**Exhibit 99.1**

**FINANCIAL SECURITYASSURANCE INC. AND SUBSIDIARIES**

Consolidated Financial Statements and Report ofIndependent Registered Public Accounting FirmDecember 31, 2006

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**FINANCIAL SECURITYASSURANCE INC. AND SUBSIDIARIES**

**CONSOLIDATEDFINANCIAL STATEMENTSAND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

**YEARSENDED DECEMBER 31, 2006, 2005 AND 2004**
| REPORT OF INDEPENDENT  REGISTERED PUBLIC ACCOUNTING FIRM         |   | 1      |   |
|------------------------------------------------------------------|--------|--------|--------|
| CONSOLIDATED  FINANCIAL STATEMENTS:                              |   |   |   |
| Consolidated Balance Sheets                                      |   | 2      |   |
| Consolidated Statements of Operations and  Comprehensive Income  |   | 3      |   |
| Consolidated Statements of Changes in Shareholder’s  Equity |   | 4      |   |
| Consolidated Statements of Cash Flows                            |   | 5      |   |
| Notes to  Consolidated Financial Statements                      |   | 7      |   |

 

The New York State Insurance Department recognizesonly statutory accounting practices for determining and reporting the financialcondition and results of operations of an insurance company, for determiningits solvency under the New York Insurance Law, and for determining whether itsfinancial condition warrants the payment of a dividend to its stockholders. Noconsideration is given by the New York State Insurance Department to financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America in making such determinations.

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**Report ofIndependent Registered Public Accounting Firm**

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

In ouropinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of operations and comprehensive income, changes inshareholder’s equity, and cash flows present fairly, in all material respects,the financial position of Financial Security Assurance Inc. andSubsidiaries (the “Company”) at December 31, 2006 and December 31, 2005,and the results of their operations and their cash flows for each of the threeyears in the period ended December 31, 2006 in conformity with accountingprinciples generally accepted in the United States of America. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits. We conducted our audits of these statements in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

| /s/ PRICEWATERHOUSECOOPERS  LLP |   |
|---------------------------------|--------|
| New York, New York              |   |
| March 29, 2007             |   |

 

1

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**FINANCIAL SECURITYASSURANCE INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS(in thousands, except per share data)**

