AMBAC FINANCIAL GROUP INC - Quarter Report: 2011 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended June 30, 2011

Commission File Number: 1-10777

Ambac Financial Group, Inc.

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

(Exact name of Registrant as specified in its charter)

(212) 668-0340

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

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

As of July 31, 2011, 302,428,811 shares of Common Stock, par value $0.01 per share, (net of 5,587,953 treasury shares) of the Registrant were outstanding.

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Ambac Financial Group, Inc. and Subsidiaries

INDEX

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PART 1 – FINANCIAL INFORMATION

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

Ambac Financial Group Inc. and Subsidiaries

Debtor-In-Possession

Consolidated Balance Sheets

See accompanying Notes to Unaudited Consolidated Financial Statements.

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Ambac Financial Group Inc. and Subsidiaries

Debtor-In-Possession

Consolidated Statements of Operations

(Unaudited)

See accompanying Notes to Unaudited Consolidated Financial Statements.

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Ambac Financial Group Inc. and Subsidiaries

Debtor-In-Possession

Consolidated Statements of Stockholders’ Equity

(Unaudited)

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See accompanying Notes to Unaudited Consolidated Financial Statements.

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Ambac Financial Group Inc. and Subsidiaries

Debtor-In-Possession

Consolidated Statements of Cash Flows

(Unaudited)

Supplemental disclosure of cash flow information:

In March 2011, the Segregated Account of Ambac Assurance issued surplus notes in connection with the commutation of two student loan transactions with a par value of $3,000 and in May 2011, the Segregated Account of Ambac Assurance issued junior surplus notes with a par value of $36,082 in connection with an office lease settlement. In 2010, Ambac Financial Group, Inc. issued an aggregate of 13,638,482 shares of its common stock upon the extinguishment of $20,311 in long-term debt. In addition, Ambac Assurance issued surplus notes with a par value of $2,000,000 in connection with the settlement of certain credit derivative liabilities.

See accompanying Notes to Unaudited Consolidated Financial Statements.

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(1) Background and Basis of Presentation

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

Ambac Assurance Corporation (“Ambac Assurance”) is Ambac’s principal operating subsidiary, which provided financial guarantees and financial services to clients in both the public and private sectors around the world. In March 2010, Ambac Assurance established a segregated account pursuant to Wisc. Stat. §611.24(2) (the “Segregated Account”) to segregate certain segments of Ambac Assurance’s liabilities. 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 refer as well to the Commissioner of Insurance for the State of Wisconsin as rehabilitator of the Segregated Account, 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. The rehabilitator of the Segregated Account is Theodore Nickel, the Commissioner of Insurance of the State of Wisconsin.

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

Ambac’s principal business strategy is to reorganize its capital structure and financial obligations through the bankruptcy process and to increase the residual value of its financial guarantee business by mitigating losses on poorly performing transactions (including through the pursuit of recoveries in respect of paid claims, litigation to recover losses or mitigate future losses, commutations of policies and repurchases of surplus notes issued in respect of claims) and maximizing the return on its investment portfolio. The execution of such strategy with respect to policies allocated to the Segregated Account will be subject to the authority of the rehabilitator of the Segregated Account to control the management of the Segregated Account. In exercising such authority, the rehabilitator will act for the benefit of policyholders, and will not take into account the interests of Ambac. Similarly, by operation of the contracts executed in connection with the establishment, and subsequent rehabilitation, of the Segregated Account, the rehabilitator retains rights to oversee and approve certain actions taken in respect of Ambac Assurance. This oversight by the rehabilitator could impair Ambac’s ability to execute the foregoing strategy. As a result of uncertainties associated with the aforementioned factors, management has concluded that there is substantial doubt about the ability of the Company to continue as a going concern. The Company’s financial statements as of June 30, 2011 and December 31, 2010 and for the three and six month periods ended June 30, 2011 and 2010 are prepared assuming the Company continues as a going concern and do not include any adjustment that might result from its inability to continue as a going concern.

