Exhibit 99.1

FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIESConsolidated Financial Statements and Report of Independent Registered Public Accounting Firm  December 31, 2008

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS  AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

1CONSOLIDATED FINANCIAL STATEMENTS:Consolidated Balance Sheets

2Consolidated Statements of Operations and Comprehensive Income

3Consolidated Statements of Changes in Shareholder's Equity

4Consolidated Statements of Cash Flows

5Notes to Consolidated Financial Statements

7


The
New York State Insurance Department recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance
company, for determining its solvency under the New York Insurance Law, and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is
given by the New York State Insurance Department to financial statements prepared in accordance with accounting principles generally accepted in the United States of America in making such
determinations.

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Report of Independent Registered Public Accounting Firm

To
Board of Directors and Shareholder
of Financial Security Assurance Inc.:

In
our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income, changes in shareholder's equity, and cash
flows present fairly, in all material respects, the financial position of Financial Security Assurance Inc. and Subsidiaries (the "Company") at December 31, 2008 and December 31,
2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our
audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.

As
discussed in Note 1 to the consolidated financial statements, in November 2008, Dexia S.A. ("Dexia"), the Company's ultimate parent, entered into an agreement to sell
the Company. As discussed in Notes 3 and 4 to the consolidated financial statements, the Company has adopted SFAS
No. 157, "Fair Value Measurements" and SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" in 2008.

/s/ PRICEWATERHOUSECOOPERS LLP New York, New York
March 18, 2009


1

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES        CONSOLIDATED BALANCE SHEETS        (in thousands, except share data)

At December 31,2008

2007ASSETSGeneral investment portfolio, available for sale:Bonds at fair value (amortized cost of $5,380,542 and $4,857,295)

$
5,264,538

$
5,019,961Equity securities at fair value (cost of $1,434 and $40,020)


374


39,869Short-term investments (cost of $615,299 and $88,972)


616,065


90,075Variable interest entities segment investment portfolio, available for sale:Bonds at fair value (amortized cost of $923,093 and $1,119,359)


923,332


1,139,568Guaranteed investment contracts from GIC Affiliates at fair value (amortized cost of $695,898 and $621,054)


801,547


639,950Short-term investments (at cost which approximates fair value)


8,221


8,618Assets acquired in refinancing transactions (includes $152,527 and $22,433 at fair value)


166,600


229,264Total investment portfolio


7,780,677


7,167,305Cash


101,151


21,770Deferred acquisition costs


299,321


347,870Prepaid reinsurance premiums


1,011,950


1,119,565Reinsurance recoverable on unpaid losses


302,124


76,478Deferred tax asset


796,257


Variable interest entities segment derivatives


378,741


634,458Credit derivatives


287,449


126,749Other assets (includes $100,000 at fair value at December 31, 2008) (See Notes 19)


642,465


682,592TOTAL ASSETS

$
11,600,135

$
10,176,787LIABILITIES, MINORITY INTEREST AND SHAREHOLDER'S EQUITYDeferred premium revenue


3,052,879


2,879,378Losses and loss adjustment expenses


1,992,178


274,556Variable interest entities segment debt (includes $799,086 at fair value at December 31, 2008)


1,243,640


2,584,800Deferred tax liability





110,156Notes payable to affiliate


172,499


210,143Credit derivatives


1,543,809


689,746Minority interest


1,111,240


138,233Other liabilities (includes $(112) and $173 at fair value)


232,900


327,474TOTAL LIABILITIES AND MINORITY INTEREST


9,349,145


7,214,486COMMITMENTS AND CONTINGENCIES (See Note 20)Preferred stock (5,000.1 shares authorized; 0 shared issued and outstanding; par value of $1,000 per share)





Common stock (330 and 344 shares authorized; issued and outstanding; par value of $45,455 and $43,605 per share)


15,000


15,000Additional paid-in capital


1,410,202


679,692Accumulated other comprehensive income (loss), net of deferred tax (benefit) provision of $(40,696) and $58,530


(75,585
)

108,669Accumulated earnings


901,373


2,158,940TOTAL SHAREHOLDER'S EQUITY


2,250,990


2,962,301TOTAL LIABILITIES, MINORITY INTEREST AND SHAREHOLDER'S EQUITY

$
11,600,135

$
10,176,787


The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

2

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME        (in thousands)

Year Ended December 31,2008

2007

2006REVENUESNet premiums written

$
701,593

$
494,463

$
476,926Net premiums earned

$
420,339

$
361,622

$
336,878Net investment income from general investment portfolio


261,784


234,786


215,595Net realized gains (losses) from general investment portfolio


(6,790
)

(2,096
)

(5,212
)Net change in fair value of credit derivatives:Realized gains (losses) and other settlements


126,891


102,800


87,200Net unrealized gains (losses)


(744,963
)

(642,609
)

31,823Net change in fair value of credit derivatives


(618,072
)

(539,809
)

119,023Net interest income from variable interest entities segment


76,450


136,041


137,844Net realized gains (losses) from variable interest entities segment


(236,220
)




Net realized and unrealized gains (losses) on derivative instruments


256,602


96,314


99,296Net unrealized gains (losses) on financial instruments at fair value


1,101,807





Income from assets acquired in refinancing transactions


11,154


20,907


24,661Net realized gains (losses) from assets acquired in refinancing transactions


(4,260
)

4,660


12,729Other income


22,172


34,417


23,806TOTAL REVENUES


1,284,966


346,842


964,620EXPENSESLosses and loss adjustment expenses


2,090,883


31,567


23,303Interest expense


12,120


21,358


25,497Amortization of deferred acquisition costs


65,700


63,442


63,012Foreign exchange (gains) losses from variable interest entities segment


1,652


134,707


146,097Interest expense from variable interest entities segment


129,864


138,220


147,621Other operating expenses


80,631


113,104


91,510TOTAL EXPENSES


2,380,850


502,398


497,040INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY INTEREST


(1,095,884
)

(155,556
)

467,580Provision (benefit) for income taxes:Current


(398
)

78,393


77,024Deferred


(821,903
)

(178,216
)

49,715Total provision (benefit)


(822,301
)

(99,823
)

126,739NET INCOME (LOSS) BEFORE MINORITY INTEREST


(273,583
)

(55,733
)

340,841Less: Minority interest


982,260


(27,656
)

(48,660
)NET INCOME (LOSS)


(1,255,843
)

(28,077
)

389,501OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAXUnrealized gains (losses) on available-for-sale securities arising during the period, net of deferred income tax provision (benefit) of $(100,514), $400 and
$8,307


(186,645
)

743


15,398Less: reclassification adjustment for gains (losses) included in net income, net of deferred income tax provision (benefit) of $(1,288), $4,933 and
$3,442


(2,391
)

9,161


6,393Other comprehensive income (loss)


(184,254
)

(8,418
)

9,005COMPREHENSIVE INCOME (LOSS)

$
(1,440,097
)
$
(36,495
)
$
398,506


The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

3

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY        (in thousands, except share data)

Common Stock



Accumulated
Other
Comprehensive
Income (Loss)Additional
Paid-In
Capital

Accumulated
Earnings

Total
Shareholders'
EquityShares

AmountBALANCE, December 31, 2005


400

$
15,000

$
841,828

$
108,082

$
1,937,516

$
2,902,426Net income for the year














389,501


389,501Other comprehensive income (loss), net of deferred income tax provision (benefit) of $4,865











9,005





9,005Capital contributions








2,637








2,637Repurchase of stock


(20
)




(100,000
)







(100,000
)Dividends paid














(140,000
)

(140,000
)Capital issuance costs








(961
)







(961
)BALANCE, December 31, 2006


380


15,000


743,504


117,087


2,187,017


3,062,608Net income (loss) for the year














(28,077
)

(28,077
)Other comprehensive income (loss), net of deferred income tax provision (benefit) of $(4,533)











(8,418
)




(8,418
)Capital contributions








113,839








113,839Repurchase of stock


(36
)




(180,000
)







(180,000
)Capital issuance costs








(764
)







(764
)Other








3,113








3,113BALANCE, December 31, 2007


344


15,000


679,692


108,669


2,158,940


2,962,301Cumulative effect of change in accounting principle, net of deferred income tax provision (benefit) of $15,225














28,276


28,276Balance at beginning of the year, adjusted


344


15,000


679,692


108,669


2,187,216


2,990,577Net income (loss) for the year














(1,255,843
)

(1,255,843
)Other comprehensive income (loss), net of deferred income tax provision (benefit) of $(99,226)











(184,254
)




(184,254
)Capital contributions








500,000








500,000Repurchase of stock


(14
)




(70,000
)







(70,000
)Dividends paid on common stock














(30,000
)

(30,000
)Surplus note








300,000








300,000Other








510








510BALANCE, December 31, 2008


330

$
15,000

$
1,410,202

$
(75,585
)
$
901,373

$
2,250,990


The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

4

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF CASH FLOWS        (in thousands)

Year Ended December 31,2008

2007

2006Cash flows from operating activities:Premiums received, net

$
662,170

$
467,626

$
483,399Credit derivative fees received, net


113,292


108,710


82,860Other operating expenses paid, net


(213,790
)

(138,048
)

(167,280
)Salvage and subrogation received (paid)


(527
)

292


1,745Losses and loss adjustment expenses paid, net


(602,870
)

(68,634
)

(405
)Net investment income received from general investment portfolio


254,243


231,322


213,341Federal income taxes paid


143,102


(108,907
)

(82,800
)Interest paid


(12,247
)

(20,925
)

(25,877
)Interest paid on variable interest entities segment


(6,709
)

(8,776
)

(5,956
)Net investment income received from variable interest entities segment


27,896


45,510


37,400Net derivative payments in variable interest entities segment


(10,809
)

(29,913
)

(23,960
)Income received from assets acquired in refinancing transactions


12,001


19,979


41,622Other


45,028


5,000


8,543Net cash provided by (used for) operating activities


410,780


503,236


562,632Cash flows from investing activities:General investment portfolio:Proceeds from sales of bonds


3,982,212


3,521,879


1,581,689Proceeds from maturities of bonds


516,865


184,469


160,846Purchases of bonds


(4,998,300
)

(4,054,958
)

(2,074,463
)Net (increase) decrease in short-term investments


(521,902
)

1,076


18,700Variable interest entities segment investment portfolio:Proceeds from maturities of bonds


119,500


265,400


103,662Net (increase) decrease in short-term


397


10,860


(16,802
)Other:Paydowns of assets acquired in refinancing transactions


36,727


110,581


88,477Proceeds from sales of assets acquired in refinancing transactions


5,193


7,956


13,643Purchases of property, plant and equipment


(2,595
)

(1,152
)

(2,263
)Other investments


989


7,257


24,109Net cash provided by (used for) investing activities


(860,914
)

53,368


(102,402
)Cash flows from financing activities:Capital contribution


500,000


112,478


Surplus Notes


300,000





Dividends paid


(30,000
)




(140,000
)Repayment of surplus notes





(108,850
)

Repayment of notes payable to affiliate


(37,644
)

(111,228
)

(142,207
)Repayment of variable interest entities segment debt


(123,730
)

(276,900
)

(87,500
)Capital issuance costs


(4,920
)

(1,829
)

(961
)Repurchase of shares


(70,000
)

(180,000
)

(100,000
)Net cash provided by (used for) financing activities


533,706


(566,329
)

(470,668
)Effect of changes in foreign exchange rates on cash balances


(4,191
)

1,835


592Net increase (decrease) in cash


79,381


(7,890
)

(9,846
)Cash at beginning of year


21,770


29,660


39,506Cash at end of year

$
101,151

$
21,770

$
29,660


The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

5

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED        (in thousands)

Year Ended December 31,2008

2007

2006Reconciliation of net income (loss) to net cash flows from operating
activities:Net income (loss)


(1,255,843
)
$
(28,077
)
$
389,501Change accrued investment income


(1,995
)

19,929


(10,798
)Change deferred premium revenue net of prepaid reinsurance premiums


281,116


143,378


138,199Change deferred acquisition costs


48,549


(7,197
)

(5,544
)Change in current federal income taxes payable


142,704


(30,515
)

(5,776
)Change in unpaid losses and loss adjustment expenses, net of reinsurance recoverable


1,491,976


7,298


21,401Provision (benefit) for deferred income taxes


(821,903
)

(178,216
)

49,715Net realized (gains) losses on investments


251,166


(15,948
)

(10,578
)Depreciation and accretion of discount


2,409


(26,643
)

31,927Minority interest


982,259


(106,136
)

(48,660
)Change in other assets and liabilities


(709,658
)

725,363


13,245Cash provided by operating activities

$
410,780

$
503,236

$
562,632


The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

6

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS    FOR THE YEARS ENDED DECEMBER 31, 2008, 2007 AND 2006

1.     ORGANIZATION AND OWNERSHIP

Financial Security Assurance Inc. ("FSA" or together with its consolidated entities, the "Company"), a wholly owned subsidiary of Financial Security
Assurance Holdings Ltd. (the "Parent"), is an insurance company domiciled in the State of New York. The Company engages in providing financial guaranty insurance on public finance obligations
in domestic and international markets. Historically, the Company also provided financial guaranty insurance on asset-backed obligations. In August 2008, the Company announced that it would cease
insuring asset-backed obligations and instead participate exclusively in the global public finance financial guaranty business. The Company operates in two business segments: a financial guaranty
segment and a variable interest entities ("VIE") segment.

Within
the financial guaranty segment, the Company insures guaranteed investment contracts ("GICs") issued by FSA Capital Management Services LLC ("FSACM"), FSA Capital Markets
Services (Caymans) Ltd. and, prior to April 2003, FSA Capital Markets Services LLC (collectively, the "GIC Affiliates"), affiliates of the Company. In November 2008, the GIC Affiliates
ceased issuing GICs. While the Company has ceased new originations of asset-backed financial guaranty business and the GIC Affiliates have ceased issuing GICs, a substantial portfolio of such
obligations remains outstanding.

The
Parent is a direct subsidiary of Dexia Holdings, Inc. ("Dexia Holdings"), which, in turn, is owned 90% by Dexia Crédit Local S.A. ("Dexia
Crédit Local") and 10% by Dexia S.A. ("Dexia"). Dexia is a Belgian corporation primarily engaged in the business of public finance, banking and investment management in France,
Belgium, Luxemburg and other European countries, as well as in the United States. Dexia Crédit Local is a wholly owned subsidiary of Dexia. At December 31, 2008, Dexia Holdings
owned over 99% of outstanding shares of the Parent.

Expected Sale of the Company

Purchase Agreement with Assured Guaranty Ltd.

In November 2008, Dexia Holdings entered into a purchase agreement (the "Purchase Agreement") providing for the sale of all Parent
shares owned by Dexia to Assured (the "Acquisition"), subject to the consummation of specified closing conditions, including regulatory approvals, absence of rating impairment and segregation or
separation of the Parent's financial products ("FP") operations from the Parent's financial guaranty operations.

Under
the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") and the rules promulgated thereunder by the Federal Trade Commission (the "FTC"), the
Acquisition may not be consummated until notifications have been given and certain information has been furnished to the FTC and the Department of Justice (the "DOJ") and specified waiting period
requirements have been satisfied. The HSR Act waiting period expired on January 21, 2009. In addition, under the insurance holding company laws and regulations applicable to the Parent and its
insurance subsidiaries and Assured's insurance company subsidiaries, before a person can acquire control of a U.S. insurance company, prior written approval must be obtained from the insurance
commissioner of the state where the insurer is domiciled. Assured has informed the Parent that Assured filed applications with the insurance departments of the States of New York and Oklahoma and the
U.K. Financial Services Authority; that the applications to the New York Insurance Department and the U.K. Financial Services Authority have been approved; and that it has made
pre-acquisition filings regarding the

7

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potential
competitive impact of the acquisition, which are deemed to have been approved. Dexia has informed Parent that it has filed an application with the U.K. Financial Services Authority in
connection with its acquisition of Assured common shares pursuant to the Purchase Agreement, which has been approved, and that it has filed disclaimers of control with the insurance departments of the
states of Maryland, New York, and Oklahoma.

Satisfying
all three rating agencies that the necessary steps have or will be taken to transfer the Parent's FP segment credit and liquidity risk to Dexia is one of the last conditions
to the Purchase Agreement closing. Rating agency confirmation that the Acquisition will not have a negative impact on the financial strength ratings of Assured's insurance company subsidiaries or FSA
and its insurance company subsidiaries is a condition for closing, and is beyond the Parent's control.

The
Company cannot estimate whether or when the remaining closing conditions will be satisfied or relevant agreements negotiated, whether the Acquisition will be completed and, if
completed, whether it will be structured as currently contemplated, or what the effects of the change in control or removal of the Parent's FP business will be on the Company and its results of
operations. If the Acquisition is not carried out, Dexia may explore other options with respect to the Parent and its subsidiaries, including selling the Parent or some of its operations to a third
party or ceasing to write new business, which may have a material adverse effect on the Company.

Dexia's Retention of the Parent's FP Business

Under the Purchase Agreement, Dexia is expected to retain the Parent's FP business after the Acquisition. The Parent's FP business
includes the Company's VIE Segment. The Purchase Agreement provides that Dexia will provide guarantees with respect to the FP business' assets and liabilities, including derivative contracts and
anticipates that some of its guarantees will benefit from guarantees provided by the French and Belgian states. Dexia Holdings, the Company's ultimate parent, agreed that if such sovereign guarantees
are provided, it will cause Parent to transfer the ownership interests of certain of the subsidiaries that conduct the FP business, or all the assets and liabilities of such subsidiaries, to Dexia
Holdings or one of its affiliates in form reasonably acceptable to Assured.

Subsequent Event

In February 2009, Dexia entered into several agreements that transfer credit and liquidity risk of the GIC operations to Dexia, (the
"FSAM Risk Transfer Transaction"). Each of the agreements executed under the FSAM Risk Transfer Transaction directly affect (1) FSA Asset Management LLC ("FSAM"), an affiliate of the Company,
and (2) the entities that absorb the risks created by FSAM. These agreements provide for the (i) elimination of FSA's guaranty of repayment of FSAM's borrowings under the credit
facilities provided by Dexia's bank subsidiaries; (ii) elimination of
FSA's guaranty of certain of FSAM's investments; and (iii) increase in the credit facilities provided to FSAM by Dexia's bank subsidiaries from $5 billion to $8 billion.

Financial Guaranty

Financial guaranty insurance generally provides an unconditional and irrevocable guaranty that protects the holder of a financial
obligation against non-payment of principal and interest when due. Upon a payment default on an insured obligation, the Company is generally required to pay the principal, interest or
other amounts due in accordance with the obligation's original payment schedule or, at its option, to pay such amounts on an accelerated basis.

Obligations
insured by the Company are generally awarded ratings on the basis of the financial strength ratings given to the Company's insurance company subsidiaries by the major
securities rating agencies. On December 31, 2008, the Company was rated Triple-A (negative credit watch) by Standard & Poor's Ratings Services ("S&P") and Fitch Ratings
("Fitch") and Aa3 (developing outlook)

8

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by
Moody's Investors Service, Inc. ("Moody's"). Prior to the third quarter of 2008, the Company's insurance company subsidiaries, as well as the obligations they insured, had been awarded
Triple-A ratings by the three major rating agencies.

During
2007 and 2008, the global financial crisis that began in the U.S. subprime residential mortgage market transformed the financial guaranty industry. By the end of November 2008,
all of the monoline guarantors that had been rated Triple-A at the beginning of the year had been downgraded in varying degrees by Moody's, and all but one had been either downgraded or
placed on negative outlook or negative credit watch by S&P and Fitch. FSA and its insurance company subsidiaries were among the last companies to be affected, and were rated
"Triple-A/stable" by all three rating agencies until July 2008. Rating agencies raised concerns about the stability of FSA's rating during the second half of 2008, and Moody's lowered
FSA's and its insurance company subsidiaries' Aaa rating to Aa3 (developing outlook) in November. These developments, combined with illiquidity in the capital markets, led to a marked reduction in the
Company's production in the second half of 2008.

Public
finance obligations insured by the Company consist primarily of general obligation bonds supported by the issuers' taxing powers, tax-supported bonds and revenue bonds
and other obligations of states, their political subdivisions and other municipal issuers supported by the issuers' or obligors' covenant to impose and collect fees and charges for public services or
specific
projects. Public finance obligations include obligations backed by the cash flow from leases or other revenues from projects serving substantial public purposes, including government office buildings,
toll roads, health care facilities and utilities.

Asset-backed
obligations insured by the Company were generally issued in structured transactions and are backed by pools of assets such as residential mortgage loans, consumer or trade
receivables, securities or other assets having an ascertainable cash flow or market value. The Company insured synthetic asset-backed obligations that generally took the form of credit default swap
("CDS") obligations or credit-linked notes that reference asset-backed securities ("ABS") or pools of securities or other obligations, with a defined deductible to cover credit risks associated with
the referenced securities or loans.

The
Company has refinanced certain poorly performing transactions by employing refinancing vehicles to raise funds, prepay the claim obligations and take control of the assets. These
refinancing vehicles are consolidated with the Company and considered part of the financial guaranty segment.

Variable Interest Entities

The Company consolidated the results of VIEs where it is the primary beneficiary. These VIEs include FSA Global Funding Limited ("FSA
Global") and Premier International Funding Co. ("Premier"). The Company does not own an equity interest in the VIEs.

FSA
Global is a special purpose funding vehicle partially owned by a subsidiary of the Parent. FSA Global issues FSA-insured medium term notes and generally invests the
proceeds from the sale of its notes in FSA-insured GICs or other FSA-insured obligations with a view to realizing the yield difference between the notes issued and the
obligations purchased with the note proceeds. Premier is principally engaged in leveraged lease transactions.

