked that there? What I’m trying to make sure of is you’re saying that October 1 is when you expect to be open for business with Connie Lee, you expect rating agencies to have completed reviews, and if you can’t get AAA, you expect to comment then or earlier. Have I got that right?

Yes. If we should run up against the wall with the rating agencies, which I do not anticipate, but if that should happen, I think that we would certainly tell you about it.

The way I’m looking at the Citigroup commutation, they took less in consideration than what they would’ve been owed under the original terms of the contract, which raises the question of why they did that. You said, if I’m not mistaken, that you would’ve been subject to considerable loss payments absent the commutation. In other words, it looks like they took less than they were entitled to because they were afraid that you might not be able to honor the original terms of the contract. Would that be a fair description of what happened, and if it isn’t a fair description of what happened, how would you describe it?

I will let David describe it, because he does it very concisely as well.

That’s pressure. I think the point you’re making on the counterparties’ opinion of the particular enhancer, in a sense, regrettably, in inverted commas that that doesn’t really apply to us. I think that perhaps it’s rather less fortunate participants in the industry, you could make that point. I think the issues here are much more complicated. Obviously, we believe we’ll be around. I think others absolutely believe that, too. I think it gets complicated in relation to how different entities have accounted for particular positions; what their view of the underlying cash flows is particularly in terms of timing. And there’s another variable, quite often I think when transactions were incepted, perhaps the counterparty took out a hedge on the counterparty risk to ourselves. Clearly, if they did that, then despite the recent dramatic reduction in our CDS spread, they’re on a very, very large gain. The combination of a check, i.e. cash, obviously with zero discounting applicable to that and the ability to close out the CDS position at a very large profit can be an enticing one. I think there’re all sorts of reasons why you have to look at the particular situations in terms of what this means to different counterparties.

Let me rephrase it a little bit here. Absent the commutation, would you have been able to pay these obligations as agreed?

Absolutely, 100% yes.

Okay, thank you.

Yes, in fact, it was quite close to our first quarter impairment number, and we disclosed that in our press release. Relating to your question on CDO impairments, the accumulative number as of June 30 is $3.1 billion. Clearly, we paid $850 million, so that number will go down, repaying down some of that estimated accredited impairment liability. Page 18 of our operating supplement provides those details. As it relates to par, we also have a very in-depth slide presentation on our website that provides the numbers for overall CDOs exposure, and that number is slightly above $60 billion.

Okay. I had $63 billion at the end of the first quarter. You said that’s in the supplement. And the CDOs, that’s everything that’s related to FAS 133. They’re the same numbers, is that correct?

Yes it is. We also footnote the commitment that happens to be. For peculiar reasons, that also is included in our FAS 133/FAS 157 calculations.

Am I right in looking at this: the $7.4 billion of derivative liabilities you get on the balance sheet at the end of Q2, that includes the $3.1 billion of true impairments, less the $850 million you’ve paid? That’s what I’m trying to get at. Of that number, what’s real in terms of losses you’re going to have to pay, and what do you view as something that’s going to revert over time back to gains? Do you see what I mean?

Yes, that’s where the reconciliation on page 18 of our supplement comes in.

Okay, all right, thanks, okay.

You can look at it at your leisure. But effectively, the differential, but if the derivative liability on the balance sheet includes some interest rates swaps, and some other things, but you want to just isolate credit default swaps, the unrealized mark, if you will, that’s on the balance sheet that is not impaired is about $3.7 billion.

Great, okay, thank you.

Our next question is coming from line of Bob Ferguson - Rutgers.

Regarding the remediation efforts, considering that you’re expecting approximately a three year recovery time for those efforts, and they will obviously meet legal challenges from the originators. Do you really feel it’s wise at this point to actually reduce your reserve today? Why not put that reduction of the reserve off a little further, until you actually see some actual results from put backs?

No, we absolutely feel it’s wise. We wouldn’t do it otherwise, clearly. I don’t really see it as a whole lot different from recoveries in other sorts of transactions. We’ve been very diligent; our auditors have been very diligent. Candidly, we have some historic experience of these matters, which I’m not permitted to go into, and we looked at that as helpful guidelines in relation to what we should do here. As I mentioned, we’ve, I think, undertaken a pretty small sampling in relation to the total anticipated potential gain here. We are covered many times over in terms of the reserves that we’ve taken. So no, all in, we feel very good about it; we absolutely acknowledge that people aren’t running towards one street stay state flats with open wallets. That’s why we discounted the projected proceeds by three years, and as I say, there’s quite coverage there. No, we feel very comfortable about it, we’re very realistic about how tough it’s going to be, but we’re very good at this and we’ll pursue it intensely.

Okay, thank you.

Our next question is coming from the line of Richard Maguire - Pershing Square.

Can you discuss the $850 million payment that you made on the commutation payment? How does that cash payment compare to the actual cash payments, and the timing of the cash payments that you would have expected to make on the contract otherwise?