| ** **                                                                                                                                  | ** ** | **As of**              | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                  | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
| **ASSETS**                                                                                                                                  | ** ** | ** **                  | ** ** |   | ** ** | ** ** |   |
| General Investment  Portfolio:                                                                                                              |       |                        |       |   |   | ** ** |   |
| Bonds at fair value (amortized cost of $4,505,898 and  $4,208,011)                                                                          |       | $                           | 4,681,144  |   |   | $ | 4,370,469 | ** ** |   |
| Equity securities at fair value (cost of $54,291 and  $54,370)                                                                              |       | 54,325                      |       |   | 54,370 | ** ** |   |
| Short-term investments (cost of $85,980 and $104,153)                                                                                       |       | 86,503                      |       |   | 104,153 | ** ** |   |
| Financial Products  Segment Investment Portfolio:                                                                                           |       |                        |       |   |   | ** ** |   |
| Bonds at fair value (amortized cost of $1,127,698 and  $1,155,832)                                                                          |       | 1,128,255                   |       |   | 1,155,992 | ** ** |   |
| Guaranteed investment contracts from GIC Affiliates at  fair value (amortized cost approximates fair value) (See Notes 4  and 19) |       | 962,815                     |       |   | 1,021,791 | ** ** |   |
| Short-term investments                                                                                                                      |       | 19,478                      |       |   | 2,674 | ** ** |   |
| Assets acquired in  refinancing transactions:                                                                                               |       |                        |       |   |   | ** ** |   |
| Bonds at fair value (amortized cost of $40,133 and  $65,865)                                                                                |       | 41,051                      |       |   | 68,421 | ** ** |   |
| Securitized loans                                                                                                                           |       | 241,785                     |       |   | 296,965 | ** ** |   |
| Other                                                                                                                                       |       | 55,036                      |       |   | 102,487 | ** ** |   |
| Total investment portfolio                                                                                                                  |       | 7,270,392                   |       |   | 7,177,322 | ** ** |   |
| Cash                                                                                                                                        |       | 29,660                      |       |   | 39,506 | ** ** |   |
| Deferred  acquisition costs                                                                                                                 |       | 340,673                     |       |   | 335,129 | ** ** |   |
| Prepaid  reinsurance premiums                                                                                                               |       | 1,004,987                   |       |   | 865,192 | ** ** |   |
| Reinsurance  recoverable on unpaid losses                                                                                                   |       | 37,342                      |       |   | 36,339 | ** ** |   |
| Other assets (See  Notes 14 and 19)                                                                                               |       | 1,496,170                   |       |   | 1,162,562 | ** ** |   |
| TOTAL ASSETS                                                                                                                                |       | $                           | 10,179,224 |   |   | $ | 9,616,050 | ** ** |   |
| **LIABILITIES, MINORITY INTEREST  AND SHAREHOLDER’S EQUITY**                                                                           | ** ** | ** **                  | ** ** |   | ** ** | ** ** |   |
| Deferred premium  revenue                                                                                                                   |       | $                           | 2,658,594  |   |   | $ | 2,380,600 | ** ** |   |
| Losses and loss  adjustment expenses                                                                                                        |       | 228,122                     |       |   | 205,718 | ** ** |   |
| Variable interest  entities’ debt                                                                                                      |       | 3,067,745                   |       |   | 2,708,773 | ** ** |   |
| Deferred federal  income taxes                                                                                                              |       | 292,905                     |       |   | 238,342 | ** ** |   |
| Notes payable to  affiliate                                                                                                                 |       | 321,370                     |       |   | 463,575 | ** ** |   |
| Surplus notes                                                                                                                               |       | 108,850                     |       |   | 108,850 | ** ** |   |
| Accrued expenses,  other liabilities and minority interest                                                                                  |       | 439,030                     |       |   | 607,766 | ** ** |   |
| TOTAL LIABILITIES AND MINORITY INTEREST                                                                                                     |       | 7,116,616                   |       |   | 6,713,624 | ** ** |   |
| COMMITMENTS AND  CONTINGENCIES (See Note 15)                                                                                           |       |                        |       |   |   | ** ** |   |
| Preferred stock (5,000.1  shares authorized; 0 shared issued and outstanding; par value of  $1,000 per share)                          |       |                        |       |   |   | ** ** |   |
| Common stock (380  and 400 shares authorized; issued and outstanding; par value of $39,474 and  $37,500 per share)                          |       | 15,000                      |       |   | 15,000 | ** ** |   |
| Additional paid-in  capital—common                                                                                                     |       | 743,504                     |       |   | 841,828 | ** ** |   |
| Accumulated other  comprehensive income (net of deferred income taxes of $63,063 and $58,198)                                               |       | 117,087                     |       |   | 108,082 | ** ** |   |
| Accumulated  earnings                                                                                                                       |       | 2,187,017                   |       |   | 1,937,516 | ** ** |   |
| TOTAL SHAREHOLDER’S EQUITY                                                                                                             |       | 3,062,608                   |       |   | 2,902,426 | ** ** |   |
| TOTAL LIABILITIES,  MINORITY INTEREST AND SHAREHOLDER’S EQUITY                                                                         |       | $                           | 10,179,224 |   |   | $ | 9,616,050 | ** ** |   |

 