The
Company's management believes that the assets held by FSA Global and Premier, including those that are eliminated in consolidation, are beyond the reach of the Company's creditors,
even in bankruptcy or other receivership. Substantially all the assets of FSA Global are pledged to secure the repayment, on a pro rata basis, of FSA Global's notes and its other obligations.

9

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2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The
accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"), which differ in certain
material respects from accounting practices prescribed or permitted by insurance regulatory authorities (see Note 26). The preparation of financial statements in conformity with GAAP requires
management to make extensive estimates and assumptions that affect the reported amounts of assets and liabilities in the Company's consolidated balance sheets at December 31, 2008 and 2007, the
reported amounts of revenues and expenses in the consolidated statements of operations and comprehensive income during the years ended December 31, 2008, 2007 and 2006 and disclosure of
contingent assets and liabilities. Such estimates and assumptions include, but are not limited to, losses and loss adjustment expenses, fair value of financial instruments, the determination of
other-than-temporary impairment ("OTTI"), the deferral and amortization of policy acquisition costs and taxes. Actual results may differ from those estimates.

Basis of Presentation

The consolidated financial statements include the accounts of the Company and its direct and indirect subsidiaries, (collectively, the
"Subsidiaries"), principally including:



The
consolidated financial statements also include the accounts of certain VIEs and refinancing vehicles as described in Note 1. Intercompany accounts and transactions have been
eliminated. Certain prior-year balances have been reclassified to conform to the current year's presentation.

Significant
accounting policies under GAAP are described below. To the extent the accounting policy calls for fair value measurement, see Note 3 for a discussion of how fair value
is measured for each financial instrument.

Investments

The Company segregates its investments into the following portfolios:



Investments
in debt and equity securities designated as available for sale are carried at fair value. The unrealized gain or loss on investments that are not hedged with derivatives or
are economically hedged but do not qualify for hedge accounting is reflected as a separate component of shareholders' equity, net of tax, unless deemed to be OTTI. OTTI is reflected in earnings as a
realized loss. The unrealized gain or loss attributable to the hedged risk on investments that qualify as fair-value
hedges is recorded in the consolidated statements of operations and comprehensive income in "net interest income from variable interest entities segment". Realized and unrealized gain or loss on the
VIE Segment Investment Portfolio has no effect on equity or net income after giving effect to minority interest.

10

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Bond
discounts and premiums are amortized on the effective yield method over the remaining terms of the securities acquired. For mortgage-backed securities and any other holdings for
which prepayment risk may be significant, assumptions regarding prepayments are evaluated periodically and revised as necessary. Any adjustments required due to the resulting change in effective
yields are recognized in current income. The cost of securities sold is based on specific identification of each security.

Short-term
investments, which are those investments with a maturity of less than one year at time of purchase, are carried at fair value. Amounts deposited in money market
funds and investments with a maturity at time of purchase of three months or less are included in short-term investments.

Variable
rate demand notes ("VRDNs") are included in bonds in the General Investment Portfolio.

VRDNs
are long-term bonds that bear floating interest rates and provide investors with the option to tender or put the bonds at par, generally on a daily, weekly or monthly
basis. Auction Rate Securities are long-term securities with interest rate reset features and are traded in the marketplace through a bidding process. The cash flows related to these
securities are presented on a gross basis in the consolidated statements of cash flows.

Mortgage
loans are carried at the lower of cost or market on an aggregate basis.

Premium Revenue Recognition

Gross and ceded premiums received at inception of an insurance contract (i.e., upfront premiums) are earned in proportion to the
expiration of the related risk. For upfront
payouts, premium earnings are greater in the earlier periods, when there is a higher amount of exposure outstanding. The amount of risk outstanding is equal to the sum of the par amount of debt
insured over the expected period of coverage. Deferred premium revenue and prepaid reinsurance premiums represent the portions of gross and ceded premium, respectively, that are applicable to coverage
of risk to be provided in the future on policies in force. When an insured issue is retired or defeased prior to the end of the expected period of coverage, the remaining deferred premium revenue and
prepaid reinsurance premium, less any amount credited to a refunding issue insured by the Company, are recognized. For premiums received on an installment basis, the Company earns the premium over the
installment period, typically less than one year, throughout the period of coverage. When the Company, through its ongoing credit review process, identifies transactions where premiums are paid on an
installment basis and certain default triggers have been breached, the Company ceases to earn premiums on such transactions.

Effective
January 1, 2009, the Company's recognition of premium revenue will change due to the adoption of Financial Accounting Standards Board ("FASB") Statement of Financial
Accounting Standard ("SFAS") No. 163, "Accounting for Financial Guarantee Insurance Contracts" ("SFAS 163"), as described in "Recently Issued Accounting Standards that are
Not Yet Effective."

Losses and Loss Adjustment Expenses

The Company establishes loss and loss adjustment expense ("LAE") liabilities based on its estimate of specific and
non-specific losses. LAE consists of the estimated cost of settling claims, including legal and other fees and expenses associated with administering the claims process.

Case Reserves

The Company calculates a case reserve for the portion of the loss and LAE liability based upon identified risks inherent in its insured
portfolio. If an individual policy risk has a reasonably estimable and probable loss as of the balance sheet date, a case reserve is established. For the remaining policy

11

---



risks
in the portfolio, a non-specific reserve is established to account for the inherent credit losses that can be statistically estimated.

Case
reserves for financial guaranty insurance companies differ from those of traditional property and casualty insurance companies. The primary difference is that traditional property
and casualty case reserves include only claims that have been incurred and reported to the insurance company. In a traditional property and casualty company, claims are incurred when defined events
occur such as an automobile accident, home fire or storm. Unlike traditional property and casualty claims, financial guaranty losses arise from the extension of credit protection and occur as the
result of the credit deterioration of the issuer or underlying assets of the insured obligations over the lives of those insured obligations. Such deterioration and ultimate loss amounts can be
projected based on historical experience in order to estimate probable loss, if any. Accordingly, specific loss events that require case reserves include (1) policies under which claim payments
have been made and additional claim payments are expected and (2) policies under which claim payments are probable and reasonably estimable, but have not yet been made.

The
Company establishes a case reserve for the present value of the estimated loss, net of subrogation recoveries, when, in management's opinion, the likelihood of a future loss on a
particular insured obligation is probable and reasonably estimable at the balance sheet date. When an insured obligation has met the criteria for establishing a case reserve and that transaction pays
a premium in installments, those premiums, if expected to be received prospectively, are considered a form of recovery and are no longer earned as premium revenue. Typically, a case reserve is
determined using cash flow or similar models that represent the Company's estimate of the net present value of the anticipated shortfall between (1) scheduled payments on the insured obligation
plus anticipated loss adjustment expenses and (2) anticipated cash flow from and proceeds to be received on sales of any collateral supporting the obligation and other anticipated recoveries.
The estimated loss, net of recovery, on a transaction is discounted using the risk-free rate appropriate for the term of the insured obligation at the time the reserve is established and
is not subsequently adjusted. In certain situations where cash flow models are not practical, a case reserve represents management's best estimate of expected loss.

The
Company records a non-specific reserve to reflect the credit risks inherent in its portfolio. The non-specific and case reserves together represent the
Company's estimate of total reserves. The establishment of a non-specific reserve for credits that have not yet defaulted is a common practice in the financial guaranty industry, although
there are differences in the specific methodologies applied by other financial guarantors in establishing and measuring these reserves.

Non-Specific Reserve

The Company establishes a non-specific reserve on its portfolio of credits because management believes that a portfolio of
insured obligations will deteriorate over its life and that the existence of inherent loss can be statistically estimated using data such as that published by rating agencies. The establishment of the
reserve is a systematic process that considers this quantitative, statistical information obtained primarily from Moody's and S&P, together with qualitative factors such as overall credit quality
trends resulting from economic and political conditions, recent loss experience in particular segments of the portfolio and changes in underwriting policies and procedures.
The factors used to establish reserves are evaluated periodically by comparing the statistically computed loss amount with the incurred losses as represented by case reserve activity to develop an
experience factor that is updated and applied to current-year originations. Management's best estimate of inherent losses associated with providing credit protection at each balance sheet
date is evaluated by applying the Moody's expected loss algorithm as an estimate of the reserve required for non-investment grade risks not requiring a core reserve. If such amount is
greater than 10% of the statistical product then an additional contribution to the non-specific reserve is made.

12

---



The
non-specific reserve established considers all levels of protection (e.g., reinsurance and overcollateralization). Net par outstanding for policies originated in
the current period is multiplied by loss frequency and severity factors, with the resulting amounts discounted at the risk-free rates using the treasury yield curve (the "statistical
calculation"). The discount rate does not change and is used to accrete the loss for the life of each policy. The loss factors used for the calculation are the product of default frequency rates
obtained from Moody's and severity factors obtained from S&P. Moody's is chosen for default frequency rates due to its credibility, large population, statistical format and reliability of future
update. The Moody's default information is applied to all credit sectors or asset classes as described below. In its publication of default rates for bonds issued from 1970-2007, Moody's
tracks bonds over a 20-year horizon by credit rating at time of issuance. For the purpose of establishing appropriate severity factors, the Company's methodology segregates the portfolio
into asset classes, including health care transactions, all other public finance transactions, pooled corporate transactions, commercial real estate, and all other asset-backed transactions. The
severity factors are derived from capital charge assessments provided by S&P. S&P capital charges project loss levels by asset class and are incorporated into their capital adequacy stress scenario
analysis.

The
product of the current-year statistical calculation multiplied by the current-year experience factor represents the present value of loss amounts calculated
for current-year originations. The present value of loss amounts calculated for the current-year originations is established at inception of each policy, and there is no
subsequent change unless significant adverse or favorable loss experience is observed. The experience factor is based on the Company's cumulative-to-date historical losses
starting from 1993, when the Company established the non-specific reserve methodology. The experience factor is calculated by dividing cumulative-to-date actual
losses incurred by the Company by the cumulative-to-date losses determined by the statistical calculation. The experience factor is reviewed and, where appropriate, updated
periodically, but no less than annually.

The
present value of loss amounts calculated for the current-year originations plus an amount representing the accretion of discount pertaining to prior-year
originations are charged to loss expense and increase the non-specific loss reserve after adjustments that
may be made to reflect observed favorable or adverse experience. The entire non-specific reserve is available to absorb probable losses inherent in the portfolio.

Since
the non-specific reserve contains the inherent losses of the portfolio, when a case reserve adjustment is deemed appropriate, whether the result of adverse or positive
credit developments, accretion or the addition of a new case reserve, a full transfer is made between the non-specific reserve and the case reserve balances with no effect to income. The
adequacy of the non-specific reserve balance is reviewed periodically and at least annually. Such analyses are performed to quantify appropriate adjustments that may be either charges or
benefits on the consolidated statements of operations and comprehensive income.

In
order to determine any adjustment to the non-specific reserve, management uses a methodology that references a calculation of expected loss for risks that are
below-investment-grade according to the Company's ratings. The calculation of expected loss relies on the following assumptions and parameters:



In
2008, management recorded additional non-specific reserves as a result of such analysis.

13

---





Reserving Methodology and Industry Practice

Management is aware that there are differences regarding the method of defining and measuring both case reserves and
non-specific reserves among participants in the financial guaranty industry. Other financial guarantors may establish case reserves only after a default and use different techniques to
estimate probable loss. Other financial guarantors may establish the equivalent of non-specific reserves, but refer to these reserves by various terms such as, but not limited to,
"unallocated losses," "active credit reserves" and "portfolio reserves," or may use different statistical techniques from those the Company uses to determine loss at a given point in time.

Management
believes that accounting literature in effect for 2008 does not address the unique attributes of financial guaranty insurance. As an insurance enterprise, the Company
initially refers to the accounting and financial reporting guidance in FAS No. 60, "Accounting and Reporting by Insurance Enterprises: ("SFAS 60"). In establishing loss liabilities, the
Company relies principally on SFAS 60, which prescribes differing treatment depending on whether a contract is a short-duration contract or a long-duration contract. Financial
guaranty insurance does not fall clearly within the definition of either short- duration or long-duration contracts. Therefore, the Company does not believe that SFAS 60 alone
provides sufficient guidance for financial guaranty claim liability recognition.

As
a result, the Company also analogizes to SFAS No. 5, "Accounting for Contingencies" ("SFAS 5"), which requires the establishment of liabilities when a loss is both
probable and reasonably estimable. The Company also relies by analogy on Emerging Issues Task Force Issue 85-20, "Recognition of fees for guaranteeing a loan," which provides general guidance
on the recognition of losses related to guaranteeing a loan. In the absence of a comprehensive accounting model provided by SFAS 60, industry participants, including the Company, have looked to
such other guidance referred to above to develop their accounting policies for the establishment and measurement of loss liabilities. The
Company believes that its financial guaranty loss reserve policy is appropriate under the applicable accounting literature, and that it best reflects the fact that a portfolio of credit-based
insurance, comprising irrevocable contracts that cannot be unilaterally changed by the insurer and that match the maturity terms of the underlying insured obligations, contains probable and reasonably
estimable losses.

Effective
January 1, 2009, the Company's measurement and recognition of claims liabilities will change due to the adoption of SFAS 163, as described in
"Recently Issued Accounting Standards."

Deferred Costs

Financial Guaranty

Deferred acquisition costs comprise expenses primarily related to the production of business, including commissions paid on reinsurance
assumed, compensation and related costs of underwriting, certain rating agency fees, premium taxes and certain other underwriting expenses, reduced by ceding commission received on premiums ceded to
reinsurers. Deferred acquisition costs are amortized over the period in which the related premiums are earned. When an insured issue is retired or defeased prior to the end of the expected period of
coverage, the remaining deferred acquisition cost is recognized. A premium deficiency would be recognized if the present value of anticipated losses and loss adjustment expenses exceeded the sum of
deferred premium revenue and estimated installment premiums.

Derivatives

Derivative contracts are entered into to manage interest rate and foreign currency risks associated with the VIE Segment Investment
Portfolio and VIE segment debt. The derivatives are recorded at fair value and generally include interest rate and currency swap agreements, which are primarily utilized to convert the Company's fixed
rate securities in the VIE Segment Investment Portfolio and VIE segment

14

---



debt
into U.S.-dollar floating rate assets and liabilities. Cash collateral received from derivative counterparties is netted with derivative receivables from the same counterparties when the right of
offset exists under master netting agreements.

The
gains and losses relating to derivatives not designated as fair-value hedges are included in "net realized and unrealized gains (losses) on derivative instruments" in the
consolidated statements of operations and comprehensive income. The gains and losses related to derivatives designated as fair-value hedges are included in either "net interest income from
variable interest entities segment" or "net interest expense from variable interest entities segment," as appropriate, along with the offsetting change in the fair value of the risk being hedged.
Hedge accounting is applied to fair value hedges provided certain criteria are met. See Note 16 for more information. All cash flows from derivative instruments are classified as "net
derivative payments in variable interest entities segment" on the statement of cash flows, regardless of their designation as fair-value hedges.

The
Company also has a portfolio of insured derivatives (primarily CDS). It considers these agreements to be a normal part of its financial guaranty insurance business, although they are
considered derivatives for accounting purposes. These agreements are recorded at fair value. Changes in fair value are recorded in "net change in fair value of credit derivatives."

In
consultation with the Securities and Exchange Commission (the "SEC"), members of the financial guaranty industry have collaborated to develop a presentation of credit derivatives
issued by financial guaranty insurers that is more consistent with that of non-insurers. Prior-period balances have been reclassified to conform to the current presentation. The
reclassifications do not affect net income or equity, although they do affect various revenue, asset and liability line items. Changes in fair value are recorded in "net change in fair value of credit
derivatives" in the consolidated statements of operations and comprehensive income. The "realized gains (losses) and other settlements" component of this income statement line includes premiums
received and receivable on written CDS contracts and premiums paid and payable on purchased contracts. If a credit event occurred that required a payment under the contract terms, this line item would
also include losses paid and payable to CDS contract counterparties due to the credit event and losses recovered and recoverable on purchased contracts.

Variable Interest Entities Segment Debt

VIE segment debt is recorded at amortized cost or fair value, if the fair value option was elected. Certain VIE liabilities include
embedded derivatives. Prior to the adoption of SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159") on January 1, 2008, changes in
fair value of embedded derivatives in VIE debt were recorded in "net realized and unrealized gains (losses) on derivative instruments." In 2008, the fair value option was elected for all VIE
liabilities containing embedded derivatives and the change in fair value of the entire debt instrument is recorded in "net unrealized gains (losses) on financial instruments at fair value."

Foreign Currency Translation

Monetary assets and liabilities denominated in foreign currencies are translated at the spot rate at the balance sheet date.
Non-monetary assets and liabilities are recorded at historical rates. Revenues and expenses denominated in foreign currencies are translated at average rates prevailing during the year.
Unrealized gains and losses on available-for-sale securities resulting from translating investments denominated in foreign currencies are recorded in accumulated other
comprehensive income unless the security is deemed OTTI. Gains and losses from transactions in foreign currencies are recorded in "other income."

15

---



Federal Income Taxes

The provision for income taxes consists of an amount for taxes currently payable and an amount for deferred taxes arising from
temporary differences between the tax bases of assets and liabilities and the amounts reported in the financial statements. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are evaluated for recoverability and a valuation
allowance is established if a deferred tax asset is determined to be non-recoverable.

Non-interest-bearing
tax and loss bonds are purchased to prepay the tax benefit that results from deducting contingency reserves as provided under Internal Revenue Code
Section 832(e). The Company records the purchase of tax and loss bonds in other assets.

The
Company recognizes tax benefits only if a tax position is "more likely than not" to prevail.

Special Purpose Entities

Asset-backed and, to a lesser extent, public finance transactions insured by the Company may employ special purpose entities ("SPEs")
for a variety of purposes. A typical asset-backed transaction, for example, employs an SPE as the purchaser of the securitized assets and as the issuer of the insured obligations. SPEs are typically
owned by transaction sponsors or charitable trusts, although the Company may have an ownership interest in some cases. The Company generally maintains certain contractual rights and exercises varying
degrees of influence over SPE issuers of FSA-insured obligations.

The
Company also bears some of the "risks and rewards" associated with the performance of those SPE's assets. Specifically, as issuer of the financial guaranty insurance policy insuring
a given SPE's obligations, the Company bears the risk of asset performance (typically, but not always, after a significant depletion of overcollateralization, excess spread, a deductible or other
credit protection).

The
Company's underwriting guidelines for public finance obligations generally require that a transaction be rated investment grade when FSA's insurance is applied. The Company's
underwriting guidelines for asset-backed obligations, which it followed prior to its August 2008 decision to cease insuring such obligations, varied by obligation type in order to reflect different
structures and types of credit support. The Company sought to insure asset-backed obligations that generally provided for one or more forms of overcollateralization or third-party protection. In
addition, the SPE typically pays a periodic premium to the Company in consideration of the issuance by the Company of its insurance policy, with the SPE's assets typically serving as the source of
payment of such premium, thereby providing some of the "rewards" of the SPE's assets to the Company. SPEs are also employed by the Company in connection with secondary market transactions and with
refinancing underperforming, non-investment-grade transactions insured by FSA. See Note 7 for more information.

The
degree of influence exercised by the Company over these SPEs varies from transaction to transaction, as does the degree to which "risks and rewards" associated with asset performance
are assumed by the Company. In analyzing special purpose entities described above, the Company considers reinsurance to be an implicit variable interest. Where the Company determines it is required
to consolidate the special purpose entity, the outstanding exposure is excluded from outstanding exposure amounts reported.

The
Company is required to consolidate SPEs that are considered VIEs where the Company is considered the primary beneficiary.

In
determining whether the Company is the Primary Beneficiary of a particular VIE, a number of factors are considered. The significant factors considered are: the design of the entity
and the risks it was created to pass-along to variable interest holders; the extent of credit risk absorbed by the

16

---



Company
through its insurance contract and the extent to which credit protection provided by other variable interest holders reduces this exposure; the exposure that the Company cedes to third party
reinsurers, to reduce the extent of expected loss which the Company absorbs; and the portion of the VIE's total notional exposure covered by the Company's insurance policy. The Company's accounting
policy is to first conduct a qualitative analysis based on the design of the VIE in order to identify whether it is the primary beneficiary. Should the qualitative analysis not provide a basis for
conclusion, the Company will perform a quantitative analysis in order to determine if it is the primary beneficiary of the VIE under review.

In
considering the significance of its interest in a particular VIE, the Company considers the extent to which both the variability it absorbs from the VIE and the Company's exposure to
that VIE are material to the Company's own financial statements. The Company believes that its surveillance categories are an appropriate measure to use for identification of VIEs in which the Company
absorbs other than insignificant variability. VIEs selected for this purpose are related to risks classified as surveillance Category IV, defined as "demonstrating sufficient deterioration to
indicate that material credit losses are possible even though not yet probable" or risks classified as surveillance Category V, defined as "transactions where losses are probable." The Company
believes that VIE-related risks classified as surveillance Categories IV and V are VIEs in which the Company absorbs a significant portion of the variability created by the
particular VIE. For a more detailed description of the surveillance categories used by the Company, see Note 9.

VIEs
in which the Company holds a significant variable interest, but which are not consolidated, have been aggregated according to principle line of business for the purpose of
disclosing the nature and extent of the Company's exposure to such VIEs. The Company considers such VIEs according to principle line of business to appropriately reflect the VIE risk and reward
characteristics in an aggregated manner. The table below displays the Company's exposure to these VIEs at December 31, 2008.