This is a very unusual transaction. Let me briefly explain why. The structure of the deal is such that once the pre-existing 30% subordination was eaten through, then for each successive inner CDO credit event, then we would have been on the hook at that point for the principal payment of the relevant tranche, and it was about $40 million a go, I believe, in terms of each tranche. As I indicated in my prepared remarks, circa 98% of the underlying inner CDOs were non-investment grade, and as we know in the marketplace, liquidity’s returning and what that means, there are buyer and sellers and obviously, liquidations. Obviously, that would’ve been and was extremely detrimental to this transaction. We go through, as we do in our remaining CDO-squareds, and the high grade deals, all the constituent CDOs, looking at the terms of each CDO in relation to the difficulty or ease, or relative closeness to liquidation-type events. When we did that, we felt very confident that we would be paying several $100 million over the remainder of this year. We think that that was an unusual thing in relation to this particular deal. Clearly, as we’ve discussed previously on normal transactions, our timely payment of P&I, and therefore, in effect much more beneficial in terms of our business model, as I alluded to.

Right. But if you were going to pay several $100 million over this year, that’s just this year; what were you expecting to pay over the life of the contract?

When you’ve got 98% of the underlying CDOs as non-investment grade, I think one can expect to pay pretty damn close to $1.4 billion over the course of time.

Right.

The liquidation element of this transaction, meaning that it’s not a timely IMP-type deal, means that you haven’t got the benefit of effectively spinning the process out for 10, 20, 30 years, which obviously makes it a much more advantageous transaction for us to settle, and that’s what we did.

If you would’ve paid nearly close to $1.4 billion on this contract, what would the timing of that had been?

As I said, over the remainder of this year, we would have spent several hundred million; I think the number was sort of $280, $300 million, with an even bigger sum, I believe, over the next year.

Would it be accurate to say, then, to the extent there were analyst estimates assuming a 100% loss on this, those estimates were actually fairly accurate?

No, they’re not accurate, because I believe that present value is important, and what we have done here is to pay, I think, a very mutually advantageous sum of money to us and our counterparty, given their position, to make a deal that makes sense. I think many people – I don’t know what your views were – would’ve anticipated a complete $1.4 billion write-off today or tomorrow. I think what we’ve done has invalidated that proposition.

Our next question is coming from the line of Eleanor Chan - Aurelius Capital.

My question is that, going back to the remediation efforts on the RMBS transaction, it seems like you are expecting a very high probability of success in terms of your remediation efforts. I was just curious like what stage of negotiations are you at with various originators? And also, does an originator have to know of the fraud in order for them to buy back the loans? Meaning, what is the standard in terms of buying back loans from pools because of a breach of reps and warranties?

The technical standard, and generally, this is I think a reasonable statement to make, is that they’re supposed to buy back or replace loans on the earlier of 90 days, or when they knew, or should’ve known about the respective breached loans in terms of reps and warranties. Going back to the first part of your question, where are we in the process, particularly in relation to the different counterparties, what we’ve done is, we have been in the process, and have submitted very detailed breach notices, loan by loan, pointing out that we have a bus driver earning $460,000, or somebody who’s apparently working in a McDonald’s in an owner-occupied mortgage, 200 or 300 miles away from the mortgaged properties. You really have to get down and dirty and provide very firm evidence and then await a response. I think right now, we’re in a holding period, for the most part, in respect of awaiting a response. We think the response will be inadequate, and obviously, you move through the legal process from there.

Okay, and then also, I think you mentioned that the expectation right now is that you would settle for $0.30 on the dollar?

No. To be clear, I didn’t make that statement. What I said was that in certain cases where the breaches already, on the work we’ve done, cover our reserves by three times, then in fact we could afford, in a sense, to settle for $0.30 on the dollar and prove out the reserving position adequately. Obviously, we’re not necessarily going in there saying, ‘we want to settle at $0.30 on the dollar.’ That isn’t what the deal documents say.

Okay. And so what net par, or what reserve number, does this $260 million correspond to?

Because you can’t make a gain, clearly, you can’t take remediation gains in excess of the reserve that you’ve posted. So the answer is the identical number.

Oh, okay. I see. So you are expecting a gain exactly in the amount of your reserve?

Precisely.

No, that’s…

In the cases where the coverage is one or higher. But clearly if we have a reserve of 100 and thus far we’ve only substantiated breaches of 20, then the reserve would be 80. If we have a reserve of 100 and substantiated breaches of 300, then the projected gain in that sense would be 100, because you can’t take a gain. Obviously, the trust would gain, the subordinate bondholders would gain but we can’t be, and neither should we be, over-remunerated as against our policy commitment.

One last comment. It’s related to the transactions, to be perfectly clear. The remediation elements are related to the transactions that we have had reserves posted against. When you look at the first quarter reserves, the $260 million relates to those transactions. There could be elements where we could choose to look at remediation for other aspects of the portfolio to obviously look to provide additional cushion against loss. But for clear reasons, we’ve focused on the most problematic transactions, in order to get that process going, and to recoup the amounts as quickly as possible.

Is it fair to say with respect to that $260 million, you’re not assuming any like, settlement discount or you’re not assuming anything if the originator has gone bankrupt, or is in receivership, that the recovery from the originator might be less than par?