Ambac’s liquidity and solvency are largely dependent on its current cash and investments of $51,311 at June 30, 2011 (excluding $2,500 of restricted cash), reaching a bankruptcy settlement with Ambac Assurance or otherwise restructuring, and on the residual value of Ambac Assurance. It is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future. The principal uses of liquidity will be the payment of operating expenses, professional advisory fees incurred in connection with the bankruptcy and expenses related to pending litigation.

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

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Chapter 11 Reorganization

As required by the Bankruptcy Code, on November 17, 2010, the United States Trustee appointed a statutory committee of creditors (“Creditors’ Committee”). The Creditors’ Committee and its legal representatives have a right to be heard on all matters that come before the Bankruptcy Court with respect to the Company. There can be no assurance that the Creditors’ Committee will support the Company’s positions on matters to be presented to the Bankruptcy Court, including any plan of reorganization. Disagreements between the Company and the Creditors’ Committee could prolong the court proceedings, negatively impact the Company’s ability to operate, and delay the Company’s emergence from bankruptcy.

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

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

On July 6, 2011, the Company, as debtor and debtor-in-possession, filed a Plan of Reorganization (as it may be amended, the “Reorganization Plan”). Under the Reorganization Plan, Ambac’s debt holders and creditors will receive all of the equity in the reorganized company. Additionally, the Reorganization Plan sets forth the revised capital structure of a newly reorganized Ambac and provides for corporate governance subsequent to emergence from bankruptcy.

The Reorganization Plan also proposes a resolution of certain issues (the “Plan Settlement”) among the Company, the Creditors’ Committee, Ambac Assurance, the Segregated Account and OCI related to (i) approximately $7,300,000 of NOLs of the consolidated tax group of which the Company is the parent and Ambac Assurance is a member (the “Ambac Consolidated Group”), (ii) certain tax refunds received in respect thereof (the “Tax Refunds”) and (iii) the sharing of expenses between the Company and Ambac Assurance. If Ambac Assurance and OCI do not accept the Plan Settlement, the Reorganization Plan provides that the Company may reject the Ambac Consolidated Group tax-sharing agreement, cause a deconsolidation of Ambac Assurance from the Ambac Consolidated Group for U.S. federal income tax purposes, and either (a) make an election pursuant to applicable Treasury Regulations to allocate to the reorganized Company the maximum amount of NOLs held by the Ambac Consolidated Group or (b) take a worthless stock loss in respect of its ownership of stock in Ambac Assurance. Further, in the absence of a Plan Settlement, the Reorganization Plan also provides for the establishment of a litigation trust for Ambac’s estate to pursue claims and causes of action against Ambac Assurance, the Segregated Account and OCI.

The Reorganization Plan specified July 29, 2011 as the deadline for Ambac Assurance and OCI to accept the Plan Settlement, and a hearing to determine whether the Disclosure Statement relating to the Reorganization Plan contains “adequate information,” as defined by the Bankruptcy Code, to enable Ambac’s creditors to decide how to vote on the Reorganization Plan (the “Disclosure Statement Approval Hearing”) was initially scheduled for August 12, 2011. On July 21, 2011, the Company, the Creditors’ Committee, Ambac Assurance and OCI agreed that the Company would adjourn the Disclosure Statement Approval Hearing, thereby delaying the vote-solicitation process. Recognizing that the delay in solicitation will result in additional costs to Ambac’s estate, OCI and Ambac Assurance’s Board of Directors approved a cash payment to the Company in the amount of $2,000 (the “Payment”) by Ambac Assurance, which was made on July 26, 2011. The parties further agreed that if the terms of a consensual Reorganization Plan are subsequently agreed upon by and among OCI, Ambac Assurance, the Company and the Creditors’ Committee, the Payment shall be credited towards any agreed obligation of Ambac Assurance to reimburse Ambac for a percentage share of the fees and disbursements incurred in the litigation with the IRS. See Note 12 to the Unaudited Consolidated Financial Statements contained in this Form 10-Q for further information on the IRS litigation. The agreement further provides that it is without prejudice of any kind with respect to the rights, remedies and positions of the Company, Ambac Assurance and OCI under, or pertaining to, any intercompany agreements. Additionally, the Company, the Creditors’ Committee, Ambac Assurance and OCI have agreed to mediate

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open issues related to the Plan Settlement. Mediation is currently scheduled for August 16 and 17, 2011. The Disclosure Statement Approval Hearing is scheduled for September 8, 2011, and the deadline for Ambac Assurance and OCI to accept the Plan Settlement is August 25, 2011.