Non-Consolidated VIEs

At December 31, 2008LiabilityNet Case Reserve

Net Non-
Specific
Reserve

Fair Value of
Credit
Derivatives

Net Par
Outstanding(1)

Number of VIEs(dollars in thousands)Asset-backed:DomesticResidential mortgages

$
1,221,410

$
36,422

$
11,263

$
9,130,637


59Consumer receivables





9,163





88,438


1Pooled corporate


25,866





110,488


797,835


10Other








34,981


125,710


1Total asset-backed


1,247,276


45,585


156,732


10,142,620


71Public finance:Domestic


263








239


1International


10,960








509,520


7Total public finance


11,223








509,759


8Total

$
1,258,499

$
45,585

$
156,732

$
10,652,379


79


---

17

---



The
Company's interest in these non-consolidated VIEs is included in "losses and loss adjustment expenses" and "credit derivatives" in the Company's balance sheet.

The
Company has consolidated certain VIEs for which it has determined that it is the primary beneficiary. The table below shows the carrying value and classification of the consolidated
VIE assets and liabilities in the Company's financial statements:

Consolidated VIEs

At December 31, 2008Total Assets

Total Liabilities

Minority Interest(in thousands)VIE segment VIEs

$
2,427,640

$
1,316,400

$
1,111,240


FSA
has provided financial guarantee insurance contracts on the assets held and the notes issued by FSA Global Funding and, as such, FSA is exposed to the risk of non-payment
of the
assets held by FSA Global Funding. In addition, aside from the financial guarantee insurance contracts provided by FSA, there are no arrangements, either explicit or implicit, which could require the
Company to provide financial support to the VIEs.

Employee Compensation Plans

The Company records a liability in other liabilities related to the vested portion of employees' outstanding "performance shares" under
the Company's 2004 Equity Participation Plan and 1993 Equity Participation Plan (the "Equity Plans"). The expense is recognized ratably over specified performance cycles. The Company also records
prepaid assets for Dexia restricted share awards made under the Company's Equity Plans and amortize these amounts over the employees' vesting periods. For more information regarding the Equity Plans,
see Note 14.

Under
SFAS No. 123, "Share-Based Payment" (revised 2004), the Company recorded $1.2 million and $1.0 million in additional after-tax expense related to
the Dexia Employee Share Plans in 2007 and 2006, respectively. There was no expense recorded in 2008.

Recently Issued Accounting Standards

In October 2008, the FASB issued FSP No. FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market
for That Asset Is Not Active" ("FSP 157"). FSP 157 clarifies the application of SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), in an inactive market, without changing its existing
principles. The FSP was effective immediately upon issuance. The adoption of FSP No. FAS 157-3 did not have an effect on the Company's financial position or results of operations or
cash flows.

Recently Issued Accounting Standards that are Not Yet Effective

In May 2008, the FASB issued SFAS 163. This statement addresses accounting standards applicable to existing and future financial
guaranty insurance and reinsurance contracts issued by insurance companies, including accounting for claims liability measurement and recognition and premium recognition and related disclosures.
SFAS 163 requires the Company to recognize a claim liability when there is an expectation that a claim loss will exceed the unearned premium revenue (liability) on a policy basis based on the
present value of expected net cash flows. The premium earnings methodology under SFAS 163 will be based on a constant rate methodology. SFAS 163 does not apply to financial guarantee
insurance contracts accounted for as derivatives within the scope of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 163 also
requires

18

---



the
Company to provide expanded disclosures relating to factors affecting the recognition and measurement of financial guaranty contracts. SFAS 163 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, except for the presentation and disclosure requirements related to claim liabilities which were effective for financial statements prepared
as of September 30, 2008. The cumulative effect of initially applying SFAS 163 is required to be recognized as an adjustment to the opening balance of retained earnings. The Company is
currently assessing the impact of SFAS 163 on the Company's consolidated financial position and results of operations.

In
March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS 133" ("SFAS 161"). This statement
amends and expands the disclosure requirements for derivative instruments and hedging activities by requiring companies to provide enhanced disclosures about (a) how and why an entity uses
derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. This statement is effective for fiscal years and interim periods beginning after
November 15, 2008. Since SFAS 161 only requires additional disclosures concerning derivatives and hedging activities, adoption of SFAS 161 will not affect the Company's
consolidated financial position and results of operations or cash flows.

In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS 160"). SFAS 160 will change the accounting for
minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This statement is effective for fiscal years beginning on or after
December 15, 2008, with early adoption prohibited. Upon adoption, SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests
and prospective adoption for all other requirements. The Company is currently assessing the impact of SFAS 160 on the Company's consolidated financial position, results of operations and cash
flows.

3.     FAIR VALUE MEASUREMENT

The Company adopted SFAS 157, effective January 1, 2008. SFAS 157 addresses how companies should measure fair value when required to use fair
value measures under GAAP. SFAS 157:



In
February 2007 the FASB issued SFAS 159. SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets and financial
liabilities not previously recorded at fair value. The Company adopted SFAS 159 on January 1, 2008 and elected fair value accounting for certain VIE segment debt and certain assets
acquired in refinancing Company insured transactions not previously carried at fair value. For more information regarding the fair value option, see Note 4.

19

---



The
Company applied its valuation methodologies for its assets and liabilities measured at fair value to all of the assets and liabilities carried at fair value effective
January 1, 2008, whether those instruments are carried at fair value as a result of the adoption of SFAS 159 or in compliance with other authoritative accounting guidance. The Company
has fair value committees to review and approve valuations and assumptions used in its models. These committees meet quarterly prior to the Company issuing its financial statements.

Fair
value is based upon pricing received from dealer quotes or alternative pricing sources with reasonable levels of price transparency, internally developed estimates that employ
credit-spread algorithms or models that use market-based or independently sourced market data inputs, including yield curves, interest rates, volatilities, debt prices, foreign exchange rates and
credit curves. In addition to market information, models also incorporate instrument- specific data, such as maturity date.

Considerable
judgment is necessary to interpret the data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount
the Company would realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair-value
amounts.

The
transition adjustment in connection with the adoption of SFAS 157 was an increase of $26.6 million after-tax to beginning retained earnings, which relates
to day one gains that had been deferred under EITF 02-03.

20

---



The
following table summarizes the components of the fair-value adjustments included in the consolidated statements of operations and comprehensive income:

Year Ended December 31,2008

2007

2006(in thousands)REVENUES GAINS/(LOSSES):Net realized gains (losses) from general investment portfolio:Fair-value adjustments attributable to impairment charges in general investment portfolio

$
(5,977
)
$


$
(284
)Net change in fair value of credit derivatives (See Note 15)

$
(618,072
)
$
(539,809
)
$
119,023Net interest income from variable interest entities segment(1):Fair-value adjustments on VIE segment investment portfolio

$
33,448

$


$
Fair-value adjustments on VIE segment derivatives


(34,844
)




Net interest income from variable interest entities segment

$
(1,396
)
$


$
Net realized gains (losses) from variable interest entities segment:Fair-value adjustments attributable to impairment charges in VIE segment investment portfolio

$
(236,220
)
$


$
Net realized and unrealized gains (losses) on derivative instruments:VIE segment derivatives(2) (See Note 16)

$
256,317

$
95,895

$
98,827Other financial guaranty segment derivatives


285


419


469Net realized and unrealized gains (losses) on derivative instruments

$
256,602

$
96,314

$
99,296Net unrealized gains (losses) on financial instruments at fair valueFinancial guaranty segment:Assets acquired in refinancing transactions

$
(17,200
)
$


$
Committed preferred trust put options


100,000





Net unrealized gains (losses) on financial instruments at fair value in the financial guaranty segment


82,800





VIE segment:Fixed-rate VIE segment debt:Fair-value adjustments other than the Company's own credit risk


(203,735
)




Fair-value adjustments attributable to the Company's own credit risk


1,222,742





Net unrealized gains (losses) on financial instruments at fair value in the VIE segment


1,019,007





Net unrealized gains (losses) on financial instruments at fair value

$
1,101,807

$


$
Net realized gains (losses) from assets acquired in refinancing transactions:Fair-value adjustments attributable to assets acquired in refinancing transactions portfolio

$
(7,723
)
$


$
(2,523
)


---

21

---



Valuation Hierarchy

SFAS 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is
based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:



A
financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

Inputs to Valuation Techniques

Inputs refer broadly to the assumptions that market participants use in pricing assets or liabilities, including assumptions about
risk. Inputs may be observable or unobservable.



Valuation Techniques

Valuation techniques used for assets and liabilities accounted for at fair value are generally categorized into three
types:



22

---





The Company uses valuation techniques that it concludes are appropriate in the specific circumstances and for which sufficient data are available. In selecting the valuation technique to
apply, management considers the definition of an exit price and considers the nature of the asset or liability being valued.

The
following is a description of the valuation methodologies the Company uses for financial instruments including the general classification of such instruments within the valuation
hierarchy.

General Investment Portfolio

The fair value of bonds in the General Investment Portfolio is generally based on quoted market prices received from dealer quotes or
alternative pricing sources with reasonable levels of price transparency. Such quotes generally consider a variety of factors, including recent trades of the same and similar securities. If quoted
market prices are not available, the valuation is based on pricing models that use dealer price quotations, price activity for traded securities with similar attributes and other relevant market
factors as inputs, including security type, rating, vintage, tenor and its position in the capital structure of the issuer. Assets in this category are primarily categorized as Level 2.

At
December 31, 2008, the Company's equity securities were comprised of common stock of Dexia. The fair value of the common stock is based upon quoted prices and is categorized as
Level 1. At December 31, 2007, the fair value of the Company's equity investment in Syncora Guaranty Re Ltd. ("SGR"), was based on redemption value and other inputs.

For
short-term investments in the General Investment Portfolio, which are those investments with a maturity of less than one year at time of purchase, the carrying amount
approximates fair value. These short-term investments include money-market funds and other highly liquid short-term investments, which are categorized as Level 1 on the
valuation hierarchy, and foreign government and agency securities, which are categorized as Level 2.

VIE Segment Investment Portfolio

The "VIE Segment Investment Portfolio" is comprised of investments supporting the VIE liabilities, which are primarily designated as
available-for-sale, but in some cases are classified as held-to-maturity. See "Other Assets and Other Liabilities." The fair value of bonds
in the VIE Segment Investment Portfolio is generally based on quoted market prices received from dealer quotes or alternative pricing sources with reasonable levels of price transparency. Such quotes
generally consider a variety of factors, including recent trades of the same and similar securities. For assets not valued by quoted market prices received from dealer quotes or alternative pricing
sources, fair value is based on either internally developed models using market-based inputs or based on broker quotes for identical or similar assets. Valuation results, particularly those derived
from valuation models and quotes on certain mortgage and asset-backed securities, could differ materially from amounts that would actually be realized in the market. Assets in the VIE Segment
Investment Portfolio are generally categorized as Level 3 on the valuation hierarchy.

The
fair value of the GICs in the VIE Segment Investment Portfolio is determined using cash flow models which include assumptions for interest rate curves based on selected benchmark
securities and weighted average expected lives. These are categorized as Level 3 on the valuation hierarchy.

For
short-term investments in the VIE Segment Investment Portfolio, which are those investments with a maturity of less than one year at time of purchase, the carrying amount
is fair value. These short-term investments include overnight money market funds, which are categorized as Level 1 on the valuation hierarchy.

23

---



Cash

For cash, the carrying amount equals fair value.

Assets Acquired in Refinancing Transactions

For certain assets acquired in refinancing transactions, fair value is either the present value of expected cash flows or a quoted
market price as of the reporting date. This portfolio is comprised primarily of bonds, securitized loans, common stock, mortgage loans, real estate and short term investments, of which bonds, common
stocks and certain securitized loans are carried at fair value. Mortgage loans are accounted for at fair value when lower than cost. The majority of the assets in this portfolio are categorized as
Level 3 in the valuation hierarchy, except for the short-term investments, which are categorized as Level 2.

Credit Derivatives in the Insured Portfolio

The Company's insured portfolio includes contracts accounted for as derivatives, namely,



The
Company considers all such agreements to be a normal part of its financial guaranty insurance business but, for accounting purposes, these contracts are deemed to be derivative
instruments and therefore must be recorded at fair value, with changes in fair value recorded in the consolidated statements of operations and comprehensive income in "net change in fair value of
credit derivatives."



In the case of CDS contracts, a trust that is consolidated by the Company writes a derivative contract that provides for payments to be
made if certain credit events occur related to certain specified reference obligations, in exchange for a fee. The need to interpose a trust is a regulatory requirement imposed by the New York State
Insurance Department as an exception to its general rule, in order to allow the financial guarantors to sell credit protection by entering into credit derivative contracts (albeit indirectly by
guaranteeing the trust), while other types of insurance enterprises may neither directly enter into such credit derivative contracts, nor provide such guarantees to a trust. The trust's obligation on
the CDS contracts it writes are guaranteed by a financial guaranty contract written by FSA that provides payments to the insured if the trust defaults on its payments under the derivative contract. In
these transactions, FSA is considered the counterparty to a financial guaranty contract that is defined as a derivative. The credit event is typically based upon failure to pay or the insolvency of a
referenced obligation. In such cases, the claim represents payment for the shortfall amount.

The
Company's accounting policy regarding CDS contract valuations requires management to make numerous complex and subjective judgments relating to amounts that are inherently uncertain.
CDS contracts are valued using proprietary models because such instruments are unique, complex and are typically highly customized transactions. Valuation models and the related assumptions are
continuously reevaluated by management and enhanced, as appropriate, based on market developments

24

---



and
improvements in modeling techniques and the availability of market observable data. Due to the significance of unobservable inputs required to value CDS contracts, they are considered to be
Level 3 under the SFAS 157 fair value hierarchy.

Significant
assumptions that, if changed, could result in materially different fair values include:



Market
perceptions of credit deterioration of the underlying referenced obligation would result in an increase in the expected exit value (the amount required to be paid to exit the
transaction due to wider credit spreads).



Determination of Current Exit Value Premium:The estimation of the current exit value premium is derived using a unique credit-spread
algorithm for
each defined CDS category that utilizes various publicly available credit indices, depending on the types of assets referenced by the CDS contract and the duration of the contract. The "exit price"
derived is technically an "entry price" and not an "exit price" (i.e., the price that would be received to sell an asset or paid to transfer a liability that is required under SFAS 157).
This is because a monoline insurer cannot observe "exit prices" for the CDS contract that it writes in a principal market since these contracts are not transferable. While SFAS 157
provides that the transaction (entry) price and the exit price may not be equal if the transaction price includes transaction costs, the Company believes those transaction costs would be the same in
an "entry" market and a hypothetical "exit" market and thus it would be inappropriate to record a day one gain when using the estimated "entry price" to determine the exit value premium.

Management
applies judgment when developing these estimates and considers factors such as current prices charged for similar agreements, if available, performance of underlying assets,
changes in internal credit assessments or rating agency-based shadow ratings, and the level at which the deductible has been set. Estimates generated from the Company's valuation process may differ
materially from values that may be realized in market transactions.

In
a financial guaranty insurance policy, a deductible is the portion of a loss under that policy that is not covered by the policy, or in other words, the amount of the loss for which
the insurer is not responsible. In a CDS contract, the deductible is quoted as a percentage of the contract's notional amount, and is also referred to as the contract's attachment point. For example,
for a CDS with a $1 billion notional amount and a 15% deductible, the Company would only be obligated to make a claim payment after the insured incurred more than $150 million (15% of
$1 billion) of losses (net of recoveries). The attachment points for each of the Company's CDS contracts vary, as the deductibles are negotiated on a
contract-by-contract basis.

In
the ordinary course, the Company does not post collateral to the counterparty as security for the Company's obligation under CDS contracts. As a result, the Company receives a smaller
fee than it would for a CDS contract that required the posting of collateral. In order to calculate the exit value premium for CDS that do not require collateral to be posted, the Company applies a
factor (the "non-collateral posting factor") to the indicated market premium for CDS contracts that require collateral to be posted. The non-collateral posting factor was 70%
for the year ended December 31, 2008.

25

---



The
Company calculates the non-collateral posting factor quarterly based in part on observable market inputs. In the market where transactions are executed, the Company has
observed since the beginning of 2008 that when a collateral posting counterparty executes a CDS contract purchasing protection from a non-collateral posting counterparty, it will hold back
a minimum of 20% of the CDS premium it charged to provide the CDS protection. The Company believes that the non-collateral posting factor has the effect of adjusting the fair value of
these contracts for the Company's credit quality in addition to adjusting the contract to a collateral posting basis. Accordingly, the Company adds to the 20% minimum an additional amount to reflect
the market price of CDS protection on FSA. The Company estimated the additional amount at December 31, 2008 to be 50% using an algorithm that uses as an input FSA's current annual
five-year CDS credit spread, which was approximately 1,421 basis points at December 31,
2008. The Company uses the current five-year CDS credit spread based on its observation that the five-year instrument is the standard term for CDS contracts used to hedge
counterparty credit risk. Quoted prices for shorter or longer terms are typically not available and, when available, are less reliable.

The
underlying securities of the Company's CDS contracts are predominantly corporate obligations, specifically investment grade pooled corporate CDS, high yield pooled corporate CDS and
collateralized loan obligations ("CLOs"). The Company's exposure to underlying securities such as those backed by domestic residential mortgage-backed securities ("RMBS") and CDOs of ABS was less than
one percent of the total CDS par outstanding at December 31, 2008.

Below
is an explanation of how the Company determines the current exit value for each of the following types of CDS contracts:



For
each of these types of CDS contracts, the price the Company charges when entering into such contract sometimes differs from the fair value determined by the Company's fair value
model at the time when the Company enters into the CDS contract. The Company refers to this difference as the "initial model adjustment," and is not an indicator of a day one gain. The initial model
adjustment is needed because of differences between the CDS contract being valued and the reference index. The initial model adjustment is calculated at the inception of a CDS contract in order to
calibrate the indicated model fair value of the CDS contract to the contractual premium rate on the trade date.

Pooled Corporate CDS Contracts:    A pooled corporate CDS contract insures the default risk of a pool of referenced
corporate entities. As there is no observable exchange trading of bespoke pooled corporate CDS, the Company values these contracts using an internal pricing model that uses the mid-point
of the bid and ask prices (the "mid-market price") of dealer quotes on specific indexes as inputs to its pricing model, principally the Dow Jones CDX for domestic corporate CDS ("DJ CDX")
and iTraxx for European corporate CDS ("iTraxx"). The mid-market price is a practical expedient for the fair-value measurement within a bid-ask spread. For those
pooled corporate CDS contracts that include both domestic and foreign reference entities, the Company applies the iTraxx price in proportion to the pool of applicable foreign reference entities
comprising the pool by calculating a weighted average of the DJ CDX and iTraxx quoted prices.

The
Company's valuation process for pooled corporate CDS involves stratifying the pools into either investment grade credits or high-yield credits and then by remaining term
to maturity, consistent with the reference indexes. Within maturity bands, further distinction is made for contracts that have higher attachment points. Both the DJ CDX and iTraxx indices provide
quoted prices for standard

26

---



attachment
and detachment points (or "tranches") for contracts with maturities of three, five, seven and ten years.

Prices
quoted for these tranches do not represent perfect pricing references, but are the only relevant market-based information available for this type of non-traded
contract. The recent market volatility in the index tranches has had a significant impact on the estimated fair value of the Company's portfolio of pooled corporate CDS.

Investment-Grade Pooled Corporate CDS Contracts:The Company applies quoted prices to its investment-grade pooled corporate CDS
contracts ("IG CDS")
by stratifying its IG CDS contracts into four maturity bands: less than 3.5 years; 3.5 to 5.5 years; 5.5 to 7.5 years; and 7.5 to 10 years. Within the maturity bands,
further distinction is made for contracts that have a significantly higher starting attachment point (usually 30% or higher).

The
CDX North America IG Index ("CDX IG Index") is comprised of prices sourced from 125 North American investment grade CDS quoted (each, an "Index CDS") and is supported by at least 10
of the largest CDS dealers. In addition to the full capital structure, the CDX IG Index also provides price quotes for various tranches delineated by attachment and detachment points: 0 to 3%; 3 to
7%; 7 to10%; 10 to 15%; 15 to 30% and 30 to 100%. Approximately every six months, a new "series" of the CDX IG Index is published ("on-the-run") based on a new grouping of
125 Index CDS, which changes the composition of the 125 Index CDS of older ("off-the-run") series. Each quarter, the Company compares the composition of the 125 Index CDS in
both the on-the-run and off-the run series of the CDX IG Index to the CDS pool referenced by the Company's IG CDS contracts (the "reference CDS pool") and uses the
average of the series of the CDX IG Index and the comparable iTraxx Index that most closely relates to the credit characteristics of the Company's IG CDS contracts, mainly the Weighted-Average Rating
Factor ("WARF"), of the Company's IG CDS contracts. The Company also remodels each of its contracts to determine if the credit quality remains Super Triple-A and compares the WARF of the
index to the WARF of each of the Company's IG CDS contracts. A "Super Triple-A" credit rating indicates a level of first-loss protection generally exceeding 1.3 times the level
required by a rating agency for a Triple-A rating. WARF is a 10,000 point scale developed by Moody's that is used as an indicator of collateral pool risk. A higher WARF indicates a lower
average collateral rating.

The
Company calibrates the quoted index price to the approximate attachment points for its IG CDS contracts by calculating the weighted average of the given quoted tranche prices for IG
CDS of a given maturity using the CDX IG Index and iTraxx quoted tranche widths. The relevant widths of the quoted tranches used by the two indices differ. DJ CDX uses tranches of 10 to 15%, 15 to
30%, and 30 to 100%, resulting in tranche widths of five, 15 and 70 percentage points, whereas iTraxx uses tranches of 9 to 12%, 12 to 22% and 22 to 100%, resulting in tranche widths of three,
10 and 78 percentage points.