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

2

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**FINANCIAL SECURITYASSURANCE INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME(in thousands)**
|                                                                                                                                                  | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                       | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **REVENUES:**                                                                                                                                    | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net premiums written                                                                                                                             |       | $                                          | 562,276    |   | $ | 604,411 |   | $ | 602,903 |   |
| Net premiums earned                                                                                                                              |       | $                                          | 424,078    |   | $ | 431,059 |   | $ | 410,439 |   |
| Net investment income                                                                                                                            |       | 215,595                                    |       | 199,227 |   | 170,942 |   |
| Net realized gains (losses)                                                                                                                      |       | (5,212                                     | )          | 5,177 |   | (970 | ) |
| Net interest income from financial products segment                                                                                              |       | 137,844                                    |       | 105,561 |   | 74,286 |   |
| Net realized and unrealized gains (losses) on  derivative instruments                                                                            |       | 131,119                                    |       | (124,851 | ) | 304,843 |   |
| Income from assets acquired in refinancing  transactions                                                                                         |       | 24,661                                     |       | 35,183 |   | 31,634 |   |
| Net realized gains from assets acquired in  refinancing transactions                                                                             |       | 12,729                                     |       | 5,601 |   | — |   |
| Other income                                                                                                                                     |       | 11,417                                     |       | 14,370 |   | 6,365 |   |
| TOTAL REVENUES                                                                                                                                   |       | 952,231                                    |       | 671,327 |   | 997,539 |   |
| **EXPENSES:**                                                                                                                                    | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Losses and loss adjustment expenses                                                                                                              |       | 23,303                                     |       | 25,365 |   | 20,599 |   |
| Interest expense                                                                                                                                 |       | 25,497                                     |       | 33,608 |   | 31,499 |   |
| Net interest expense from financial products segment                                                                                             |       | 147,621                                    |       | 124,219 |   | 126,793 |   |
| Policy acquisition costs                                                                                                                         |       | 63,012                                     |       | 68,340 |   | 62,201 |   |
| Foreign exchange (gains) losses from financial  products segment                                                                                 |       | 133,708                                    |       | (162,398 | ) | 79,270 |   |
| Other operating expenses                                                                                                                         |       | 91,510                                     |       | 74,212 |   | 69,835 |   |
| TOTAL EXPENSES                                                                                                                                   |       | 484,651                                    |       | 163,346 |   | 390,197 |   |
| INCOME BEFORE  INCOME TAXES, MINORITY INTEREST AND EQUITY IN EARNINGS OF UNCONSOLIDATED  AFFILIATES                                         |       | 467,580                                    |       | 507,981 |   | 607,342 |   |
| Provision for income  taxes:                                                                                                                     |       |                                       |       |   |   |   |   |
| Current                                                                                                                                          |       | 77,024                                     |       | 128,611 |   | 62,489 |   |
| Deferred                                                                                                                                         |       | 49,715                                     |       | 14,412 |   | 60,929 |   |
| Total provision                                                                                                                                  |       | 126,739                                    |       | 143,023 |   | 123,418 |   |
| NET INCOME BEFORE  MINORITY INTEREST AND EQUITY IN EARNINGS OF UNCONSOLIDATED AFFILIATES                                                         |       | 340,841                                    |       | 364,958 |   | 483,924 |   |
| Less: Minority  interest                                                                                                                         |       | (48,660                                    | )          | 12,980 |   | 120,397 |   |
| Plus: Equity in  earnings of unconsolidated affiliates                                                                                           |       | —                                     |       | — |   | 3,761 |   |
| NET INCOME                                                                                                                                       |       | 389,501                                    |       | 351,978 |   | 367,288 |   |
| OTHER COMPREHENSIVE  INCOME (LOSS), NET OF TAX:                                                                                                  |       |                                       |       |   |   |   |   |
| Unrealized gains (losses) arising during period net  of deferred income tax provision (benefit) of $8,307, $(36,635) and $5,676                  |       | 15,398                                     |       | (49,954 | ) | 11,968 |   |
| Less: Reclassification adjustment for gains included  in net income net of deferred income tax provision (benefit) of $3,442,  $6,776 and $(542) |       | 6,393                                      |       | 12,584 |   | (428 | ) |
| Other comprehensive income (loss)                                                                                                                |       | 9,005                                      |       | (62,538 | ) | 12,396 |   |
| COMPREHENSIVE INCOME                                                                                                                             |       | $                                          | 398,506    |   | $ | 289,440 |   | $ | 379,684 |   |

 