No, clearly the first thing you do, when you’re contemplating action of any sort in these matters, is a) you look through the reps and warranties to make sure that they’re substantive, and b) look at the entity who’s sitting behind them. For a bankrupt entity, you don’t waste your time. We’re not looking at that with any hope or expectation, and none of the numbers that we’ve talked about this morning are, in effect, from anything other than what we firmly believe to be creditworthy counterparties.

Okay. I have a question on the financial services segment. Has the insurance company taken any reserves on the any potential losses that the financial services segment might take as a result of a ratings downgrade, which triggers a termination and collateralization requirement? Because it seems like the financial services investment portfolio is $1.5 billion or so underwater. I’m just curious if the insurance company, which insures all the GIT contracts, whether the insurance company has taken any reserves for that part of the portfolio.

We’ve looked at it from a number of different ways. We have to employ several different accounting regimes here; let’s start with statutory. From a statutory perspective, one would need to recognize a reserve for any case reserves for defaulted items. We clearly don’t have that in this particular case, being the obligation of the insurance company, Ambac Assurance, to its affiliate, the GIT businesses. That would be one element of the calculation. If we were to have to, say, provide unsecured lending, one would have to look at that asset and whether or not that asset that has been provided – the loan, if you will – would be non-admitted. One would look to the resources of the company at that time in this situation to make a conclusion there. Most likely, the conclusion would be that that would be a non-admitted asset. That’s the statutory aspect of it. From a GAAP consolidated aspect, clearly, we don’t have this issue to deal with. That full mark-to-market has been recognized, either through the income statement as other than temporary impairment, or through our equity section, because the entire portfolio is valued at fair value. That’s all recognized on a consolidated basis, that decline. We also file a subsidiary GAAP statement in our SEC filings of the insurance company consolidated. One would look at that, and our view of that has been that we would look to a book value basis. If there were to be further declines in our credit rating, we might have to revisit that. But at present time, and we provided a chart, a slide on page 45 of our presentation to address that, the book value of the business based upon detailed reviews of potential for tranche losses of the at-risk securities, mostly the originally AAA Alt-A RMBS that we have in our financial services portfolio, yield very little tranche losses. They have suffered significant market value declines, but the detailed analysis we’ve done, including using some third party experts and analysis to also take a second look at that, would support our view. We have not recognized anything at that level either.

Okay. It sounds like it’s only at the point where you really anticipate a payment of the loss when you would actually recognize the reserve. Is that correct?

As I stated, the payment of the loss is obvious, but if we were to be downgraded and we have collateralization requirements, particularly at the single-A and the A3 level, beneath that, we might be required to make some type of loans from the insurance company to provide the collateral. Then there might be a consequence at that particular point in time, as I’ve described.

Thank you.

We have time for one final question, and that question will be from line of Alistair Lumsden - CQS Alistair Lumsden – CQS: I see on the high grade CDO portfolio, you’re taking around about a 5% impairment, and as I recall from earlier quarterly calls that you’ve always made a very strong point about how you only have to pay principal out on those deals until final maturity. Given that it’s so far away from the market value of high grade CDOs, can we assume that those are very unlikely to be commuted?

No, and let me just correct you. The principal payment is the earlier of legal, final, all – when there’s no collateral, so meaning zero collateral in the underlying deal. That’s the basic rule for virtually all the transactions that we have. The question of commutation, and I’m not going to go into this in too much detail, we’ve remained very active in the area, but if you think about it from a counterparty’s perspective, a lot depends on where they’ve booked particular transactions. It’s pretty clear that the markets are increasingly rewarding certainty with respect to any of these assets, be those assets effectively contingently on our books, or via the policies of CDS contracts that we’ve issued on others’ books. I think there’re all sorts of incentives in terms of equity discount rates and the like to settle. In addition, to the extent that different counterparties entered into counterparty hedges to protect that counterparty exposure against us in respect of the deal at conception, there are substantial gains. I think that there’re all sorts of things going on here. I think the deal we settled was more obvious in some ways, because of the cash flow timing profile that we’ve talked about previously.

I think it’s time now that we finish. We’ve gone over the time; the questions have been very good. I’d like to reiterate one last point I made earlier, just as a closure here and in continuation of David’s comment. There will be no commutations unless they are economically justifiable for our shareholders and policyholders. Rest assured, we get many calls that start out by saying you’re desperate, and we’re here to help. Then, there is a varying degree of time that they come back and realize, we’re not maybe so desperate, and then serious discussion ensues. We either come to something that we think makes sense, some mutual sense for ourselves and the counterparty or not. I just wanted to close by saying, we’re not desperate to do deals just for the sake of doing deals. They have to be good deals, and we expect the market is intelligent, and would be able to make that judgment. If there are any further questions, we apologize for not getting to them, but I urge you to call us directly. We’ll be available the rest of the week, particularly Pete Poillon and Vandana Sharma, as well as Sean, David and myself would be very happy to take your questions. I appreciate your time and your interest, and I wish to thank you very much on behalf of the Ambac management team here.

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.