27

---



The
Company's IG CDS contracts typically attach at 10% or higher. The following table indicates FSA's typical attachment points and total tranche widths:

Portfolio Classification

Index Quoted
Duration

FSA's Typical
Attachment
Point

FSA's Total
Tranche Width(in years)Less than 3.5 Yrs


3


10
%

90
%3.5 to 5.5 Yrs


5


10


905.5 to 7.5 Yrs:Lower attachment


7


15


85Higher attachment


7


30


707.5 to 10 Yrs:Lower attachment


10


15


82.5Higher attachment


10


30


70


To
calculate the weighted average price for the entire tranche width of the Company's IG CDS (the "total tranche width"), a price is obtained for each quoted tranche comprising the total
tranche width, and the sum of the weighted average prices is divided by the total tranche width. The price for each quoted tranche is the mid-market of the quoted price for that tranche,
weighted by the width of that tranche. The following table illustrates the calculation of the weighted-average price of the Company's IG CDS contracts with a maturity of up to 3.5 years, given
quoted CDX IG tranche prices of 332 basis points, 83.5 basis points and 68.4 basis points for the 10 to 15%, 15 to 30%, and 30 to 100% tranches, respectively.

FSA Portfolio
ClassificationCDX IG Mid-Market Price Multiplied by the Tranche WidthTotal
Tranche
Width

Weighted
Average
PriceAttachment/
Detachment

10 to 15%

15 to 30%

30 to 100%

TotalLess than 3.5 Yrs


332 bps × 5 =
1,660.0


83.5 bps × 15 =
1,252.5


68.4 bps × 70 =
4,788.0


7,700.5


90


85.6 bps


The Company applies a factor to the quoted prices (the "IG calibration factor"). The calibration factor is intended to calibrate the index price
to each of the Company's pooled corporate investment grade CDS contracts, which reference pools of entities that are typically of lower average credit quality than those reflected in the CDX IG Index.
The IG calibration factor is determined for each IG CDS contract by calibrating the WARF of the index so that it approximately equals the WARF of each IG CDS contract. To do so, the Company
recalculates the index price after removing from the index the reference obligations that have the highest ratings. This recalculated index price is then divided by the unadjusted index to arrive at
the IG calibration factor. As of December 31, 2008, the IG calibration factor applied to the Company's IG CDS contracts ranged from 112% to 530% of the WARF of the index.

The
Company's Transaction Oversight Department reviews the pooled corporate CDS portfolio regularly and no less than quarterly and factors in any rating changes. Any new reported credit
events under a given CDS contract are factored into the contract's deductible level. As such credit events occur, the contract's attachment point is recalculated based on the revised deductible amount
to determine if the attachment point for each contract in the portfolio continues to be at a "Super Triple-A" credit rating.

To
arrive at the exit value premium applied to each of the Company's IG CDS contracts, the Company:



28

---





Below
is an example of the pricing algorithm that is applied to the Company's domestic IG CDS contracts with durations of 3.5 to 5.5 years, assuming an average IG calibration
factor of 296%, to determine the exit premium value as of December 31, 2008:

Index
Duration

Unadjusted Quoted
Price

After IG Calibration
Factor

Adjusted to Non-Collateral
Posting Contract Value5 yrs


85.1 bps


251.9 bps


75.6 bps


High-Yield Pooled Corporate CDS Contracts:In order to estimate the market price for high-yield pooled corporate CDS
contracts ("HY CDS"), the Company uses the average of the dealer mid-market prices obtained for the most senior quoted of the respective three-year, five-year and
seven-year tranches of the CDX North America High Yield Index ("CDX HY Index"). The CDX HY Index is comprised of prices sourced from 100 of the most liquid North American high yield CDS
quoted (each, an "Index CDS") and is supported by more than 10 of the largest CDS dealers. In addition to the full capital structure, the CDX HY Index also provides price quotes for various tranches
delineated by attachment and detachment points: 0 to 10%; 10 to 15%; 15 to 25%; 25 to 35%; and 35 to 100%. The Company uses an average of the dealer mid-market quotes of the index because
the Company believes that dealer price quotes have historically been indicative of where trades have been executed in the high-yield market.

The
Company applies a factor to the quoted prices (the "HY calibration factor"). The HY calibration factor is intended to calibrate the index price to each of the Company's pooled
corporate high-yield CDS contracts, which reference pools of entities that are typically of higher average credit quality than those reflected in the CDX HY Index. The HY calibration
factor is determined for each HY CDS contract by calibrating the WARF of the index so that it approximately equals the WARF of each HY CDS contract. To do so, the Company recalculates the index price
after removing from the index the reference obligations that have the lowest ratings. This recalculated index price is then divided by the unadjusted index to arrive at the HY calibration factor. At
December 31, 2008, the HY calibration factor applied to the Company's HY CDS contracts ranged from 28% to 100% of the WARF of the index.

Approximately
every six months, a new "series" of the CDX HY Index is published ("on-the-run") based on a new grouping of 100 single name CDS, which changes the
composition of the Index of older ("off-the-run") series. The Company compares the composition of the Index in both the on-the-run and
off-the run series of the HY index to each CDS pool (i.e., "reference entities" or companies included in each contract) referenced by the Company's contracts (the "reference CDS
pool"). Based on that comparison, the Company determines which of the actively quoted series most closely relates to the credit characteristics, mainly with reference to the WARF, of the Company's HY
CDS contracts, and then uses the average of dealer quotes of that series. The Company also remodels each of its contracts to determine if the credit quality remains Super Triple-A and
compares the WARF of the index to the WARF of each of the Company's HY CDS contracts.

To
arrive at the exit value premium that is applied to each of the Company's CDS contracts in a given maturity band, the non-collateral posting factor is applied to the
weighted-average market price determined for that maturity band.



29

---





Below
is an example of the pricing algorithm that is applied to the Company's domestic HY CDS contracts with durations of 3.5 to 5.5 years, assuming an average HY calibration
factor of 100% to determine the exit premium value as of December 31, 2008:

Index
Duration

Unadjusted Quoted Price

After HY
Calibration
Factor

Adjusted to Non-Collateral Posting
Contract Value5 yrs


266.3 bps


266.3 bps


79.9 bps


CDS of Funded CDOs and CLOs:    Prior to August 2008, the Company sold protection to financial institutions in a
principal-to-principal market in which transactions are highly customized and negotiated independently. The Company therefore cannot observe "exit" prices for the CDS contracts
it writes in this market since these contracts are not transferable. In the absence of a principal exit market, the Company determines the fair value of a CDS contract it writes by using an
internally-developed estimate of an "exit price" that a hypothetical market participant (i.e., a similarly rated monoline financial guarantee insurer, or "monoline insurer") would accept to
assume the risk from the CDS writer on the measurement date, on terms identical to the contract written by the CDS writer. The Company believes this approach is reasonable because the hypothetical
exit market has been defined as other monoline insurers. In essence, the exit market participants are the same as the monoline participants competing in the entry market.

As
with pooled corporate CDS, there is no observable exchange trading of CDS of funded CDOs and CLOs. The price of protection charged by a CDS writer is based on the "credit spread
component" of the "all-in credit spread" of funded CLOs, as quoted by underwriter participants. As the all-in credit spread for a given CLO may not always be observable in the
market, the CDS writer often utilizes an index, published by an underwriter participant, such as the "all-in" London Interbank Offered Rate ("LIBOR") spread for Triple-A rated
cash-funded CLOs (the "Triple-A CLO Funded Rate") as published by J.P. Morgan Chase & Co. The Triple-A CLO Rate is an all-in credit spread
that includes both a funding and credit spread component.

The
CDS protection of a CLO provided by the Company is priced to capture only the credit spread component, as the CDS writer is not providing funding for the CLO, only credit protection.
The contracts on which the Company has provided credit protection are regularly evaluated to ascertain whether or not the original Triple-A credit rating is still considered appropriate.
The Company determines the exit value premium for all these CDS of CLO contracts in its portfolio that are rated Triple-A with reference to the Triple-A CLO Funded Rate, which
is currently the only regularly and frequently quoted rate observable in the market. The Triple-A CLO Funded Rate was 500 bps as of December 31, 2008. The Company applies a credit
component factor to the Triple-A CLO Funded Rate as a means of estimating the fair value of its Triple-A rated contract, which only refers to the credit component. The credit
and funding components were 50% each as of December 31, 2008. The components are determined judgmentally and can vary based on estimates provided to the Company by external market participants,
specifically purchasers of CDS protection on Triple-A CLO risk and investors in Triple-A CLO bonds.

30

---



To
arrive at the exit value premium that is applied to each of the Company' CDO and CLO CDS contracts, the non-collateral posting factor is applied to the weighted-average
market price determined for each maturity band.

The
determination of the exit value premium is summarized as follows:

Triple-A CLO
Funded Rate

After Credit Component
Factor

After Non-Collateral Posting
FactorRate


500 bps


250 bps

75 bps


Other Structured Obligations Valuation:For CDS for which observable market value information is not available, management applies its
best judgment
to estimate the appropriate current exit value premium, and takes into consideration the Company's estimation of the price at which the Company would currently charge to provide similar protection,
and other factors such as the nature of the underlying reference credit, the Company's attachment point, and the tenor of the CDS contract.



The Company generally utilizes reinsurance to purchase protection for CDS contracts it writes in the same way that it employs
reinsurance in respect of other financial guaranty insurance policies. The Company's uses of reinsurance to mitigate risk exposures for CDS contracts and financial guaranty insurance policies are
nearly identical as they involve the same reinsurers, the same underwriting process evaluating the reinsurers and the same credit risk management and surveillance processes supporting the reinsurance
function. The Company enters into reinsurance agreements on CDS contracts primarily on a quota share basis. Under a quota share reinsurance agreement with a reinsurer, the Company cedes to the
assuming reinsurer a proportionate share of the risk and premium.

The
determination of the hypothetical exit market is a key factor in determining the fair value of protection purchased (the "ceded" or "reinsurance" contract) with respect to a CDS
contract written by a financial guarantor (the "direct contract"). SFAS 157 requires that the valuation premise, used to measure the fair value of an asset, must consider the asset's "highest
and best use" from the perspective of market participants. Generally, the valuation premise used for a financial asset is "in-exchange" since this type of asset provides maximum value to
market participants on a stand-alone basis. The maximum value of a ceded contract to the CDS writer's exit market participants is in combination with the CDS writer's direct contract. Therefore the
appropriate valuation premise to use for a ceded contract is the "in-use" premise.

The
Company determines the fair value of a CDS contract in which it purchases protection from a reinsurer (the "ceded CDS contract") as the proportionate percentage of the fair value of
the related
written CDS contracts, adjusted for any ceding commission and consideration of counterparty risk. In quota share reinsurance agreements, the assuming reinsurer typically pays a ceding commission
periodically over the life of the CDS contract to the ceding company that is intended to defray the ceding company's costs for the services it provides to the reinsurer, such as risk selection,
underwriting activities and ongoing servicing and reporting. As an element of the fair value of the ceded CDS contract, the ceding commission paid to the ceding company represents the ceding company's
profit on the ceded CDS contract after considering counterparty credit risk, (i.e., the difference between (a) the price of the protection the ceding company purchased from the
reinsurer, which is net of the ceding commission, and (b) the price that the ceding company would receive to exit the ceded CDS contract in its principal market, which is comprised of other
ceding insurers of comparable credit standing). The Company applies a credit valuation adjustment to the fair value of a ceded CDS contract due from a reinsurer if the reinsurer's credit quality (as
determined by CDS price if available, or if not, its credit rating) is less than that of the Company's based upon the premise that the exit market for these contracts would be another monoline
financial guarantee insurer that has similar credit rating or spread as the Company.

31

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The Company insures interest rate swaps entered into in connection with the issuance of certain public finance obligations. Because the
financial guaranty contract insures a derivative, the financial guaranty contract is deemed to be a derivative. Therefore, the contract is required to be carried at fair value, with the change in fair
value being recorded in the determination of net income (loss). As there is no observable market for these policies, the fair value of these contracts is determined by using an internally-developed
model and, therefore, they are classified as Level 3 in the valuation hierarchy.

Insured
NIM securitizations issued in connection with certain mortgage-backed security financings and financial guaranty contracts with embedded derivatives are deemed to be hybrid
instruments that contain an embedded derivative if they were issued after January 1, 2007. The Company elected to record these financial instruments at fair value under SFAS No. 155,
"Accounting for Certain Hybrid Financial Instruments." Changes in the fair value of these contracts are recorded in the consolidated statements of operations and comprehensive income. As there is no
observable market for these policies, the fair value of these contracts is based on internally-derived estimates and they are, therefore, classified as Level 3 in the valuation hierarchy.

VIE Segment Derivatives

On the date of adoption, all derivatives used to hedge VIE debt were valued by obtaining prices from brokers or counterparties, and
accordingly were classified as Level 3 in
the valuation hierarchy. At December 31, 2008, the majority of these derivatives were valued using a pricing model that uses observable market inputs such as interest rate curves, foreign
exchange rates and inflation indices. Therefore, these derivatives are classified as Level 2 in the valuation hierarchy at December 31, 2008. If a significant model input had been used
that was not observable in the market, the derivative would have been classified as a Level 3 in the valuation hierarchy.

Other Assets and Other Liabilities

Other assets primarily include held-to-maturity investments in VIE Segment Investment Portfolio, receivables for securities sold and
the fair value of the committed preferred trust securities ("CPS"). As there is no observable market for the Company's CPS, fair value of the CPS is based on internally-derived estimates and,
therefore, these put options are categorized as Level 3 in the fair value hierarchy.

The
Company determined the fair value of the CPS by estimating the fair value of a floating rate security with an estimated market yield reflective of the underlying committed preferred
security structure and the relevant coupon based on the capped auction rate.

Other
liabilities include payables for securities purchased and derivative obligations. For receivable for securities sold and payable for securities purchased, the carrying amount is
cost, which approximates fair value because of the short maturity.

VIE Segment Debt

The fair value of the VIE segment debt is determined based on a discounted cash flow model. Fair value calculated by these models
includes assumptions for interest rate curves based on selected benchmark securities and weighted average expected lives. In addition, the valuation of the fair-valued liabilities includes
an adjustment to reflect the credit quality of the Company that represents the impact of changes in market credit spreads on these liabilities. The fair-valued liabilities are categorized
as Level 3 in the valuation hierarchy. See Note 4 for a description of the VIE segment debt for which the Company elected fair value option.

32

---



Net Financial Guarantee Contracts Written

The fair value of net financial guarantees written is based on the estimated cost to the Company of transferring the outstanding
insured portfolio to another financial guarantor of comparable credit standing, under current market conditions. The fair value of net financial guarantees written incorporates (i) deferred
premium revenue, (ii) amounts recoverable from reinsurers on unpaid losses, (iii) estimated future installment premiums receivable, and (iv) losses and loss adjustment expenses.
These fair values are based on inputs observable in the market, where available, as well as inputs which are not readily observable in the market. SFAS 157 requires the risk of nonperformance
to be included in the estimation of fair value of financial liabilities. The Company's credit risk as measured by the credit spread on its CDS, has been factored into the fair value of the financial
guarantees written in order to account for the risk of nonperformance.

Notes Payable to Affiliate

For notes payable, the carrying amount represents the principal amount due at maturity. The fair value is based on a discounted cash
flow model that includes assumptions for interest rate curves based on selected benchmark securities and weighted average expected lives.

The
following table presents the financial instruments carried at fair value at December 31, 2008, by caption on the consolidated balance sheet and SFAS 157 valuation
hierarchy.

33

---



Assets and Liabilities Measured at Fair Value on a Recurring Basis

At December 31, 2008Level 1

Level 2

Level 3

FIN 39
Netting(1)

Total(in thousands)Assets:General investment portfolio, available for sale:Bonds

$


$
5,219,789

$
44,749

$


$
5,264,538Equity securities


374











374Short-term investments


9,687


606,378








616,065VIE segment investment portfolio, available for sale:Bonds





22,470


900,862





923,332GICs








801,547





801,547Short-term investments


8,221











8,221Assets acquired in refinancing transactions





20,962


117,814





138,776VIE segment derivatives





754,328


59,268


(434,855
)

378,741Credit derivatives(2)








287,449





287,449Other assets:CPS








100,000





100,000Total assets at fair value

$
18,282

$
6,623,927

$
2,311,689

$
(434,855
)
$
8,519,043Liabilities:VIE segment debt

$


$


$
799,086

$


$
799,086Credit derivatives








1,543,809





1,543,809Other liabilities:Other financial guarantee segment derivatives





(112
)







(112
)Total liabilities at fair value

$


$
(112
)
$
2,342,895

$


$
2,342,783


---

Non-Recurring Fair Value Measurements

Mortgage loans in the portfolio of assets acquired in refinancing transactions are carried at the lower of cost or market on an
aggregate basis. At December 31, 2008, such investments were carried at their market value of $13.8 million. The mortgage loans are classified as Level 3 of the fair value

34

---



hierarchy
as there are significant unobservable inputs used in the valuation of such loans. An indicative dealer quote is used to price the non-performing portion of these mortgage loans.
The performing loans are valued using management's determination of future cash flows arising from these loans, discounted at the rate of return that would be required by a market participant. This
rate of return is based on indicative dealer quotes.

Changes in Level 3 Recurring Fair Value Measurements

The table below includes a rollforward of the balance sheet amounts for financial instruments classified by the Company within
Level 3 of the valuation hierarchy for the year ended December 31, 2008. When a determination is made to classify a financial instrument within Level 3, the determination is based
upon the significance of the unobservable data to the overall fair value measurement. However, Level 3 financial instruments may include, in addition to the unobservable or Level 3
components, observable components. Accordingly, the gains and losses in the table below include changes in fair value due in part to observable factors that are part of the valuation methodology.
Level 3 assets were 19.9% of total assets at December 31, 2008. Level 3 liabilities were 24.7% of total liabilities at December 31, 2008.

Level 3 Rollforward

Year Ended December 31, 2008Change in
Unrealized
Gains/(Losses)
Related to
Financial
Instruments
Held at
December 31,
2008Total Pre-tax Realized/Unrealized
Gains/(Losses)(1) Recorded in:Fair Value
at
January 1,
2008

Net
Income
(Loss)

Other
Comprehensive
Income (Loss)

Purchases,
Issuances,
Settlements,
net

Transfers
in and/or
out of
Level 3(2)

Fair
Value at
December 31,
2008(in thousands)General investment portfolio, available for sale:Bonds

$
59,840

$
(720
)(3)
$
(10,953
)
$
(3,418
)
$


$
44,749

$
Equity securities


39,000


(36,075
)(3)




(2,925
)







VIE segment investment portfolio, available for sale(4):Bonds


1,120,533


(200,622
)(5)

(19,049
)







900,862


(200,139
)GICs


639,950





86,753


74,844





801,547


Assets acquired in refinancing transactions


170,492


(17,200
)(6)

(3,564
)

(31,914
)




117,814


(17,200
)VIE segment debt(4)


(1,852,759
)

994,239
(7)




59,434





(799,086
)

1,000,302VIE segment derivatives(4)


634,458


(3,593
)(8)







(571,597
)

59,268


11,957CPS





100,000
(6)










100,000


100,000Net credit derivatives(9)


(522,033
)

(618,072
)(10)




(116,255
)




(1,256,360
)

(632,678
)


---

35

---



The table below shows the carrying amount and fair value of the Company's other financial instruments:

Other Financial Instruments

At December 31, 2008

At December 31, 2007Carrying
Amount

Fair Value

Carrying
Amount

Fair Value(in thousands)Assets acquired in refinancing transactions

$
14,073

$
14,073

$
229,264

$
231,801Other assets


542,465


542,465


682,592


682,592Net financial guarantee contracts written


(3,730,984
)

(3,256,605
)

(1,957,891
)

(1,748,668
)VIE segment debt(1)


(444,554
)

(249,895
)

(2,584,800
)

(2,630,139
)Notes payable to affiliate


(172,499
)

(189,964
)

(210,143
)

(211,998
)Other liabilities


(233,012
)

(233,012
)

(327,301
)

(327,301
)


---

4.     FAIR VALUE OPTION

The Company adopted SFAS 159 effective January 1, 2008. SFAS 159 provides an option to elect fair value as an alternative measurement for
selected financial assets and financial liabilities not previously
carried at fair value. The fair-value option may be applied to single eligible instruments, is irrevocable and is applied only to entire instruments and not to portions of instruments. For
a discussion of the Company's valuation methodologies, see Note 3.

The
Company's fair value elections were intended to mitigate the volatility in earnings that had been created by recording financial instruments and the related risk management
instruments on a different basis of accounting, to eliminate the operational complexities of applying hedge accounting or to conform to the fair value elections made by the Company in 2006 under its
International Financial Reporting Standards reporting to Dexia. The requirement, under SFAS 157, to incorporate a reporting entity's own credit risk in the valuation of liabilities which are
carried at fair value, has created some additional volatility in earnings as credit risk is not hedged. The following table provides detail regarding the Company's elections by consolidated balance
sheet line at January 1, 2008.

36

---



Carrying Value of
Financial
Instruments

Transition
Gain/(Loss)
Recorded in
Retained
Earnings

Adjusted Carrying
Value
of Financial
Instruments(in thousands)Assets acquired in refinancing transactions

$
163,285

$
2,537
(1)
$
165,822VIE segment debt


(1,824,676
)

(28,083
)

(1,852,759
)Subtotal





(25,546
)Minority interest





28,083Deferred income taxes





(888
)Cumulative effect of adoption of SFAS 159




$
1,649


---



Elections

On January 1, 2008, the Company elected to record the following at fair value:



Changes in Fair Value under the Fair Value Option Election

The following table presents the pre-tax changes in fair value included in the consolidated statements of operations and
comprehensive income for the year ended December 31, 2008, for items for which the SFAS 159 fair value election was made.

Net Unrealized Gains (Losses) on Financial Instruments at Fair Value

Year Ended December 31,
2008(in thousands)Assets acquired in refinancing transactions

$
(17,200
)VIE segment debt(1)


1,019,007






The
table above includes gains of approximately $1.2 billion for the year ended December 31, 2008, that are attributable to changes in the Company's own credit spread.