Ambac’s exclusive right to file a plan of reorganization expired on July 6, 2011, the date the Reorganization Plan was filed. Ambac’s exclusive right to solicit votes to accept or reject a plan of reorganization currently expires on September 6, 2011. Because of the adjournment of the Disclosure Statement Approval Hearing and the resulting delay in solicitation of votes to accept or reject the Reorganization Plan, Ambac has filed a motion seeking to extend its exclusive right to solicit votes to accept or reject a plan of reorganization to December 5, 2011. This motion is scheduled to be heard by the Bankruptcy Court on August 10, 2011. If Ambac’s exclusivity period lapses, any party in interest would be able to file a plan of reorganization for Ambac. In addition to being approved by at least one class of holders of impaired claims, a plan of reorganization must satisfy certain requirements of the Bankruptcy Code and must be confirmed by the Bankruptcy Court in order to become effective.

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

A significant consideration for any restructuring or reorganization is the impact, if any, on Ambac’s estimated $7,300,000 net operating loss tax carry forward. Ambac considers the NOLs to be a valuable asset. However, Ambac’s ability to use the NOLs could be substantially limited if there were an “ownership change” as defined under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). In general, an ownership change would occur if shareholders owning 5% or more of Ambac’s stock increased their percentage ownership (by value) in Ambac to 50% or more, as measured over a rolling three year period beginning with the last ownership change. These provisions can be triggered by new issuances of stock, merger and acquisition activity or normal market trading. On February 2, 2010, Ambac entered into a Tax Benefit Preservation Plan to reduce the risk of an ownership change resulting from the trading of Ambac’s stock. Moreover, on November 30, 2010, the Bankruptcy Court entered an order restricting certain transfers of equity interests in, and claims against, Ambac in order to mitigate the possibility of an ownership change occurring prior to consummation of the Reorganization Plan and to increase the likelihood that Ambac will be able to utilize a special exception under Section 382 of the Code for ownership changes occurring as a result of a bankruptcy plan of reorganization. On July 21, 2011, the Company filed a notice (the “Reporting Notice”) requiring that any entity holding claims against the Company in an amount that equals or exceeds $55,000 (each, a “Substantial Claimholder”) to serve upon the Company and its counsel a “Substantial Claimholder Notice” in the form attached to the Reporting Notice. Each Substantial Claimholder could, in certain circumstances, be required to sell a portion of its claims pursuant to a further order of the Bankruptcy Court.

Segregated Account

Pursuant to the Plan of Operation for the Segregated Account, Ambac Assurance has allocated to the Segregated Account (1) certain policies insuring or relating to credit default swaps; (2) residential mortgage-backed securities (“RMBS”) policies; (3) certain Student Loan Policies; and (4) other policies insuring obligations with substantial projected impairments or relating to transactions which have contractual triggers based upon Ambac Assurance’s financial condition or the commencement of rehabilitation, which triggers are potentially damaging (collectively, the “Segregated Account Policies”). The policies described in (4) above include (a) certain types of securitizations, including commercial asset-backed transactions, consumer asset-backed transactions and other types of structured transactions; (b) the policies relating to Las Vegas Monorail Company; (c) policies relating to debt securities purchased by, and the debt securities issued by, Juneau Investments, LLC and Aleutian Investments, LLC, which are both finance companies owned by Ambac Assurance; (d) policies relating to leveraged lease transactions; and (e) policies relating to interest rate, basis, and/or currency swap or other swap transactions. Claims on Segregated Account Policies remain subject to a payment moratorium until the Segregated Account Rehabilitation Plan (as defined below) becomes effective. Insurance claims presented during the moratorium of $2,113,754 for policies allocated to the Segregated Account have not yet been paid. Net par exposure as of June 30, 2011 for policies allocated to the Segregated Account is $40,523,516. Ambac Assurance also allocated the