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

3

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**FINANCIAL SECURITYASSURANCE INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDER’S EQUITY(in thousands)**
|                                                                                                          | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital-  Common** | ** ** | **Unrealized  Gain on  Investments** | ** ** | **Accumulated  Earnings** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|---------------------------|------------|-----------|------------|
| BALANCE,  December 31, 2003                                                                         |       | $                 | 15,000     |                                      | $          | 819,918                                   |       |                      | $          | 158,224   |       |   | $ | 1,335,250 |   | $ | 2,328,392 |   |
| Net income for  the year                                                                                 |       | —            |       | —                                    |       |                                      | —     |                      |       | 367,288   |       | 367,288 |   |
| Net change in  accumulated other comprehensive income (net of deferred income tax expense of  $6,218)    |       | —            |       | —                                    |       |                                      | 12,396     |                      |       | —    |       | 12,396 |   |
| Capital  contributions                                                                                   |       | —            |       | 20,419                                    |       |                                      | —     |                      |       | —    |       | 20,419 |   |
| Dividends paid                                                                                           |       | —            |       | —                                    |       |                                      | —     |                      |       | (30,000   | )          | (30,000 | ) |
| Capital issuance  costs                                                                                  |       | —            |       | (1,260                                    | )          |                                      | —     |                      |       | —    |       | (1,260 | ) |
| BALANCE,  December 31, 2004                                                                         |       | 15,000            |       | 839,077                                   |       |                                      | 170,620    |                      |       | 1,672,538 |       | 2,697,235 |   |
| Net income for  the year                                                                                 |       |              |       |                                      |       |                                      |       |                      |       | 351,978   |       | 351,978 |   |
| Net change in  accumulated other comprehensive income (net of deferred income tax benefit of  $(29,859)) |       | —            |       | —                                    |       |                                      | (62,538    | )                         |       | —    |       | (62,538 | ) |
| Capital  contributions                                                                                   |       | —            |       | 4,094                                     |       |                                      | —     |                      |       | —    |       | 4,094 |   |
| Dividends paid                                                                                           |       | —            |       | —                                    |       |                                      | —     |                      |       | (87,000   | )          | (87,000 | ) |
| Capital issuance  costs                                                                                  |       | —            |       | (1,343                                    | )          |                                      | —     |                      |       | —    |       | (1,343 | ) |
| BALANCE,  December 31, 2005                                                                         |       | 15,000            |       | 841,828                                   |       |                                      | 108,082    |                      |       | 1,937,516 |       | 2,902,426 |   |
| Net income for  the year                                                                                 |       | —            |       | —                                    |       |                                      | —     |                      |       | 389,501   |       | 389,501 |   |
| Net change in  accumulated other comprehensive income (net of deferred income tax expense of  $4,865)    |       | —            |       | —                                    |       |                                      | 9,005      |                      |       | —    |       | 9,005 |   |
| Capital  contributions                                                                                   |       | —            |       | 2,637                                     |       |                                      | —     |                      |       | —    |       | 2,637 |   |
| Repurchase of  stock                                                                                     |       | —            |       | (100,000                                  | )          |                                      | —     |                      |       | —    |       | (100,000 | ) |
| Dividends paid                                                                                           |       | —            |       | —                                    |       |                                      | —     |                      |       | (140,000  | )          | (140,000 | ) |
| Capital issuance  costs                                                                                  |       |              |       | (961                                      | )          |                                      | —     |                      |       | —    |       | (961 | ) |
| BALANCE,  December 31, 2006                                                                         |       | $                 | 15,000     |                                      | $          | 743,504                                   |       |                      | $          | 117,087   |       |   | $ | 2,187,017 |   | $ | 3,062,608 |   |

 