37

---



Aggregate Fair Value and Aggregate Remaining Contractual Principal Balance Outstanding

The following table reflects the aggregate fair value and the aggregate remaining contractual principal balance outstanding at
December 31, 2008, for certain assets acquired in refinancing transactions and VIE segment debt for which the SFAS 159 fair value option has been elected.

At December 31, 2008Remaining
Aggregate
Contractual Principal
Amount
Outstanding

Fair Value(in thousands)Assets acquired in refinancing transactions

$
133,124
(1)
$
117,796VIE segment debt(2)


1,681,855


799,086


---

5.     GENERAL INVESTMENT PORTFOLIO

The following table summarizes the components of the net investment income generated by the General Investment Portfolio:

Year Ended December 31,2008

2007

2006(in thousands)Bonds and short-term investments

$
263,559

$
234,495

$
213,959Equity securities


1,609


3,483


4,523Investment expenses


(3,384
)

(3,192
)

(2,887
)Net investment income from general investment portfolio

$
261,784

$
234,786

$
215,595


The
credit quality of fixed-income securities in the General Investment Portfolio based on amortized cost was as follows:

General Investment Portfolio Fixed-Income Securities by Rating

Rating(1)

At
December 31, 2008
Percent of BondsAAA(2)


42.9
%AA


36.3A


19.2BBB


1.5Not Rated


0.1Total


100.0
%


---

38

---



The
General Investment Portfolio includes bonds insured by FSA ("FSA-Insured Investments") that were acquired in the ordinary course of business. Of the bonds included in the
General Investment Portfolio at December 31, 2008, 6.6% were insured by FSA and 28.8% were insured by other monolines. All of the FSA-Insured Investments were investment grade
without giving effect to the FSA insurance. The average shadow rating of the FSA-insured investments, which is the rating without giving effect to the FSA guaranty, was the
Single-A range. These assets are included in the Company's surveillance process and, at December 31, 2008, no loss reserves were anticipated on any of these assets. See
Note 27 for more information.

The
amortized cost and fair value of the securities in the General Investment Portfolio were as follows:

General Investment Portfolio by Security Type

At December 31, 2008Investment Category

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair Value(in thousands)U.S. Treasury securities and obligations of U.S. government corporations and agencies

$
103,725

$
9,127

$
(23
)
$
112,829Obligations of U.S. states and political subdivisions


4,321,118


87,081


(168,414
)

4,239,785Mortgage-backed securities


393,001


13,365


(9,492
)

396,874Corporate securities


203,396


7,650


(3,492
)

207,554Foreign securities(1)


333,646


334


(50,271
)

283,709Asset-backed securities


25,656





(1,869
)

23,787Total bonds


5,380,542


117,557


(233,561
)

5,264,538Short-term investments


615,299


825


(59
)

616,065Total fixed-income securities


5,995,841


118,382


(233,620
)

5,880,603Equity securities


1,434





(1,060
)

374Total General Investment Portfolio

$
5,997,275

$
118,382

$
(234,680
)
$
5,880,977




At December 31, 2007Investment Category

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair Value(in thousands)U.S. Treasury securities and obligations of U.S. government corporations and agencies

$
85,088

$
4,046

$
(87
)
$
89,047Obligations of U.S. states and political subdivisions


3,920,509


149,893


(5,837
)

4,064,565Mortgage-backed securities


390,992


5,032


(1,698
)

394,326Corporate securities


190,048


3,866


(1,123
)

192,791Foreign securities(1)


248,006


8,584


(285
)

256,305Asset-backed securities


22,652


279


(4
)

22,927Total bonds


4,857,295


171,700


(9,034
)

5,019,961Short-term investments


88,972


2,260


(1,157
)

90,075Total fixed-income securities


4,946,267


173,960


(10,191
)

5,110,036Equity securities


40,020


4


(155
)

39,869Total General Investment Portfolio

$
4,986,287

$
173,964

$
(10,346
)
$
5,149,905


---

39

---





The following table shows the gross unrealized losses and fair value of bonds in the General Investment Portfolio, aggregated by investment category and length of time that individual
securities have been in a continuous unrealized loss position:

Aging of Unrealized Losses of Bonds in General Investment Portfolio

At December 31, 2008Aging Categories

Number of
Securities

Amortized
Cost

Unrealized
Losses

Fair Value

Unrealized
Loss as a
Percentage of
Amortized
Cost(dollars in thousands)Less than Six Months(1)U.S. Treasury securities and obligations of U.S. government corporations and agencies




$
137

$
(1
)
$
136


(0.7
)%Obligations of U.S. states and political subdivisions





993,745


(58,846
)

934,899


(5.9
)Mortgage-backed securities





8,684


(118
)

8,566


(1.4
)Corporate securities





20,654


(1,459
)

19,195


(7.1
)Foreign securities





220,257


(30,425
)

189,832


(13.8
)Asset-backed securities





23,288


(1,469
)

21,819


(6.3
)Total


310


1,266,765


(92,318
)

1,174,447


(7.3
)More than Six Months but Less than 12 Months(2)U.S. Treasury securities and obligations of U.S. government corporations and agencies





37


(1
)

36


(2.7
)Obligations of U.S. states and political subdivisions





587,069


(53,447
)

533,622


(9.1
)Mortgage-backed securities





31,793


(8,310
)

23,483


(26.1
)Corporate securities





24,441


(1,389
)

23,052


(5.7
)Foreign securities





95,887


(18,890
)

76,997


(19.7
)Asset-backed securities





1,456


(117
)

1,339


(8.0
)Total


230


740,683


(82,154
)

658,529


(11.1
)12 Months or More(3)U.S. Treasury securities and obligations of U.S. government corporations and agencies





331


(21
)

310


(6.3
)Obligations of U.S. states and political subdivisions





407,344


(56,121
)

351,223


(13.8
)Mortgage-backed securities





10,157


(1,064
)

9,093


(10.5
)Corporate securities





8,179


(644
)

7,535


(7.9
)Foreign securities





4,072


(956
)

3,116


(23.5
)Asset-backed securities





912


(283
)

629


(31.0
)Total


184


430,995


(59,089
)

371,906


(13.7
)TotalU.S. Treasury securities and obligations of U.S. government corporations and agencies





505


(23
)

482


(4.6
)Obligations of U.S. states and political subdivisions





1,988,158


(168,414
)

1,819,744


(8.5
)Mortgage-backed securities





50,634


(9,492
)

41,142


(18.7
)Corporate securities





53,274


(3,492
)

49,782


(6.6
)Foreign securities





320,216


(50,271
)

269,945


(15.7
)Asset-backed securities





25,656


(1,869
)

23,787


(7.3
)Total


724

$
2,438,443

$
(233,561
)
$
2,204,882


(9.6
)


---

40

---





At December 31, 2007Aging Categories

Number of
Securities

Amortized
Cost

Unrealized
Losses

Fair Value

Unrealized
Loss as a
Percentage of
Amortized
Cost(dollars in thousands)Less than Six Months(1)U.S. Treasury securities and obligations of U.S. government corporations and agencies




$
17,043

$
(17
)
$
17,026


(0.1
)%Obligations of U.S. states and political subdivisions





87,782


(1,247
)

86,535


(1.4
)Mortgage-backed securities





220


(0
)

220


(0.0
)Corporate securities





4,527


(22
)

4,505


(0.5
)Foreign securities





37,836


(285
)

37,551


(0.8
)Asset-backed securities














Total


53


147,408


(1,571
)

145,837


(1.1
)More than Six Months but Less than 12 Months(2)U.S. Treasury securities and obligations of U.S. government corporations and agencies














Obligations of U.S. states and political subdivisions





326,960


(4,132
)

322,828


(1.3
)Mortgage-backed securities





158


(6
)

152


(3.8
)Corporate securities





12,297


(433
)

11,864


(3.5
)Foreign securities














Asset-backed securities














Total


121


339,415


(4,571
)

334,844


(1.3
)12 Months or More(3)U.S. Treasury securities and obligations of U.S. government corporations and agencies





2,099


(70
)

2,029


(3.3
)Obligations of U.S. states and political subdivisions





11,324


(458
)

10,866


(4.0
)Mortgage-backed securities





110,896


(1,692
)

109,204


(1.5
)Corporate securities





28,226


(668
)

27,558


(2.4
)Foreign securities














Asset-backed securities





2,985


(4
)

2,981


(0.1
)Total


180


155,530


(2,892
)

152,638


(1.9
)TotalU.S. Treasury securities and obligations of U.S. government corporations and agencies





19,142


(87
)

19,055


(0.5
)Obligations of U.S. states and political subdivisions





426,066


(5,837
)

420,229


(1.4
)Mortgage-backed securities





111,274


(1,698
)

109,576


(1.5
)Corporate securities





45,050


(1,123
)

43,927


(2.5
)Foreign securities





37,836


(285
)

37,551


(0.8
)Asset-backed securities





2,985


(4
)

2,981


(0.1
)Total


354

$
642,353

$
(9,034
)
$
633,319


(1.4
)%


---

41

---



In 2008, the Company had realized gains for sales of bonds, offset in part by an OTTI charge of $6.0 million for several municipal bonds.
There were no OTTI charges in the General Investment Portfolio in 2007 and 2006.

Management
has determined that the remaining unrealized losses in fixed-income securities at December 31, 2008 are primarily attributable to the current interest rate environment
and has concluded that these unrealized losses are temporary in nature based upon (a) the lack of principal or interest payment defaults on these securities, (b) the creditworthiness of
the issuers, and (c) the Company's ability and current intent to hold these securities until a recovery in fair value or maturity. As of December 31, 2008 and 2007, 100% of the
securities that were in a gross unrealized loss position were rated investment grade. Management has based its conclusions on current facts and circumstances. Events could occur in the future that
could change management conclusions about its ability and intent to hold such securities.

The
amortized cost and fair value of fixed-income securities in the General Investment Portfolio at December 31, 2008 and 2007, by contractual maturity, are shown below. Actual
maturities could differ from contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.

Distribution of Fixed-Income Securities in General Investment Portfolio  by Contractual Maturity

At December 31,2008

2007Amortized
Cost

Fair Value

Amortized
Cost

Fair Value(in thousands)Due in one year or less

$
797,372

$
801,867

$
148,286

$
150,306Due after one year through five years


1,034,999


1,044,285


1,353,006


1,423,378Due after five years through ten years


823,258


827,436


816,987


852,469Due after ten years


2,921,555


2,786,354


2,214,344


2,266,630Mortgage-backed securities(1)


393,001


396,874


390,992


394,326Asset-backed securities(2)


25,656


23,787


22,652


22,927Total fixed-income securities in General Investment Portfolio

$
5,995,841

$
5,880,603

$
4,946,267

$
5,110,036


---

Proceeds
from sales of long-term bonds from the General Investment Portfolio during 2008, 2007 and 2006 were $3,982.2 million, $3,521.9 million and
$1,581.7 million, respectively. Proceeds from maturities of bonds for the General Investment Portfolio during 2008, 2007 and 2006 were $516.9 million, $184.5 million and
$160.8 million, respectively. Gross gains of $51.1 million, $5.2 million and $0.8 million and gross losses of $52.0 million, $7.3 million and
$5.7 million were realized on sales in 2008, 2007 and 2006, respectively.

Bonds
and short-term investments at an amortized cost of $10.0 million and cash of $1.8 million at December 31, 2008 and bonds and short-term
investments at an amortized cost of $10.1 million and cash of $1.8 million at December 31, 2007, were on deposit with regulatory authorities as required by insurance regulations.

42

---



Equity Investments

In 2008, the Company sold its investment in SGR Redeemable Preferred Shares. Amounts recorded by the Company in connection with SGR are
as follows:

As of and for the Year Ended
December 31,2008

2007

2006(in thousands)Equity securities

$


$
39,000

$
54,016Dividends earned from SGR


1,609


3,465


4,518Realized gain (loss) on sale


(36,100
)







6.     VIE SEGMENT INVESTMENT PORTFOLIO

All the investments supporting VIE liabilities are insured by the Company. The credit quality of the available-for-sale securities in the
VIE Segment Investment Portfolio, without the benefit of the Company's insurance, was as follows:

Available-for-Sale Securities in the VIE Segment Investment Portfolio by Rating

Rating(1)

At December 31, 2008
Percent of BondsAAA


0.9
%A


80.0BBB


19.1Total


100.0
%


---

The
following tables present the amortized cost and fair value of available-for-sale securities and short-term investments held in the VIE Segment
Investment Portfolio:

Available-for-Sale Securities in the VIE Segment Investment Portfolio by Security Type

At December 31, 2008Investment Category

Amortized
Cost

Gross
Unrealized
Gains

Fair Value(in thousands)Obligations of U.S. states and political subdivisions

$
12,931

$


$
12,931Foreign securities


9,300


239


9,539Asset-backed securities


900,862





900,862Total available-for-sale bonds


923,093


239


923,332Available-for-sale GICs


695,898


105,649


801,547Short-term investments


8,221





8,221Total available-for-sale securities

$
1,627,212

$
105,888

$
1,733,100


43

---





At December 31, 2007Investment Category

Amortized
Cost

Gross
Unrealized
Gains

Fair Value(in thousands)Obligations of U.S. states and political subdivisions

$
15,443

$
729

$
16,172Foreign securities


9,177


430


9,607Asset-backed securities


1,094,739


19,050


1,113,789Total available-for-sale bonds


1,119,359


20,209


1,139,568Available-for-sale GICs


621,054


18,896


639,950Short-term investments


8,618





8,618Total available-for-sale securities

$
1,749,031

$
39,105

$
1,788,136


Historically,
the Company had the ability and intent to hold the VIE Segment Investment Portfolio to maturity. However, the Company no longer has the intent to hold such
securities to maturity, due to Dexia's agreement under the Purchase Agreement to retain the VIE operations and segregate or separate the Company's VIE operations from the Company's financial guaranty
operations. As a result, the Company was required to record an OTTI charge for all assets in the portfolio in an unrealized loss position at December 31, 2008.

OTTI
of $236.2 million was recorded in "net realized gains (losses) from variable interest entities segment" on the VIE Segment Investment Portfolio in 2008. At
December 31, 2007, there were no securities in an unrealized loss position.

The
amortized cost and fair value of available-for-sale bonds and short-term investments in the VIE Segment Investment Portfolio by contractual
maturity are shown below. Actual maturities could differ from contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment
penalties.

Distribution of Available-for-Sale Bonds  in the VIE Segment Investment Portfolio by Contractual Maturity

At December 31,2008

2007Amortized
Cost

Fair Value

Amortized
Cost

Fair Value(in thousands)Due in one year or less

$
17,521

$
17,760

$
8,618

$
8,618Due after one year through five years








9,177


9,607Due after ten years


12,931


12,931


15,443


16,172Asset-backed securities(1)


900,862


900,862


1,094,739


1,113,789Total available-for-sale bonds and short-term investments

$
931,314

$
931,553

$
1,127,977

$
1,148,186


---

Proceeds
from maturities of bonds for the VIE Segment Investment Portfolio during 2008, 2007 and 2006 were $119.5 million, $265.4 million and
$103.7 million, respectively.

The
amortized cost and fair value of the GICs in the VIE Segment Investment Portfolio by contractual maturity are shown below. Actual maturities could differ from contractual maturities
because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.

44

---





Distribution of Available-for-sale GICs  in the VIE Segment Investment Portfolio by Contractual Maturity

At December 31,2008

2007Amortized
Cost

Fair
Value

Amortized
Cost

Fair
Value(in thousands)Due in one year or less

$
15,000

$
15,000

$
168,039

$
168,039Due after one year through five years


88,751


88,751


103,751


103,751Due after five years through ten years


210,914


234,541


27,744


27,744Due after ten years


381,233


463,255


321,520


340,416Total available-for-sale GICs

$
695,898

$
801,547

$
621,054

$
639,950


At
December 31, 2008 and 2007, there were two held-to-maturity GICs in the VIE Segment Investment Portfolio with carrying value of
$279.2 million and $277.5 million, respectively, with maturity dates of October 3, 2012 and November 12, 2013. These GICs are recorded in "other assets."

The
Company pledges and receives collateral related to certain business lines or transactions. The following is a description of those arrangements by transaction type.

Securities Pledged to Note Holders and Derivative Counterparties

Substantially all the assets of FSA Global are pledged to secure the repayment, on a pro rata basis, of FSA Global's notes and its
other obligations. FSA Global, under the terms of its derivative agreements, is not required to pledge collateral. Its counterparties, however, may be required to pledge collateral or transfer assets
to FSA Global.

At
December 31, 2008, the Company had received $434.9 million of collateral from counterparties to reduce its net derivative exposure to such parties.

7.     ASSETS ACQUIRED IN REFINANCING TRANSACTIONS

The Company has rights under certain of its financial guaranty insurance policies and indentures that allow it to accelerate the insured notes and pay claims
under its insurance policies upon the occurrence of predefined events of default. To mitigate financial guaranty insurance losses, the Company may elect to purchase the outstanding insured obligation
or its underlying collateral. Generally, refinancing vehicles reimburse FSA in whole for its claims payments in exchange for assignments of certain of FSA's rights against the trusts. The refinancing
vehicles obtain their funds from the proceeds of FSA-insured GICs issued in the ordinary course of business by the GIC Affiliates. The refinancing vehicles are consolidated into the
Company's financial statements.

The
following table presents the balance sheet components of the assets acquired in refinancing transactions:

Summary of Assets Acquired in Refinanced Transactions

At December 31,2008

2007(in thousands)Bonds

$
886

$
5,949Securitized loans


130,056


177,810Other assets


35,658


45,505Total

$
166,600

$
229,264


45

---



The
accretable yield on the securitized loans at December 31, 2008, 2007 and 2006 was $7.5 million, $148.8 million and $157.3 million,
respectively.

The
bonds within the refinanced asset portfolio all have contractual maturities of less than five years. Actual maturities could differ from contractual maturities because borrowers have
the right to call or prepay certain obligations with or without call or prepayment penalties.

8.     DEFERRED ACQUISITION COSTS

Acquisition costs deferred and the related amortization charged to expense are as follows:

Rollforward of Deferred Acquisition Costs

Year Ended December 31,2008

2007

2006(in thousands)Balance, beginning of period

$
347,870

$
340,673

$
335,129Costs deferred during the period:Ceded and assumed commissions


(10,526
)

(83,252
)

(79,713
)Premium taxes


13,856


13,182


14,032Compensation and other acquisition costs


13,821


140,709


134,237Total


17,151


70,639


68,556Costs amortized during the period


(65,700
)

(63,442
)

(63,012
)Balance, end of period

$
299,321

$
347,870

$
340,673


9.     LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the liability for losses and loss adjustment expenses, which consist of the case and non-specific reserves, is summarized below.
Adjustments to reserves represent management's estimate of the amount required to cover the present value of the net cost of claims based on statistical provisions for new originations.

Reconciliation of Net Loss and Loss Adjustment Expenses

Year Ended December 31,2008

2007

2006(in thousands)Case Reserve Activity:Gross balance at January 1

$
174,557

$
90,306

$
89,984Less reinsurance recoverable


76,478


37,342


36,339Net balance at January 1


98,079


52,964


53,645Transfer from non-specific reserve


2,036,437


69,384


1,221Paid (net of recoveries) related to:Current year recovery (paid)


16,682


(8,248
)

Prior year


(615,589
)

(16,021
)

(1,902
)Total paid


(598,907
)

(24,269
)

(1,902
)Net balance at December 31


1,535,609


98,079


52,964Plus reinsurance recoverable


283,973


76,478


37,342Gross balance at December 31


1,819,582


174,557


90,306


46

---



Year Ended December 31,2008

2007

2006(in thousands)Non-Specific Reserve Activity:Gross balance at January 1


99,999


137,816


115,734Provision for lossesCurrent year


1,338


25,797


17,837Prior year


2,089,545


5,770


5,466Transfers to case reserves


(2,036,437
)

(69,384
)

(1,221
)Net balance at December 31


154,445


99,999


137,816Plus reinsurance recoverable


18,151





Gross balance at January 1


172,596


99,999


137,816Total gross case and non-specific reserves

$
1,992,178

$
274,556

$
228,122


The
following table shows the gross and net par outstanding on transactions with case reserves, the gross and net case reserves recorded and the number of transactions
comprising case reserves.

Case Reserve Summary

At December 31, 2008Gross Par
Outstanding

Net Par
Outstanding

Gross Case
Reserve

Net Case
Reserve

Number
of Risks(dollars in thousands)Asset-backedHELOCs

$
4,833,059

$
3,853,788

$
745,790

$
593,752


10Asset-backedAlt-A CES


999,475


954,296


245,702


234,158


5Asset-backedOption ARM


1,674,743


1,587,145


282,131


260,599


9Asset-backedAlt-A first-lien


1,226,480


1,122,333


106,545


96,327


10Asset-backedNIMs


90,070


85,341


15,961


15,817


3Asset-backedSubprime


298,457


280,128


24,521


20,757


5Asset-backedother


54,491


50,969


13,685


12,933


3Public finance


1,238,816


698,708


172,063


88,082


6Financial products portfolio


1,672,616


1,672,616


213,184


213,184


73Total

$
12,088,207

$
10,305,324

$
1,819,582

$
1,535,609


124


At December 31, 2007Gross Par
Outstanding

Net Par
Outstanding

Gross Case
Reserve(1)

Net Case
Reserve(1)

Number
of Risks(dollars in thousands)Asset-backedHELOCs

$
1,803,340

$
1,442,657

$
69,633

$
56,913


5Asset-backedSubprime


22,280


18,335


3,399


1,583


2Asset-backedother


24,905


22,219


4,890


4,684


2Public finance


1,164,248


560,610


96,635


34,899


4Total

$
3,014,773

$
2,043,821

$
174,557

$
98,079


13


The
table below presents certain assumptions inherent in the calculations of the case and non-specific reserves:

Assumptions for Case and Non-Specific Reserves

At December 31,2008

2007Case reserve discount rate

1.90%5.90%

3.13%5.90%Non-specific reserve discount rate

6.00%

1.20%7.95%Current experience factor

20.4

2.0


47

---



During
2008, loss and loss adjustment expenses was $2,090.9 million. The increase for the year was driven primarily by deteriorating credit performance in home
equity lines of credit ("HELOCs"), financial products portfolio, Alt-A closed end second lien mortgage securities ("CES"), Option adjustable rate mortgage loan ("Option ARMs"),
Alt-A first lien and public finance transactions. "Alt-A" refers to borrowers whose credit falls between prime and subprime. In addition, the net non-specific
reserves increased by $54.5 million for the year. Management's current reserve estimates assume loss levels for transactions backed by second-lien mortgage products will remain at
their peaks until mid-2009 and slowly recover to more normal rates by mid-2010. For first-lien mortgage transactions, where losses take longer to develop than in
second-lien mortgage transactions, peak conditional default rates are assumed to continue until mid-2010 and then decline linearly over 12 months to 25% of the peak,
remain there for three years and then taper down to 5% of peak rates over several years.