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following to the Segregated Account: (i) all remediation claims, defenses, offsets, and/or credits (except with respect to recoveries arising from remediation efforts or reimbursement or collection rights), if any, in respect of the Segregated Account Policies, (ii) Ambac Assurance’s disputed contingent liability under the recently settled long-term lease with One State Street, LLC (“OSS”), and its contingent liability (as guarantor), if any, under the recently terminated Ambac Assurance UK Limited (“Ambac UK”) lease with British Land, (iii) Ambac Assurance’s limited liability interests in Ambac Credit Products, LLC (“ACP”), Ambac Conduit Funding LLC, Aleutian Investments, LLC (“Aleutian”) and Juneau Investments, LLC (“Juneau”) and (iv) all of Ambac Assurance’s liabilities as reinsurer under reinsurance agreements (except for reinsurance assumed from Everspan). Effective November 7, 2010, the Plan of Operation for the Segregated Account was amended for the purpose of allocating to the Segregated Account (i) any and all liabilities (including contingent liabilities) it has or may have, now or in the future, to Ambac, or any successor to Ambac, in regard to, or respecting, tax refunds and/or the July 18, 1991 Tax Sharing Agreement, as amended (other than any liability to Ambac pertaining to any possible misallocation of up to $38,486 of tax refunds received by Ambac Assurance in September 2009 and February 2010), (ii) any and all liabilities (including contingent liabilities) it has or may have, now or in the future, to the IRS and/or the United States Department of the Treasury (the “U.S. Treasury”) in regard to, or in respect of, taxes imposed under the Internal Revenue Code of 1986, as amended (the “Federal Taxes”), for taxable periods ending on or prior to December 31, 2009 and, (iii) to the extent not described in clause (ii), any and all liabilities (including contingent liabilities) Ambac Assurance has or may have, now or in the future, to the IRS and/or the U.S. Treasury in regard to, or respect of, any Federal Tax refunds that were received prior to November 7, 2010 by Ambac Assurance, Ambac or their affiliates (each of clauses (i), (ii) and (iii), the “Allocated Disputed Contingent Liabilities”). In addition, on November 8, 2010, the rehabilitation court issued an order for temporary supplemental injunctive relief (the “State Court Injunction”) enjoining Ambac, any successor-in-interest, any state court receiver of Ambac, all persons purporting to be creditors of Ambac, the IRS and all other federal and state governmental entities from commencing or prosecuting any actions, claims, lawsuits or other formal legal proceedings relating to the Allocated Disputed Contingent Liabilities.

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

On October 8, 2010, the rehabilitator filed a plan of rehabilitation for the Segregated Account (the “Segregated Account Rehabilitation Plan”) in the Dane County Circuit Court in Wisconsin (the “Rehabilitation Court”). The Rehabilitation Court confirmed the Segregated Account Rehabilitation Plan on January 24, 2011. The effective date of the Segregated Account Rehabilitation Plan will be determined by the rehabilitator. The Segregated Account Rehabilitation Plan also makes permanent the injunctions issued by the Rehabilitation Court on March 24, 2010.

The confirmed Segregated Account Rehabilitation Plan provides that holders of permitted policy claims will receive 25% of their permitted claims in cash and 75% in surplus notes issued by the Segregated Account. The issuance of surplus notes by both Ambac Assurance, and by the Segregated Account as contemplated by the current Segregated Account Rehabilitation Plan, could subject Ambac Assurance to the risk of deconsolidation from Ambac for tax purposes, which may also result in a Section 382 limitation with respect to Ambac Assurance’s NOLs or an attribution of NOLs to Ambac, or could subject Ambac Assurance to the risk of recognizing significant cancellation of indebtedness income (“CODI”). Any of these consequences would likely have a material adverse effect on the financial condition of Ambac Assurance and the Segregated Account. As such, the rehabilitator is considering substantial amendments to the Segregated Account Rehabilitation Plan and/or the initiation of rehabilitation proceedings with respect to Ambac Assurance. Such amendments to the Segregated Account Rehabilitation Plan (and, presumably, any rehabilitation plan with respect to Ambac Assurance) could include the elimination of the issuance of surplus notes by the Segregated Account and/or the imposition of transfer restrictions on any surplus notes issued by the Segregated Account. Any such amendments to the Segregated Account Rehabilitation Plan could adversely affect the interests of Ambac security holders and holders of securities insured by Ambac Assurance as such amendments could reduce the likelihood of consummation of an agreement between Ambac and Ambac Assurance with respect to the Plan Settlement. The parties’ failure to consummate such an agreement increases the likelihood that Ambac’s bankruptcy case will convert to a Chapter 7 liquidation proceeding, with attendant adverse consequences to Ambac security holders and holders of securities insured by Ambac Assurance (including, without limitation, the loss of the NOLs or limiting the use of the NOLs to offset gain realized in connection with the sale of Ambac’s assets).

In March 2011, the Segregated Account issued Segregated Account Surplus Notes with a par value of $3,000 in connection with the commutation of insurance policies allocated to the Segregated Account. At June 30, 2011, the Segregated Account had outstanding Segregated Account Surplus Notes in an aggregate par amount of $53,000, which are reported in Long-term Debt on the Consolidated Balance Sheet with a carrying value of $5,843 based on an imputed interest rate of 52.8% at the date of issuance and have a scheduled maturity of June 7, 2020. Interest on the Segregated Account Surplus Notes is payable annually in June at the rate of 5.1% on the unpaid principal balance outstanding. All payments of principal and interest on the Segregated Account Surplus Notes are subject to the prior approval of the OCI. If the OCI does not approve the payment of interest on the Segregated Account Surplus Notes, such interest will accrue and compound annually until paid. The Segregated Account Surplus Notes were issued pursuant to a

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fiscal agency agreement entered into with The Bank of New York Mellon, as fiscal agent. To the extent that interest payments are deferred for more than five years, a portion of the deferred interet may not be deducted until paid of disallowed under the applicable high yield debt obligation provisions of the Code.

In May 2011, the Segregated Account issued Segregated Account Junior Surplus Notes with a par value of $36,082 in connection with a settlement agreement (the “Settlement Agreement”) to terminate Ambac’s existing headquarters office lease with One State Street LLC (“OSS”). The Junior Surplus Notes are reported in Long-term Debt on the Consolidated Balance Sheet with a carrying value of $3,639 based on an imputed interest rate of 58.3% at the date of issuance and have a scheduled maturity of June 7, 2020. Interest on the Segregated Account Junior Surplus Notes is payable annually in June at the rate of 5.1% on the unpaid principal balance outstanding. No payment of interest on or principal of the junior surplus notes may be made until all existing and future indebtedness of the Segregated Account, inclusive of Segregated Account Surplus Notes, policy claims and claims having statutory priority have been paid in full. All payments of principal and interest on the Segregated Account Surplus Notes are subject to the prior approval of the OCI. If the OCI does not approve the payment of interest on the Segregated Account Surplus Notes, such interest will accrue and compound annually until paid. The Settlement Agreement settled all claims among Ambac, Ambac Assurance, the Segregated Account of Ambac Assurance Corporation and OSS relating to the terminated lease. Additionally, Ambac Assurance entered into a new lease (the “New AAC Lease”) with OSS for an initial term commencing on May 19, 2011 through December 31, 2015. The New AAC Lease provides for the rental of a reduced amount of space at Ambac’s current location, One State Street Plaza. The Settlement Agreement also provides that OSS will have an allowed general unsecured claim in Ambac’s bankruptcy case for approximately $14,000 (the “AFG Payment”). The AFG Payment will be made by Ambac in the same form as payment is made to Ambac’s other creditors.

On June 1, 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 all outstanding Surplus Notes issued by Ambac and the Segregated Account on the first scheduled interest payment date of June 7, 2011.

Reclassifications:

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

(2) Debtor in Possession Financial Information

Liabilities Subject to Compromise

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