The
increase in losses paid is driven by payments on HELOC transactions. Generally, once the overcollateralization is exhausted on an insured HELOC transaction, the Company pays a claim
if losses in a period exceed spread for the period, and, to the extent excess spread exceeds losses, the Company is reimbursed for any losses paid to date. In 2008, the Company paid net HELOC claims
of $577.7 million. This brought the inception to date net claim payments on HELOC transactions to $625.3 million. There were no claims paid on most other classes of insured transactions
through December 31, 2008. Most claim payments on Alt-A CES are not payable until 2037 or later. Option ARM claim payments are expected to occur between 2010 and 2012.

During
2007, the Company charged $31.6 million to loss expense, consisting of $25.8 million for originations of new business and $5.8 million related to accretion on
the reserve for in-force business. Net case reserves increased $45.1 million in 2007 due primarily to the establishment of new case reserves for HELOC and public finance
transactions, offset in part by the settlement of several pooled corporate collateralized bond obligations ("CBOs"), which were accrued for in prior years. As of December 31, 2007, an estimated
ultimate loss (discounted to present value) of $65.0 million on HELOC transactions had been transferred from the non-specific reserve to case reserves, which increased the
experience factor. Such estimate of loss is net of reinsurance and anticipated recoveries and is reevaluated on a quarterly basis. In the second half of 2007, the Company paid a total of
$47.6 million in HELOC claims, of which $39.5 million represented what the Company
deemed to be recoverable and was recorded as salvage and subrogation ("S&S") recoverable as of December 31, 2007.

During
2006, the Company charged $23.3 million to loss expense, consisting of $17.8 million for originations of new business and $5.5 million related to accretion on
the reserve for in-force business. Net case reserves decreased $0.7 million due primarily to loss payments and some improvement in CBO transactions, offset in part by the
establishment of a new case reserve for a municipal health care transaction.

The
Company assigns each insured credit to one of five designated surveillance categories to facilitate the appropriate allocation of resources to monitoring, loss mitigation efforts and
rating the credit condition of each risk exposure. Such categorization is determined in part by the risk of loss and in part by the level of routine involvement required. The surveillance categories
are organized as follows:



48

---





The
tables below present the gross and net par and interest outstanding and deferred premium revenue in the insured portfolio for risks classified as described above:

Par and Interest Outstanding  Excluding Credit Derivatives

At December 31, 2008Gross
Par

Gross
Interest

Net
Par

Net
Interest

No. of
risks

Weighted Avg Life

Gross
Deferred
Premium
Revenue

Net
Deferred
Premium
Revenue(dollars in millions)Categories I and II

$
433,542

$
273,907

$
330,811

$
196,976


11,194


13.5

$
2,899

$
1,964Category III


13,487


5,902


9,845


3,427


117


8.0


109


50Category IV


1,260


321


1,181


289


8


4.5


0


0Category V with no claim payments


7,033


2,226


6,374


1,866


34


8.0


41


25Category V with claim payments


5,153


899


4,023


661


20


3.9


4


2Total

$
460,475

$
283,255

$
352,234

$
203,219


11,373


12.9

$
3,053

$
2,041


Case Reserves

At December 31,2008

2007Gross

Net

Gross

Net(in thousands)Category V no claim payments

$
1,031,656

$
921,214

$
112,629

$
64,430Category V with claim payments


787,926


614,395


61,928


33,649Total

$
1,819,582

$
1,535,609

$
174,557

$
98,079




At
December 31, 2008
Category V(in thousands)Gross undiscounted cash outflows expected in future

$
3,745,709Less: Gross estimated recoveries (S&S) in future


1,515,903Subtotal


2,229,806Less: Discount taken on subtotal


410,224Gross case reserve


1,819,582Less: Reinsurance recoverable on unpaid losses (net of discount of $35.3 million)


283,973Net case reserve

$
1,535,609


Management
periodically evaluates its estimates for losses and LAE and establishes reserves that management believes are adequate to cover the present value of the
ultimate net cost of claims. The Company will continue, on an ongoing basis, to monitor these reserves and may periodically adjust such

49

---



reserves,
upward or downward, based on the Company's actual loss experience, its mix of business and economic conditions. However, because of the uncertainty involved in developing these estimates,
the ultimate liability may differ materially from current estimates.

10.   VARIABLE INTEREST ENTITIES SEGMENT DEBT

At December 31, 2008, interest rates on VIE segment debt were between 1.98% and 6.22% per annum. Payments due under the VIE segment debt included
$692.2 million of future interest accretion on zero coupon obligations. The following table presents the combined principal amounts due under VIE Segment debt for 2009 and each of the next four
years ending December 31 and thereafter:

Expected Maturity Schedule of VIE Segment Debt

Year

Principal
Amount(in thousands)2009

$
359,4412010


94,4282011


18,5042012


144,5282013


145,338Thereafter


2,056,395Total

$
2,818,634


11.   OUTSTANDING EXPOSURE

The Company's insurance policies typically guarantee the scheduled payments of principal and interest on public finance and asset-backed (including credit
derivatives in the insured portfolio) obligations. The gross amount of financial guaranties in force (principal and interest) was $833.9 billion at December 31, 2008 and
$857.9 billion at December 31, 2007. The net amount of financial guaranties in force was $631.5 billion at December 31, 2008 and $622.9 billion at
December 31, 2007.

The
Company seeks to limit its exposure to losses from writing financial guarantees by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous
collateral requirements on asset-backed obligations, as well as through reinsurance.

Actual
maturities could differ from contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties. The
expected maturities for asset-backed obligations are, in general, considerably shorter than the contractual maturities for such

50

---



obligations.
For asset-backed obligations, the full par outstanding for each insured risk is shown in the maturity category that corresponds to the legal final maturity of such risk:

Contractual Terms to Maturity of Net Par Outstanding of Insured Obligations(1)

At December 31,2008

2007Terms to Maturity

Public Finance

Asset-Backed

Public Finance

Asset-Backed(in millions)0 to 5 years

$
59,743

$
36,803

$
54,037

$
42,7145 to 10 years


64,224


29,186


58,719


34,85810 to 15 years


59,443


17,818


53,738


19,33215 to 20 years


46,735


737


44,446


2,64420 years and above


76,274


33,131


71,767


44,087Total

$
306,419

$
117,675

$
282,707

$
143,635


---

Contractual Terms to Maturity of Ceded Par Outstanding of Insured Obligations

At December 31,2008

2007Terms to Maturity

Public Finance

Asset-Backed

Public Finance

Asset-Backed(in millions)0 to 5 years

$
15,407

$
6,224

$
16,500

$
7,2115 to 10 years


17,555


6,829


17,895


7,80810 to 15 years


18,270


2,722


19,617


1,66415 to 20 years


16,810


119


19,143


1,85720 years and above


34,721


2,432


42,635


3,420Total

$
102,763

$
18,326

$
115,790

$
21,960


The
par outstanding of insured obligations in the public finance insured portfolio includes the following amounts by type of issue:

Summary of Public Finance Insured Portfolio(1)

At December 31,Gross Par Outstanding

Ceded Par Outstanding

Net Par OutstandingTypes of Issues

2008

2007

2008

2007

2008

2007(in millions)Domestic obligationsGeneral obligation

$
155,249

$
146,883

$
30,186

$
32,427

$
125,063

$
114,456Tax-supported


73,718


69,534


18,272


19,453


55,446


50,081Municipal utility revenue


63,516


57,975


13,175


13,610


50,341


44,365Health care revenue


21,841


25,843


9,656


11,796


12,185


14,047Housing revenue


9,310


9,898


1,876


2,187


7,434


7,711Transportation revenue


32,493


29,189


11,189


11,782


21,304


17,407Education/University


9,560


7,178


1,658


1,710


7,902


5,468Other domestic public finance


2,858


2,773


677


900


2,181


1,873Subtotal


368,545


349,273


86,689


93,865


281,856


255,408International obligations


40,637


49,224


16,074


21,925


24,563


27,299Total public finance obligations

$
409,182

$
398,497

$
102,763

$
115,790

$
306,419

$
282,707


---

51

---





The par outstanding of insured obligations in the asset-backed insured portfolio includes the following amounts by type of collateral:

Summary of Asset-Backed Insured Portfolio

At December 31,Gross Par Outstanding

Ceded Par Outstanding

Net Par OutstandingTypes of Collateral

2008

2007

2008

2007

2008

2007(in millions)Domestic obligationsResidential mortgages

$
19,453

$
22,882

$
2,401

$
3,108

$
17,052

$
19,774Consumer receivables(1)


6,946


12,647


907


1,076


6,039


11,571Pooled corporate


63,764


69,317


8,861


10,110


54,903


59,207Financial products(2)


15,253


19,468








15,253


19,468Other domestic asset-backed


3,194


4,000


1,626


2,024


1,568


1,976Subtotal


108,610


128,314


13,795


16,318


94,815


111,996International obligations


27,391


37,281


4,531


5,642


22,860


31,639Total asset-backed obligations

$
136,001

$
165,595

$
18,326

$
21,960

$
117,675

$
143,635


---

In
its asset-backed business, the Company considers geographic concentration as a factor in underwriting insurance covering securitizations of pools of such assets as residential
mortgages or consumer receivables. However, after the initial issuance of an insurance policy relating to such securitizations, the geographic concentration of the underlying assets may not remain
fixed over the life
of the policy. In addition, in writing insurance for other types of asset- backed obligations, such as securities primarily backed by government or corporate debt, geographic concentration is not
deemed by the Company to be significant, given other more relevant measures of diversification, such as issuer or industry diversification.

The
Company seeks to maintain a diversified portfolio of insured public finance obligations designed to spread its risk across a number of geographic areas. The following table sets
forth those

52

---



states
in which municipalities located therein issued an aggregate of 2% or more of the Company's net par amount outstanding of insured public finance securities:

Public Finance Insured Portfolio by Location of Exposure

At December 31, 2008Number of
Risks

Net Par
Amount
Outstanding(1)

Percent of Total
Net Par Amount
Outstanding

Ceded Par
Amount
Outstanding(dollars in millions)Domestic obligationsCalifornia


1,121

$
40,868


13.3
%
$
12,864New York


775


23,158


7.5


10,220Pennsylvania


894


20,537


6.7


4,488Texas


826


19,525


6.4


4,604Illinois


756


16,612


5.4


6,083Florida


291


15,585


5.1


4,620Michigan


639


13,093


4.3


2,157New Jersey


659


12,509


4.1


6,063Washington


344


10,225


3.3


3,754Massachusetts


241


7,896


2.6


4,289Ohio


452


7,242


2.4


1,678Georgia


129


7,000


2.3


1,482Indiana


300


6,674


2.2


1,199All other U.S. locations


3,405


80,932


26.4


23,188Subtotal


10,832


281,856


92.0


86,689International obligations


173


24,563


8.0


16,074Total


11,005

$
306,419


100.0
%
$
102,763


---

12.   FEDERAL INCOME TAXES

The Company adopted FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109"
("FIN 48") as of January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes in an entity's financial statements pursuant to FASB Statement No. 109,
"Accounting for Income Taxes" and provides thresholds for recognizing and measuring benefits of a tax position taken or expected to be taken in a tax return. Consequently, the Company recognizes tax
benefits only on tax positions where it is "more likely than not" to prevail. There was no effect on the Company's statements of operations and comprehensive income from adopting FIN 48.

Dexia
Holdings, the Parent and the Company and its subsidiaries, except FSA International, file a consolidated federal income tax return. Under the terms of a
tax-sharing agreement, each company pays taxes on a separate return basis.

In
addition, the Company and its subsidiaries or branches file separate tax returns in various states and local and foreign jurisdictions, including the United Kingdom, Japan, Mexico and
Australia. With limited exceptions, the Company and its Subsidiaries are no longer subject to income tax examinations for its 2004 and prior tax years for U.S. federal, state and local, or
non-U.S. jurisdictions.

53

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The
cumulative balance sheet effects of deferred federal tax consequences are as follows:

Components of Deferred Tax Assets and Liabilities

December 31,2008

2007(in thousands)Loss and loss adjustment expense reserves

$
367,632

$
37,650Deferred compensation


41,786


70,709Unrealized capital losses


25,470


Derivative fair-value adjustments


710,954


109,817Foreign currency transaction loss


73,538


72,960Minority interest





2,257Tax credits


15,731


Undistributed earnings


37,830


Other


5,294


3,109Total deferred federal income tax assets


1,278,235


296,502Deferred acquisition costs


(90,249
)

(109,237
)Deferred premium revenue adjustments


(44,502
)

(67,562
)Unrealized capital gains





(58,530
)Contingency reserves





(162,686
)Undistributed earnings





(5,340
)Minority interest


(341,534
)

Other


(5,693
)

(3,303
)Total deferred federal income tax liabilities


(481,978
)

(406,658
)Net deferred federal income tax asset (liability)

$
796,257

$
(110,156
)


A
valuation allowance is required when it is more likely than not that a portion or all of a deferred tax asset will not be realized. All evidence, both positive and negative, needs to
be identified and considered in making the determination. Future realization of the existing deferred tax asset will depend on the Company's ability to generate sufficient taxable income of
appropriate character (i.e. ordinary income versus capital gains) within the carryback and carryforward periods available under the tax law.

The
net deferred tax asset of $796 million at December 31, 2008 consists primarily of $368 million related to loss reserves, and $453 million related to mark
to market on CDS, offset by other net liabilities. The Company's management has concluded that no valuation allowance is necessary based on the following analysis: The $368 million tax benefit
from loss reserves and $453 million from CDS would be realizable against future ordinary income. Negative evidence includes the uncertainty of selling financial guaranty policies in the future
as well as the stability of the Company's credit rating by the three principal rating agencies. However, the Company has substantial streams of future premium earnings from its in force insured
portfolio, with the total aggregating to approximately $3.5 billion at December 31, 2008. Even with the uncertainty of future business and the stability of the Company's credit rating,
future premium revenues, coupled with investment income less expenses, are expected to be more than sufficient to offset current incurred losses, including credit derivatives losses. The Company's
loss reserves represent the discounted value of future claims. Therefore, the accretion of losses to the undiscounted future value has also been taken into consideration, and the Company does not
anticipate any significant additional loss trends. The Company expects future accretion on loss reserves of about $410.2 million. In addition, except for true credit losses,
mark-to-market losses from

54

---



CDS
contracts will reverse over time. As the mark-to-market losses reverse, the deferred tax asset will also reverse. To the extent that true credit losses increase, the
related mark-to-market losses will not fully reverse and the Company may not be able to offset such future losses against future ordinary income.

The
Company treats its CDS contracts as insurance contracts for U.S. tax purposes. The current federal tax treatment of CDS contracts is an unsettled area of tax law. Market participants
are generally treating CDS contracts for tax purposes as either: (1) notional principal contract ("NPC") derivative instruments, (2) guarantees, (3) insurance contracts, or
(4) capital assets. The Company believes that it is more likely than not that its CDS contracts are either NPC or insurance contracts. Both receipts and payments arising from NPC and insurance
contracts are characterized as ordinary income (although a termination of a CDS contract as an NPC may be treated as a capital transaction). Although the Company believes it is properly treating
potential losses on its CDS contracts as ordinary, there are no assurances that the Internal Revenue Service ("IRS") will agree with the Company. Should the IRS disagree with the Company and
characterize such losses, if any, as capital losses, the Company's ability to realize a related tax asset would be more limited, possibly leading to a reduction or elimination of the related deferred
tax asset.

The
Company recognized tax benefits of $3.7 million and $3.0 million for 2008 and 2007, respectively, from the expiration of the statute of limitations for the 2004 and
2003 tax years. Of the tax benefits, $0.6 million and $0.5 million were related benefits from the release of accrued interest for 2008 and 2007, respectively.

A
reconciliation of the effective tax rate (before minority interest and equity in earnings of unconsolidated affiliates) with the federal statutory rate follows:

Effective Tax Rate Reconciliation

Year Ended December 31,2008

2007

2006Tax provision (benefit) at statutory rate


(35.0
)%

(35.0
)%

35.0
%Tax-exempt investments


(5.4
)

(34.3
)

(11.6
)Minority interest


(31.4
)

6.2


3.6Fair-value adjustment for CPS


(3.2
)




Other


0.0


(1.1
)

0.1Provision (benefit) for income taxes


(75.0
)%

(64.2
)%

27.1
%


The
current-year effective tax rate reflects significant mark to market income in FSA Global Funding debt that was not tax-effected. The prior-year
effective tax rate reflects the lower ratio of tax-exempt interest income to year-to-date pre-tax loss due to the significant negative fair value
adjustments.

The
total amount of unrecognized tax benefits at December 31, 2008 and December 31, 2007 was $14.5 million and $17.7 million, respectively. If recognized, the
entire amount would favorably affect the effective tax rate. The Company recognizes interest and penalties related to unrecognized tax benefits as part of income taxes. For the years ended
December 31, 2008 and 2007, the Company accrued $0.1 million benefit and $0.4 of expenses, respectively, related to interest and penalties. Cumulative interest and penalties of $1.4 and
$1.5 million were accrued on the Company's balance sheet at

55

---



December 31,
2008 and December 31, 2007, respectively. A reconciliation of the beginning to ending unrecognized tax benefits follows:

Reconciliation of Unrecognized Tax Benefit

Year Ended December 31,2008

2007(in thousands)Balance at January 1, 2008

$
17,680

$
20,208Reductions as a result of a lapse in the statute of limitations


(3,143
)

(2,528
)Balance at December 31, 2008

$
14,537

$
17,680


The
Company believes that within the next 12 months, it is reasonably possible that unrecognized tax benefits for positions taken on previously filed tax returns will become
recognized as a result of the expiration of statute of limitations for the 2005 tax year, which absent any extension, will close in September 2009.

13.   NOTES PAYABLE TO AFFILIATE

The Company had $172.5 million of notes payable to GIC Affiliates at December 31, 2008 and $210.1 million at December 31, 2007. For
the years ended December 31, 2008, 2007 and 2006 the Company recorded $12.1 million, $16.4 million and $20.1 million, respectively, of interest expense on the notes
payable.

Principal
payments due under these notes for each of the next five years ending December 31 and thereafter are as follows:

Expected Maturity Schedule of Notes Payable

Expected Withdrawal Date

Principal Amount(in thousands)2009

$
13,4792010


6,9752011


18,2622012


23,8792013


31,179Thereafter


78,725Total

$
172,499


14.   EMPLOYEE BENEFIT PLANS

Defined Contribution Plans

The Company maintains both qualified and non-qualified, non-contributory defined contribution pension plans for
the benefit of eligible employees. Contributions are based on a fixed percentage of employee compensation. Pension expense, which is funded annually, amounted to $5.9 million,
$6.8 million and $6.6 million for the years ended December 31, 2008, 2007 and 2006, respectively.

The
Company has an employee retirement savings plan for the benefit of eligible employees. The plan permits employees to contribute a percentage of their salaries up to limits prescribed
by Internal

56

---



Revenue
Code Section 401(k). Contributions by the Company are discretionary, and none have been made.

Equity Participation Plans

Through 2004, performance shares were awarded under the Parent's 1993 Equity Participation Plan (the "1993 Equity Plan"). The 1993
Equity Plan authorized the discretionary grant of performance shares by the Human Resources Committee to key employees. The amount earned for each performance share depends on the attainment of
certain growth rates of adjusted book value as defined by the 1993 Equity Plan, and book value per outstanding share over specified three-year performance cycles.

Performance
shares issued prior to January 1, 2005 permitted the participant to elect, at the time of award, growth rates including or excluding realized and unrealized gains and
losses on the Parent's consolidated investment portfolios. Performance shares issued after January 1, 2005 do not offer the option to include the impact of unrealized gains and losses on the
investment portfolio. No payout occurs if the compound annual growth rate of the Parent's consolidated adjusted book value and book value per outstanding share over specified three-year
performance cycles is less than 7%, and a 200% payout occurs if the compound annual growth rate is 19% or greater. Payout percentages are interpolated for compound annual growth rates between 7% and
19%.

In
2004, the Company adopted the 2004 Equity Participation Plan (the "2004 Equity Plan"), which continues the incentive compensation program formerly provided under the Company's 1993
Equity Participation Plan. The 2004 Equity Plan provides for performance share units comprised 90% of performance shares (which provide for payment based upon the Parent's consolidated performance
over two specified three-year performance cycles as described above) and 10% of shares of Dexia restricted stock. Performance shares have generally been awarded on the basis of two
sequential three-year performance cycles, with one third of each award allocated to the first cycle, which commences on the date of grant, and two thirds of each award allocated to the
second cycle, which commences one year after the date of grant. The Company recognizes expense ratably over the course of each three-year performance cycle. The total number of performance
shares authorized under this plan was 3.3 million. At December 31, 2008, 2.3 million performance shares remained available for distribution.

The
Dexia restricted stock component is a fixed plan, where the Company purchases Dexia shares and establishes a prepaid expense for the amount paid, which is amortized over
2.5-year and 3.5-year vesting periods. In 2008 and 2007, FSA purchased shares that economically defeased its liability for $3.8 million and $4.7 million,
respectively. These amounts are being amortized to expense over the employees' vesting periods. For the years ended December 31, 2008, 2007 and 2006, the after-tax amounts amortized
into income were $2.7 million, $2.5 million and $1.7 million, respectively.

57

---





Performance shares granted under the 1993 Equity Plan and 2004 Equity Plan are as follows:

Performance Shares

Outstanding
at
Beginning of
Year

Granted
During
the Year

Paid out
During
the Year

Forfeited
During the
Year

Outstanding
at
End of Year

Price per
Share
at Grant
Date

Paid During
the Year(in thousands)2006


1,195,978


370,441


340,429


15,696


1,210,294

$
139.22

$
60,9932007


1,210,294


306,368


364,510


37,550


1,114,602


145.61


61,8722008


1,114,602


313,245


349,533


100,901


977,413


156.99


46,590


At
December 31, 2008, 276,842 outstanding performance shares were fully vested, with a value of $0. At December 31, 2008, the total compensation cost related to
non-vested performance shares not yet recognized was $0.

At
December 31, 2007, 349,533 outstanding performance shares were fully vested, with a value of $46.6 million. These amounts were paid in the first quarter of 2008. At
December 31, 2007, the total compensation cost related to non-vested performance shares not yet recognized was $130.2 million.

The
estimated final cost of these performance shares is accrued over the performance period. The after-tax benefit of $35.9 million for the year ended
December 31, 2008 and expense of $35.7 million and $34.3 million, for the years ended December 31, 2008, 2007 and 2006, respectively, was recorded for the performance
shares. In 2008, the accrual for performance shares was completely written off to reflect the Company's performance, resulting in a benefit to income.

Awards
of Dexia restricted stock remain restricted for an additional six months after the end of each vesting period. Shares of Dexia restricted stock purchased under the 2004 Equity
Plan are as follows:

Dexia Restricted Stock Shares

Outstanding
at
Beginning of
Year

Purchased
During
the Year

Vested
During
the Year

Forfeited
During the
Year

Outstanding
at
End of Year

Price per
Share at
Purchase
Date2006


180,296


190,572


22,146


4,574


344,148

$
24.172007


344,148


158,096


65,524


17,607


419,113


29.802008


419,113


248,886


178,449


50,170


439,380


23.61


58

---



15.   CREDIT DERIVATIVES IN THE INSURED PORTFOLIO

The components of the net change in the fair value of credit derivatives are shown in the table below:

Summary of the Net Change in the Fair Value of Credit Derivatives

Year Ended December 31,2008

2007

2006(in thousands)Net change in fair value of credit derivatives:Realized gains (losses) and other settlements(1)

$
126,891

$
102,800

$
87,200Net unrealized gains (losses):CDS:Pooled corporate CDS:Investment grade


(165,295
)

(159,748
)

21,034High yield


(242,294
)

(151,779
)

8,057Total pooled corporate CDS


(407,589
)

(311,527
)

29,091Funded CLOs and CDOs


(226,530
)

(288,762
)

0Other structured obligations


(77,939
)

(35,474
)

1,900Total CDS


(712,058
)

(635,763
)

30,991IR swaps and FG contracts with embedded derivatives


(32,905
)

(6,846
)

832Subtotal


(744,963
)

(642,609
)

31,823Net change in fair value of credit derivatives

$
(618,072
)
$
(539,809
)
$
119,023


---

The
fair value of credit derivatives is reported in the balance sheet as "other assets" or "other liabilities" based on the net gain or loss position with each counterparty. The
unrealized component includes the market appreciation or depreciation of the derivative contracts, as discussed in Note 3.

Unrealized Gains (Losses) of the Credit Derivative Portfolio(1)

At December 31,2008

2007(in thousands)Pooled corporate CDS:Investment grade

$
(255,980
)
$
(116,175
)High yield(2)


(374,249
)

(144,419
)Total pooled corporate CDS


(630,229
)

(260,594
)Funded CLOs and CDOs


(478,904
)

(263,422
)Other structured obligations(2)


(108,841
)

(32,954
)Total CDS


(1,217,974
)

(556,970
)IR swaps and FG contracts with embedded derivatives(2)


(38,386
)

(6,027
)Total net credit derivatives

$
(1,256,360
)
$
(562,997
)






59

---





Prior
to the adoption of SFAS 157 on January 1, 2008 (the "Adoption Date"), the Company followed EITF 02-03. Under EITF 02-03, the
Company was prohibited from recognizing a profit at the inception of its CDS contracts (referred to as "day one" gains) because the fair value of those derivatives is based on a valuation technique
that incorporated unobservable inputs. Accordingly, the Company deferred approximately $40.9 million pre-tax of day one gains related to the fair value of CDS contracts purchased
that were not permitted to be recognized under EITF 02-03. As SFAS 157 nullified the guidance in EITF 02-03, the Company recognized a transition adjustment
totaling $40.9 million of previously deferred day one gains (pre-tax) in beginning retained earnings on the Adoption Date. See Note 3 for further discussion of the Company's
adoption of SFAS 157.

The
negative fair-value adjustments for the year ended December 31, 2008 were a result of continued widening of credit spreads in the insured CDS portfolio, offset in
part by the positive income effects of the Company's own credit spread widening. Despite the structural protections associated with CDS contracts written by FSA, the significant widening of credit
spreads on pooled corporate CDS and funded CDOs and CLOs, as with other structured credit products, resulted in a decline in the fair value of these contracts compared with December 31, 2007.

As
the fair value of a CDS contract incorporates all the remaining future payments to be received over the life of the CDS contract, the fair value of that contract will change, in part,
solely from the passage of time as fees are received.

The
Company's typical CDS contract is different from CDS contracts entered into by parties that are not financial guarantors because:



CDS
contracts in the asset-backed portfolio represent 71.2% of total asset-backed par outstanding. The Company has grouped CDS contracts by major category of underlying instrument for
purposes of internal risk management and external reporting. The tables below summarize the credit rating, net par outstanding and remaining weighted average lives for the primary components of the
Company's CDS portfolio. Net par outstanding in the table below is also included in the tables in Note 11.

60

---



Selected Information for CDS Portfolio

At December 31, 2008Credit RatingsRemaining
Weighted
Average
LifeTriple-A*(1)

Triple-A

Double-A

Other
Investment
Grades(2)

Below
Investment
Grade(3)

Net Par
Outstanding(4)(in millions)

(in years)Pooled Corporate CDS:Investment grade


100
%


%


%


%


%
$
17,464


4.1High yield


41


54








5


15,467


2.4Funded CDOs and CLOs


27


65
(5)

7


1





31,681


2.6Other structured obligations(6)


53


11
(5)

8


27


1


8,272


2.6Total


50


41


4


4


1

$
72,884


2.9




At December 31, 2007Credit RatingsRemaining
Weighted
Average
LifeTriple-A*(1)

Triple-A

Double-A

Other
Investment
Grades(2)

Below
Investment
Grade

Net Par
Outstanding(4)(in millions)

(in years)Pooled Corporate CDS:Investment grade


91
%

1
%

8
%


%


%
$
22,883


4.1High yield


95








5





14,765


3.3Funded CDOs and CLOs


28


72
(5)










33,000


3.4Other structured obligations(6)


62


36
(5)

1


1





13,529


2.1Total


62


34


3


1




$
84,177


3.4


---

16.   VARIABLE INTEREST ENTITIES SEGMENT DERIVATIVE INSTRUMENTS

The Company enters into derivative contracts to manage interest rate and foreign currency exposure in its VIE segment debt and VIE Segment Investment Portfolio.

As
a result of market interest rate fluctuations, fixed-rate assets and liabilities appreciate or depreciate in market value. Gains or losses on the derivative instruments
that are linked to the

61

---



fixed-rate
assets and liabilities being hedged are expected to substantially offset this unrealized appreciation or depreciation relating to the risk being hedged.

The
Company uses foreign currency contracts to manage the foreign exchange risk associated with certain foreign currency-denominated assets and liabilities. Gains or losses on the
derivative instruments that are linked to the foreign currency denominated assets or liabilities being hedged are expected to substantially offset this variability.

In
order for a derivative to qualify for hedge accounting, it must be highly effective at reducing the risk associated with the exposure being hedged. In order for a derivative to be
designated as a hedge, there must be documentation of the risk management objective and strategy, including identification of the hedging instrument, the hedged item and the risk exposure, and how
effectiveness is to be assessed prospectively and retrospectively. To assess effectiveness, the Company uses analysis of the sensitivity of fair values to changes in the risk being hedged, as well as
dollar value comparisons of the change in the fair value of the derivative to the change in the fair value of the hedged item that is attributable to the risk being hedged. The extent to which a
hedging instrument has been and is expected to continue to be effective at achieving offsetting changes in fair value must be assessed and documented at least quarterly. Any ineffectiveness must be
reported in current-period earnings. If it is determined that a derivative is not highly effective at hedging the designated exposure, hedge accounting is discontinued.

An
effective fair-value hedge is defined as one whose periodic change in fair value is 80% to 125% correlated with the change in fair value of the hedged item. The difference
between a perfect hedge (i.e., the change in fair value of the hedge and hedged item offset one another so that there is zero effect on the consolidated statements of operations and
comprehensive income, referred to as being "100% correlated") and the actual correlation within the 80% to 125% effectiveness range is the ineffective portion of the hedge. A failed hedge is one whose
correlation falls outside of the 80% to 125% effectiveness range.

The
net loss related to the ineffective portion of the Company's fair-value hedges including changes in fair value of hedging instruments related to the passage of time,
which was excluded from the assessment of hedge ineffectiveness, was $49 thousand in 2007. For 2008, this measure is not meaningful as substantially all assets in fair value hedging
relationships have been recorded in the statement of operations and comprehensive income as OTTI.

The
inception-to-date net unrealized gain on derivatives (excluding accrued interest and collateral) in the VIE segment of $206.2 million and
$474.4 million at December 31, 2008 and 2007, respectively, is recorded in "other assets" or "other liabilities," as applicable.

Changes in Hedge Accounting Designations

As of January 1, 2008, the Company adopted SFAS 159 and elected the fair value option for certain fixed-rate
liabilities in the VIE segment debt portfolio, as described in Note 4. The fair value option allows the fair value adjustment on these liabilities to be recorded in earnings without hedge
documentation and effectiveness testing requirements prescribed under SFAS 133. However, when the fair value option is elected, the fair value adjustment of liabilities must incorporate all
components of fair value, including valuation adjustments related to the reporting entity's own credit risk. Under hedge accounting, only the component of fair value attributable to the hedged risk
(i.e. interest rate risk) was recorded in earnings.

As
of January 1, 2008, fixed-rate assets in the available-for-sale VIE Segment Investment Portfolio that were economically hedged with interest
rate swaps were designated in fair value hedging relationships. Prior to January 1, 2008, changes in the fair value of these economically hedged assets were recorded in "accumulated other
comprehensive income," whereas the corresponding changes in fair value of the related hedging instrument were recorded in earnings. Under fair value hedge

62

---



accounting,
the fair value adjustments related to the hedged risk are recorded in earnings and adjust the amortized cost basis of the related assets. The interest and fair value adjustments on the
derivatives and the interest income and fair value adjustment on the assets attributable to the hedged interest rate risk are recorded in "net interest income from variable interest entities segment"
in the consolidated statements of operations and comprehensive income, thereby offsetting each other and reflecting economic inefficiency on the hedging relationship in earnings. The Company does not
seek to apply hedge accounting to all of its economic hedges.

17.   MINORITY INTEREST IN FSA GLOBAL

All equity and net income of the VIEs are shown as minority interest. The VIEs are consolidated into all applicable captions of the consolidated financial
statements under FASB Interpretation 46(R), "Consolidation of Variable Interest Entities."

18.   REINSURANCE

The Company obtains reinsurance to increase its policy-writing capacity on both an aggregate-risk and a single-risk basis; to meet rating
agency, internal and state insurance regulatory limits; to diversify risk; to reduce the need for additional capital; and to strengthen financial ratios. The Company reinsures portions of its risks
with affiliated (see Note 25 for more information) and unaffiliated reinsurers under quota share, first-loss and excess-of-loss treaties and on a facultative
basis.

Reinsurance
does not relieve the Company of its obligations to policyholders. In the event that any or all of the reinsuring companies are unable to meet their obligations, or contest
such obligations, the Company may be unable to recover amounts due. A number of FSA's reinsurers are required to pledge collateral to secure their reinsurance obligations to FSA in an amount equal to
their statutory unearned premium, loss and contingency reserves associated with the ceded business. FSA requires collateral from reinsurers primarily to (a) receive statutory credit for the
reinsurance, (b) provide liquidity to FSA in the event of claims on the reinsured exposures, and (c) enhance rating agency credit for the reinsurance.

Amounts
of ceded and assumed business were as follows:

Summary of Reinsurance

Year Ended December 31,2008

2007

2006(in thousands)Written premiums ceded

$
32,176

$
273,255

$
275,175Written premiums assumed


1,848


5,015


10,793Earned premiums ceded


139,625


146,900


141,232Earned premiums assumed


14,331


5,226


3,356Losses and loss adjustment expense payments ceded


214,833


5,052


3,486Losses and loss adjustment expense payments assumed


694


13


8




At December 31,2008

2007(in thousands)Principal outstanding ceded

$
121,089,257

$
137,749,095Principal outstanding assumed


6,152,541


4,433,549Deferred premium revenue assumed


17,604


30,087Losses and loss adjustment expense reserves assumed





579


63

---



The
Company cedes approximately 23% of its gross par insured to a diversified group of reinsurers, including other monolines. Based on ceded par outstanding at December 31, 2008,
56.1% of FSA's reinsurers were rated Double-A- or higher at March 13, 2009. Some are still under review by rating agencies. The Company's reinsurance contracts generally
allow the Company to recapture ceded business after certain triggering events, such as reinsurer downgrades. Included in the table below is $12,099 million in ceded par outstanding related to
insured CDS.

Reinsurance Recoverable and Ceded Par Outstanding by Reinsurer and Ratings

Ratings at March 13, 2009

At December 31, 2008Reinsurer

Moody's
Reinsurer
Rating

S&P
Reinsurer
Rating

Reinsurance
Recoverable

Ceded
Par
Outstanding

Ceded Par
Outstanding
as a % of
Total(dollars in millions)Assured Guaranty Re Ltd.


Aa3


AA

$
82.5

$
32,843


27
%Tokio Marine and Nichido Fire Insurance Co., Ltd.


Aa2
(1)

AA
(1)

133.6


31,481


26Radian Asset Assurance Inc.


Ba1


BBB+


37.2


24,449


20RAM Reinsurance Co. Ltd.


Baa3


A+


22.3


11,930


10Syncora Guarantee Inc.


Ca


CC





4,135


4Swiss Reinsurance Company


A1


A+


11.0


4,098


3R.V.I. Guaranty Co., Ltd.


Baa3


A-





4,109


3Mitsui Sumitomo Insurance Co. Ltd.


Aa3


AA
(1)

8.9


2,658


2CIFG Assurance North America Inc.


Ba3


BB


17.9


1,901


2Ambac Assurance Corporation


Baa1


A


0.2


1,075


1Other(2)


Various


Various


1.0


2,410


2Valuation allowance


N/A


N/A


(12.5
)




Total







$
302.1

$
121,089


100
%


---

In
2008, $28.5 million of net premiums earned resulted from commutations or cancellations of reinsurance contracts. The largest such transactions were with SGR and Bluepoint Re.
Limited ("Bluepoint").

In
July 2008, the Company agreed to re-assume all reinsurance ceded to SGR, which consisted of $8.4 billion in outstanding par, in exchange for the June 30,
2008 statutory basis ceded unearned premium, net of its applicable ceding commission, any case basis reserves established at that date and a $35.0 million commutation premium. The Company
agreed to cede a portion of this business, approximately $6.4 billion of outstanding par with no outstanding case basis reserves, to Syncora Guarantee Inc. ("SGI") (formerly XL Capital
Assurance), an affiliate of SGR, as of the re-assumption date. Ceded net unearned premiums and future ceded case reserves are secured by collateral then held in a trust. Since SGI was an
affiliate of SGR, the Company did not consider the portion of the business bought back from SGR and subsequently ceded to SGI as commuted and as a result did not record any commutation gain on that
portion of the business. The Company recorded a commutation gain of $10.0 million on the business it retained, which was recorded in "other income" in the statement of operations and
comprehensive income. In 2008, $14.8 million of earned premium related to this commutation.

64

---



In
September 2008, FSA agreed to re-assume a portion of the business it ceded to SGI in July for the statutory basis ceded unearned premium, net of its applicable ceding
commissions. This resulted in a commutation gain of $10 million, which was recorded in other income in the statement of operations and comprehensive income. In 2008, $1.5 million of
earned premium related to this commutation.

Due
to a liquidation order against Bluepoint, the Company is treating all reinsurance ceded to Bluepoint as cancelled as of the August 29, 2008 date of the liquidation order.
Subsequent to September 30, 2008, in accordance with guidance obtained from the New York Insurance Department, the Company drew down from collateral maintained in trust by Bluepoint an amount
equal to the net statutory basis unearned premium and case basis reserves and, as a result, the Company was able to take credit for such balances. In 2008, $9.4 million of earned premium
related to this commutation.

19.   OTHER ASSETS

The detailed balances that comprise other assets at December 31, 2008 and 2007 are as follows:

Other Assets

At December 31,2008

2007(in thousands)Other assets:VIE other invested assets

$
304,598

$
301,599Tax and loss bonds





153,844Accrued interest in VIE segment investment portfolio


10,443


14,333Accrued interest income on general investment portfolio


70,465


63,317Salvage and subrogation recoverable


10,431


39,669CPS at fair value


100,000


Other assets


146,528


109,830Total other assets

$
642,465

$
682,592


20.   COMMITMENTS AND CONTINGENCIES

Leases

Effective June 2004, the Company entered into a 21-year sublease agreement with Deutsche Bank AG for office space at
31 West 52nd Street, New York, New York to be used as the Company's headquarters. The Company moved to this space in June 2005. The lease contains scheduled rent increases
every five years after a 19-month rent-free period, as well as lease incentives for initial construction costs of up to $6.0 million, as defined in the sublease. The
lease contains provisions for rent increases related to increases in the building's operating expenses. The lease also contains a renewal option for an additional ten-year period, and an
option to rent additional office space at various points in the future, in each case at then-current market rents. In addition, the
Company and its Subsidiaries lease additional office space under non-cancelable operating leases, which expire at various dates through 2013.

65

---



Future Minimum Rental Payments

Year

At
December 31,
2008(in thousands)2009

$
9,0762010


8,7202011


8,4392012


8,4442013


8,144Thereafter


96,009Total

$
138,832


Rent
expense was $9.5 million in 2008, $8.9 million in 2007 and $9.4 million in 2006.

Insured Portfolio

In connection with its financial guaranty business, the Company had outstanding commitments to provide guarantees of
$4,639.4 million at December 31, 2008. These commitments are typically short term and principally relate to primary and secondary public finance debt issuances. Commitments are
contingent on the satisfaction of all conditions set forth in the contract. These commitments may expire unused or be cancelled at the counterparty's request. Therefore, the total commitment amount
does not necessarily reflect actual future guaranteed amounts.

Legal Proceedings

The entitlements of the Chief Executive Officer and the President of the Company under their employment agreements with the Parent are
in dispute.

In
November 2006, (i) the Parent received a subpoena from the Antitrust Division of the U.S. Department of Justice issued in connection with an ongoing criminal investigation of
bid rigging of awards of municipal GICs and other municipal derivatives and (ii) the Company received a subpoena from the SEC related to an ongoing industry-wide investigation
concerning the bidding of municipal GICs and other municipal derivatives. Pursuant to the subpoenas the Parent has furnished to the DOJ and SEC records and other information with respect to the
Parent's municipal GIC business. On February 4, 2008, the Parent received a "Wells Notice" from the staff of the Philadelphia Regional Office of the SEC relating to the foregoing matter. The
Wells Notice indicates that the SEC staff is considering recommending that the SEC authorize the staff to bring a civil injunctive action and/or institute administrative proceedings against the
Parent, alleging violations of Section 10(b) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") and Rule 10b-5 thereunder and Section 17(a) of the
Securities Act of 1933, as amended. The Parent has had ongoing discussions with the DOJ and the SEC. The ultimate loss that may arise from these investigations is uncertain.

66

---





During 2008 nine putative class action lawsuits were filed in federal court alleging federal antitrust violations in the municipal derivatives industry, seeking damages and alleging,
among other things, a conspiracy to fix the pricing of, and manipulate bids for, municipal derivatives, including GICs. These cases have been coordinated and consolidated for pretrial proceedings in
the U.S. District Court for the Southern District of New York asMDL 1950, In re Municipal Derivatives Antitrust Litigation,Case
No. 1:08-cv-2516 ("MDL 1950").

Five
of these cases name both the Parent and the Company: (a)Hinds County, Mississippi v. Wachovia Bank, N.A.(filed on or about
March 13, 2008); (b)Fairfax County, Virginia v. Wachovia Bank, N.A.(filed on or about March 12, 2008);
(c)Central Bucks School District, Pennsylvania v. Wachovia Bank N.A.(filed on or about June 4, 2008);
(d)Mayor & City Counsel of Baltimore, Maryland v. Wachovia Bank N.A.(filed on or about July 3, 2008); and
(e)Washington County, Tennessee v. Wachovia Bank N.A.(filed on or about July 14, 2008). Four of the cases name only the Parent and also
allege that the defendants violated state antitrust law and common law by engaging in illegal bid-rigging and market allocation, thereby depriving the cities of competition in the awarding
of GICs and ultimately resulting in the cities paying higher fees for these products: (a)City of Oakland, California v. AIG Financial Products
Corp.(filed on or about April 23, 2008); (b)County of Alameda, California v. AIG Financial Products Corp.(filed
on or about July 8, 2008); (c)City of Fresno, California v. AIG Financial Products Corp.(filed on or about July 17, 2008); and
(d)Fresno County Financing Authority v. AIG Financial Products Corp. (filed on or about December 24, 2008).

Interim
lead counsel for the MDL 1950 plaintiffs filed a Consolidated Class Action Complaint ("Consolidated Complaint") in August 2008 alleging violations of the federal antitrust laws.
Defendants filed motions to dismiss the Consolidated Complaint. The MDL 1950 court has determined that it will handle federal claims alleged in the Consolidated Complaint before addressing state
claims. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of
loss that may arise from these lawsuits.

The
Parent and the Company also are named in five non-class actions originally filed in the California Superior Courts alleging violations of California law related to the
municipal derivatives industry:



67

---





These
cases have been transferred to the S.D.N.Y. and consolidated withMDL 1950for pretrial proceedings. The complaints in these
lawsuits generally seek unspecified monetary damages, interest, attorneys' fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from
these lawsuits.

The
Parent and the Company have received various regulatory inquiries and requests for information regarding a variety of subjects. These include subpoenas duces tecum and
interrogatories from the State of Connecticut Attorney General and the Attorney General of the State of California related to antitrust concerns associated with the methodologies used by rating
agencies for determining the credit rating of municipal debt, including a proposal by Moody's to assign corporate equivalent ratings to municipal obligations, and communications with rating agencies.
The Parent and the Company are in the process of satisfying such requests. The Company may receive additional inquiries from these or other regulators and expects to provide additional information to
such regulators regarding their inquiries in the future.

In
December 2008 and January 2009, the Comapny and various other financial guarantors were named in three complaints filed in the Superior Court, San Francisco County: (a) City of
Los Angeles Department of Water and Power v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CG-08-483689; Sacramento Municipal
Utility District v. Ambac Financial Group et. al (filed on or about December 31, 2008), Case No. CGC-08-483691; and (c) City of Sacramento v. Ambac Financial
Group Inc. et. al (filed on or about January 6, 2009), Case No. CGC-09-483862. These complaints alleged participation in a conspiracy in violation of California's
antitrust laws to maintain a dual credit rating scale that misstated the credit default risk of municipal bond issuers and created market demand for municipal bond insurance and participation in risky
financial transactions in other lines of business that damaged each bond insurer's financial condition (thereby undermining the value of each of their guaranties), and a failure to adequately disclose
the impact of those transactions on their financial condition. These latter allegations form the predicate for five separate causes of action against each of the Insurers: breach of contract, breach
of the covenant of good faith and fair dealing, fraud, negligence, and negligent misrepresentation. The complaints in these lawsuits generally seek unspecified monetary damages, interest, attorneys'
fees, costs and other expenses. The Company cannot reasonably estimate the possible loss or range of loss that may arise from these lawsuits.

In
August 2008 a number of financial institutions and other parties, including FSA, were named as defendants in a civil action brought in the circuit court of Jefferson County, Alabama
relating to the County's problems meeting its debt obligations on its $3.2 billion sewer debt: Charles E. Wilson vs. JPMorgan Chase & Co et al (filed on or about August 8, 2008 in
the Circuit Court of Jefferson County, Alabama), Case No. 01-CV-2008-901907.00, a putative class action. The action was brought on behalf of rate payers, tax
payers and citizens residing in Jefferson County, and alleges conspiracy and fraud in connection with the issuance of the County's debt. The complaint in this lawsuit seeks unspecified monetary
damages, interest, attorneys' fees and other costs. The Company cannot reasonably estimate the possible loss or range of loss that may arise from this lawsuit. The Company was also named as a
defendant in a second civil action regarding Jefferson County, Alabama, but was dismissed from such action in January 2009.

There
are no other material legal proceedings pending to which the Company is subject.

21.   DIVIDENDS AND CAPITAL REQUIREMENTS

FSA's ability to pay dividends depends on FSA's financial condition, results of operations, cash requirements, rating agency capital adequacy and other related
factors, and is also subject to restrictions contained in the insurance laws and related regulations of New York and other states.

68

---



Under
the insurance laws of the State of New York, FSA may pay dividends out of earned surplus, provided that, together with all dividends declared or distributed by FSA during the preceding
12 months, the dividends do not exceed the lesser of (a) 10% of policyholders' surplus as of its last statement filed with the Superintendent of Insurance of the State of New York (the
"New York Superintendent") or (b) adjusted net investment income during this period. FSA paid dividends of $30.0 million in 2008, no dividends in 2007 and $140.0 million in 2006.
Based upon FSA's statutory statements for December 31, 2008, the maximum amount normally available for payment of dividends by FSA without regulatory approval over the following
12 months would be approximately $62.0 million, subject to certain limitations.

In
lieu of dividends, FSA may repurchase shares of its common stock from shareholders, subject to the New York Superintendent's approval. The New York Superintendent has approved the
repurchase by the Company of up to $500.0 million of its shares from the Parent through December 31, 2008. The Company repurchased $70.0 million of its common stock during the
first six months of 2008, and retired the shares. As the amounts paid for repurchases may not exceed cumulative statutory earnings from January 1, 2006 through the end of the quarter prior to
the repurchase, the Company was unable to make repurchases during the third and fourth quarter of 2008. In 2007 and 2006, the Company repurchased $180.0 million and $100.0 million of
shares of its common stock, respectively, from FSA Holdings and retired such shares.

At
December 31, 2007, the Company repaid its entire surplus note obligation of $108.9 million to its Parent. In addition, the Parent forgave all interest expense for 2007,
which totaled $5.0 million, including $3.6 million already paid by the Company and $1.4 million of accrued interest. The Parent recontributed to the Company the proceeds from the
repayment of the surplus note plus the amount of interest expense already paid. All surplus note transactions were approved by the New York Superintendent. The Company paid interest of
$5.4 million in 2006.

In
2008, Dexia Holdings contributed $1,012.1 million of capital to the Parent, which included $4.3 million contributed by a liquidation of program shares and phantom shares
held by directors. In the first
quarter of 2008, the Parent contributed capital to FSA of $500 million. In the third quarter of 2008, FSA issued a non-interest bearing surplus note with no term to its Parent in
exchange for $300 million, which due to the terms of the agreement is recorded as capital.

22.   CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES

The Company has a credit arrangement aggregating $150.0 million provided by commercial banks and intended for general application to insured transactions.
If the Company is downgraded below Aa3 by Moody's and AA- by S&P, the lenders may terminate the commitment, and the commitment commission becomes due and payable. If the Company is
downgraded below Baa3 by Moody's and BBB- by S&P, any outstanding loans become due and payable. At December 31, 2008, there were no borrowings under this arrangement, which expires
on April 21, 2011.

The
Company has a standby line of credit in the amount of $350.0 million with a group of international banks to provide loans to the Company after it has incurred, during the term
of the facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $350.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%,
which amounted to $1,612.0 million at December 31, 2008. The obligation to repay loans made under this agreement is a limited recourse obligation payable solely from, and collateralized
by, a pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This commitment has a term expiring on
April 30, 2015. The rating downgrade of FSA by Moody's to Aa3 in November 2008 resulted in an increase to the commitment fee. No amounts have been utilized under this commitment at
December 31, 2008.

69

---



In
June 2003, $200.0 million of CPS, money market committed preferred trust securities, were issued by trusts created for the primary purpose of issuing the CPS, investing the
proceeds in high-quality commercial paper and providing the Company with put options for issuing to the trusts non-cumulative redeemable perpetual preferred stock (the
"Preferred Stock") of the Company. There are four trusts, each with an initial aggregate face amount of $50 million. These trusts hold auctions every 28 days at which time investors
submit bid orders to purchase CPS. If the Company were to exercise a put option, the applicable trust would transfer the portion of the proceeds attributable to principal received upon maturity of its
assets, net of expenses, to the Company in exchange for Preferred Stock of the Company. The Company pays a floating put premium to the trusts, which represents the difference between the commercial
paper yield and the winning auction rate (plus all fees and expenses of the trust). If an auction does not attract sufficient clearing bids, however, the auction rate will be subject to a maximum rate
of 200 basis points above LIBOR for the next succeeding distribution period. Beginning in August 2007, the CPS required the maximum rate for each of the relevant trusts. The Company continues to have
the ability to exercise its put option and cause the related trusts to purchase the Company
Preferred Stock. The cost of the facility was $4.9 million, $1.8 million and $1.0 million for 2008, 2007 and 2006, respectively, and was recorded within other operating expenses.
The trusts are vehicles for providing the Company access to new capital at its sole discretion through the exercise of the put options. The Company does not consider itself to be the primary
beneficiary of the trusts because it does not retain the majority of the residual benefits or expected losses.

Certain
notes held by FSA Global contain provisions that could extend the stated maturities of those notes. To ensure FSA Global will have sufficient cash flow to repay its own debt
issuances that relate to such notes, it entered into several liquidity facilities with Dexia for $419.4 million. Certain notes held by FSA Global benefit from a liquidity facility with XL
Insurance Ltd. for $341.5 million.

23.   SEGMENT REPORTING

The Company operates in two business segments: financial guaranty and variable interest entities. The financial guaranty segment is primarily in the business of
providing financial guaranty insurance on public finance obligations. Historically it also provided financial guaranty insurance on asset-backed obligations. The VIE segment includes the VIEs'
operations. See Note 1 for a description of each segment's business. The following tables summarize the financial information by segment as of and for the years ended December 31, 2008,
2007 and 2006:

Financial Information Summary by Segment

For the Year Ended December 31, 2008Financial
Guaranty

Variable
Interest
Entities

Intersegment
Eliminations

Total(in thousands)Revenues:External

$
167,648

$
1,117,318

$


$
1,284,966Intersegment


2,663





(2,663
)

Expenses:External


(2,248,455
)

(132,395
)




(2,380,850
)Intersegment





(2,663
)

2,663


Income (loss) before income taxes


(2,078,144
)

982,260





(1,095,884
)Minority interest





(982,260
)




(982,260
)GAAP income to operating earnings adjustments


431,938








431,938Pre-tax segment operating earnings (losses)


(1,646,206
)







(1,646,206
)Segment assets

$
9,172,500

$
2,427,642

$
(7
)
$
11,600,135


70

---





For the Year Ended December 31, 2007Financial
Guaranty

Variable
Interest
Entities

Intersegment
Eliminations

Total(in thousands)Revenues:External

$
98,230

$
248,612

$


$
346,842Intersegment


3,002





(3,002
)

Expenses:External


(229,064
)

(273,334
)




(502,398
)Intersegment





(3,002
)

3,002


Income (loss) before income taxes


(127,832
)

(27,724
)




(155,556
)Minority interest





27,656





27,656GAAP income to operating earnings adjustments


628,955








628,955Pre-tax segment operating earnings (losses)


501,123


(68
)




501,055Segment assets

$
7,429,956

$
2,746,471

$
360

$
10,176,787




For the Year Ended December 31, 2006Financial
Guaranty

Variable
Interest
Entities

Intersegment
Eliminations

Total(in thousands)Revenues:External

$
714,085

$
250,535

$


$
964,620Intersegment


3,584





(3,584
)

Expenses:External


(201,705
)

(295,335
)




(497,040
)Intersegment





(3,584
)

3,584


Income (loss) before income taxes


515,964


(48,384
)




467,580Minority interest





48,660





48,660GAAP income to operating earnings adjustments


(1,823
)







(1,823
)Pre-tax segment operating earnings (losses)


514,141


276





514,417Segment assets

$
6,956,967

$
3,212,845

$


$
10,169,812


Reconciliations of Segments' Pre-Tax Operating Earnings (Losses) to Net Income (Loss)

For the Year Ended December 31, 2008Financial
Guaranty

Variable
Interest
Entities

Intersegment
Eliminations

Total(in thousands)Pre-tax operating earnings (losses)

$
(1,646,206
)
$


$


$
(1,646,206
)Operating earnings to GAAP income adjustments


(431,938
)







(431,938
)Tax (provision) benefit











822,301Net income (loss)










$
(1,255,843
)


71

---





For the Year Ended December 31, 2007Financial
Guaranty

Variable
Interest
Entities

Intersegment
Eliminations

Total(in thousands)Pre-tax operating earnings (losses)

$
501,123

$
(68
)
$


$
501,055Operating earnings to GAAP income adjustments


(628,955
)







(628,955
)Tax (provision) benefit











99,823Net income (loss)










$
(28,077
)




For the Year Ended December 31, 2006Financial
Guaranty

Variable
Interest
Entities

Intersegment
Eliminations

Total(in thousands)Pre-tax operating earnings (losses)

$
514,141

$
276

$


$
514,417Operating earnings to GAAP income adjustments


1,823








1,823Tax (provision) benefit











(126,739
)Net income (loss)










$
389,501


The
intersegment revenues and expenses relate to premiums paid by FSA Global on FSA-insured notes.

GAAP
income to operating earnings adjustments are primarily comprised of fair-value adjustments deemed to be non-economic. Such adjustments relate to
(1) non-economic fair-value adjustments for credit derivatives in the insured portfolio, (2) non-economic fair-value adjustments for
instruments with economically hedged risks and (3) fair-value adjustments attributable to the Company's own credit risk. Management believes that by making such adjustments the
measure more closely reflects the underlying economic performance of segment operations.

Net Premiums Earned by Geographic Distribution

Year Ended December 31,2008

2007

2006(in thousands)United States

$
342,697

$
307,507

$
293,475International


77,642


54,115


43,403Total premiums

$
420,339

$
361,622

$
336,878


24.   NON-CASH TRANSACTION

In a non-cash transaction, FSA Global exercised collateral calls under various swap agreements to reduce swap counterparty exposure. Cash collateral
from the swap counterparties totaling $194.3 million and $76.5 million in 2008 and 2007, respectively were deposited directly into the GIC Affiliates, which, in turn, issued a GIC of
equal values to FSA Global.

In
connection with repayment of its entire surplus note obligation of $108.9 million to its Parent, FSA Holdings forgave all interest expense for 2007 which included
$1.4 million of accrued interest expense.

The
Company received no tax benefit in 2008 and 2007 and received tax benefits of $1.1 million in 2006, by utilizing its Parent's losses. This amount was recorded as a capital
contribution.

72

---





25.   RELATED PARTY TRANSACTIONS

The Company enters into various related party transactions, primarily with Dexia, and, until mid-2008, SGR. The primary related party transactions
during 2008 between the Company and Dexia are as follows:



SGR
had an equity interest in FSA International until 2005, at which time the Company repurchased shares in FSA International held by SGR. The Company had a preferred stock investment in
SGR until third quarter of 2008. The primary related party transactions with SGR are as follows.



73

---





The
table below summarizes amounts included in the financial statement captions resulting from various types of transactions executed with related parties as well as outstanding
exposures with related parties:

Amounts Reported for Related Party Transactions  in the Consolidated Balance Sheets

At December 31,2008

2007(in thousands)Dexia(1)VIE segment investment portfolio

$
537

$
252VIE segment derivatives


79,825


273,452Other assets


31,353


31,328Deferred premium revenue


(2,541
)

(2,839
)VIE segment debt


(9,400
)

(199,739
)Net credit derivatives at fair value


(226,973
)

(66,072
)Other liabilities


(2,721
)

(2,349
)Exposure:Gross par outstanding


14,498,129


18,234,174SGR(2)Prepaid reinsurance


N/A


132,560Reinsurance recoverable for unpaid losses


N/A


10,172Investment in SGR





39,000GIC Affiliates(3)Guaranteed investment contracts from GIC Affiliates at fair value


801,547


639,950Other assets


282,197


282,645VIE segment debt


(25,000
)

(25,000
)Other liabilities


(161
)

(224
)


74

---



Amounts Reported for Related Party Transactions  in the Consolidated Statements of Operations and Comprehensive Income

For the Year Ended December 31,2008

2007

2006(in thousands)Dexia(1)Gross premiums earned

$
2,795

$
1,579

$
2,708Net change in fair value of credit derivatives


(138,727
)

(42,792
)

22,749Net interest income (expense) from VIE segment investment portfolio


(36,323
)

875


3,627Net realized and unrealized gains (losses) from VIE segment derivatives


224,846


(43,226
)

25,709Net unrealized gains (losses) on financial instruments at fair value


4,821





Interest income (expense) from VIE segment debt


(13,474
)

(10,327
)

(9,775
)Other operating expenses


(407
)

(531
)

(318
)SGR(2)Ceded premiums


(127,074
)

39,828


46,069Dividends received from SGR


1,609


3,465


4,518GIC Affiliates(3)Premiums earned


43,766


43,866


35,369Net interest income (expense) from VIE segment investment portfolio


28,135


52,080


55,450Other income


1,694


16,676


12,389Interest income (expense) from VIE segment debt


(830
)

(12,421
)

(20,263
)


---

26.   STATUTORY ACCOUNTING PRACTICES

GAAP differs in certain significant respects from statutory accounting practices, applicable to insurance companies, that are prescribed or permitted by insurance
regulatory authorities. The principal differences result from the following statutory accounting practices:



75

---





Consolidated
statutory net loss was $1,376.7 million for 2008, and net income of $312.9 million for 2007 and $339.6 million for 2006. Statutory surplus totaled
$710.7 million for 2008 and $1,608.8 million for 2007. Statutory contingency reserves totaled $1,281.6 million for 2008 and $1,094.3 million for 2007.

27.   EXPOSURE TO MONOLINES

The tables below summarize the exposure to each financial guaranty monoline insurer by exposure category and the underlying ratings of the Company's insured
risks.

Summary of Exposure to Monolines

At December 31, 2008Insured PortfoliosFSA
Insured Par
Outstanding(1)

Ceded Par
Outstanding

General
Investment
Portfolio(2)(in millions)

(in thousands)Assured Guaranty Re Ltd.

$
972

$
32,843

$
81,324Radian Asset Assurance Inc.


96


24,449


1,941RAM Reinsurance Co. Ltd.





11,930


Syncora Guarantee Inc.


1,364


4,135


26,385CIFG Assurance North America Inc.


195


1,901


23,955Ambac Assurance Corporation


4,976


1,075


626,288ACA Financial Guaranty Corporation


19


943


Financial Guaranty Insurance Company


5,385


279


29,119MBIA Insurance Corporation(3)


4,022





938,700Total

$
17,029

$
77,555

$
1,727,712


---

76

---



Exposures to Monolines and Ratings of Underlying Risks

At December 31, 2008Insured Portfolios(1)FSA
Insured Par
Outstanding(2)

Ceded Par
Outstanding

General
Investment
Portfolio(3)(dollars in millions)

(dollars in
thousands)Assured Guaranty Re Ltd.Exposure(4)

$
972

$
32,843

$
81,324Triple-A



%

5
%

2
%Double-A


10


40


Single-A


24


38


81Triple-B


8


15


17Below Investment Grade


58


2


Radian Asset Assurance Inc.Exposure(4)

$
96

$
24,449

$
1,941Triple-A


4
%

8
%


%Double-A





43


100Single-A


14


38


Triple-B


57


10


Below Investment Grade


25


1


RAM Reinsurance Co. Ltd.Exposure(4)

$


$
11,930

$
Triple-A



%

13
%


%Double-A





41


Single-A





32


Triple-B





12


Below Investment Grade





2


Syncora Guarantee Inc.Exposure(4)

$
1,364

$
4,135

$
26,385Triple-A


30
%


%


%Double-A





8


22Single-A


21


36


75Triple-B


25


56


Below Investment Grade


24





Not Rated








3CIFG Assurance North America Inc.Exposure(4)

$
195

$
1,901

$
23,955Triple-A



%

2
%


%Double-A


2


27


Single-A


9


37


100Triple-B


89


30


Below Investment Grade





4


Ambac Assurance CorporationExposure(4)

$
4,976

$
1,075

$
626,288Triple-A


6
%


%


%Double-A


42


9


42Single-A


32


39


53Triple-B


11


52


4Below Investment Grade


9


0


1


77

---



At December 31, 2008Insured Portfolios(1)FSA
Insured Par
Outstanding(2)

Ceded Par
Outstanding

General
Investment
Portfolio(3)(dollars in millions)

(dollars in
thousands)ACA Financial Guaranty CorporationExposure(4)

$
19

$
943

$
Triple-A



%


%


%Double-A


69


72


Single-A





26


Triple-B


11


2


Below Investment Grade


20





Financial Guaranty Insurance CompanyExposure(4)

$
5,385

$
279

$
29,119Triple-A



%


%


%Double-A


33





64Single-A


57


100


35Triple-B


8





1Below Investment Grade


2





MBIA Insurance CorporationExposure(4)

$
4,022

$


$
938,700Triple-A



%


%


%Double-A


54





40Single-A


14





55Triple-B


32





4Below Investment Grade








1


---

28.   OTHER INCOME

The following table shows the components of "other income". In 2008, other income included $20.1 million related to commutation gains. See Note 27
for more information.

Year Ended December 31,2008

2007

2006(in thousands)Foreign exchange gain (loss) on assets

$
(2,201
)
$
30,061

$
15,186Commutation gain


20,127





Other


4,246


4,356


8,620Subtotal

$
22,172

$
34,417

$
23,806


78

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