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

4

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**FINANCIAL SECURITYASSURANCE INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS(in thousands)**
|                                                                                                             | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from operating  activities:                                                                      |       |                                        |       |   |   |   |   |
| Premiums received, net                                                                                      |       | $                                           | 566,259    |   | $ | 621,877 |   | $ | 588,341 |   |
| Policy acquisition and other operating expenses paid,  net                                                  |       | (167,280                                    | )          | (165,833 | ) | (134,067 | ) |
| Salvage and subrogation                                                                                     |       | 1,745                                       |       | (362 | ) | 7,327 |   |
| Losses and loss adjustment expenses paid                                                                    |       | (405                                        | )          | (1,124 | ) | (42,936 | ) |
| Net investment income received                                                                              |       | 213,341                                     |       | 200,623 |   | 170,958 |   |
| Net investment income received in financial products  segment                                               |       | 37,400                                      |       | 40,599 |   | 30,189 |   |
| Interest paid in financial products segment                                                                 |       | (5,956                                      | )          | (6,739 | ) | (3,216 | ) |
| Net derivative payments in financial products segment                                                       |       | (23,960                                     | )          | (25,655 | ) | (18,986 | ) |
| Federal income taxes paid                                                                                   |       | (82,800                                     | )          | (114,066 | ) | (61,863 | ) |
| Interest paid                                                                                               |       | (25,877                                     | )          | (33,748 | ) | (32,765 | ) |
| Income received from refinanced assets                                                                      |       | 41,622                                      |       | 37,359 |   | 28,485 |   |
| Other, net                                                                                                  |       | 8,543                                       |       | (3,040 | ) | 3,038 |   |
| Net cash provided by (used for) operating activities                                                        |       | 562,632                                     |       | 549,891 |   | 534,505 |   |
| Cash flows from investing  activities:                                                                      |       |                                        |       |   |   |   |   |
| Proceeds from sales of bonds                                                                                |       | 1,581,689                                   |       | 1,716,954 |   | 1,155,749 |   |
| Proceeds from maturities of bonds                                                                           |       | 160,846                                     |       | 129,700 |   | 267,800 |   |
| Purchases of bonds                                                                                          |       | (2,074,463                                  | )          | (2,189,640 | ) | (1,882,243 | ) |
| Purchases of property and equipment                                                                         |       | (2,263                                      | )          | (32,354 | ) | (5,130 | ) |
| Net change in short-term investments                                                                        |       | 18,700                                      |       | 158 |   | (27,967 | ) |
| Purchases of financial products segment bonds                                                               |       | —                                      |       | (309,674 | ) | (144,639 | ) |
| Maturity of financial products segment bonds                                                                |       | 103,662                                     |       | 292,150 |   | 213,825 |   |
| Net change in financial products segment short-term  investments                                            |       | (16,802                                     | )          | (1,479 | ) | 9,908 |   |
| Assets acquired in refinancing transactions                                                                 |       | —                                      |       | — |   | (378,672 | ) |
| Paydowns of assets acquired in refinancing  transactions                                                    |       | 88,477                                      |       | 92,514 |   | 102,534 |   |
| Proceeds from sales of assets acquired in refinancing  transactions                     |       | 13,643                                      |       | 182,701 |   | 60,953 |   |
| Other investments                                                                                           |       | 24,109                                      |       | 2,127 |   | 14,305 |   |
| Net cash provided by (used for) investing activities                                                        |       | (102,402                                    | )          | (116,843 | ) | (613,577 | ) |
| Cash flows from financing  activities:                                                                      |       |                                        |       |   |   |   |   |
| Distribution to minority shareholder                                                                        |       | —                                      |       | (55,443 | ) | (6,980 | ) |
| Surplus notes repaid                                                                                        |       | —                                      |       | — |   | (44,000 | ) |
| Proceeds from issuance of financial products segment  debt (see Note 4)       |       | —                                      |       | 206,674 |   | 102,139 |   |
| Issuance of notes payable                                                                                   |       | —                                      |       | — |   | 378,672 |   |
| Repayment of notes payable                                                                                  |       | (142,207                                    | )          | (287,186 | ) | (130,157 | ) |
| Capital issuance costs                                                                                      |       | (961                                        | )          | (1,343 | ) | (1,260 | ) |
| Dividends paid                                                                                              |       | (140,000                                    | )          | (87,000 | ) | (30,000 | ) |
| Repurchase of shares                                                                                        |       | (100,000                                    | )          | — |   | — |   |
| Repayment of preferred stock                                                                                |       | —                                      |       | — |   | (6,300 | ) |
| Repayment of financial products segment debt                                                                |       | (87,500                                     | )          | (189,230 | ) | (190,681 | ) |
| Net cash provided by (used for) financing activities                                                        |       | (470,668                                    | )          | (413,528 | ) | 71,433 |   |
| Effect of changes in  foreign exchange rates on cash balances                                               |       | 592                                         |       | (1,304 | ) | 1,993 |   |
| Net increase  (decrease) in cash                                                                            |       | (9,846                                      | )          | 18,216 |   | (5,646 | ) |
| Cash at beginning  of year                                                                                  |       | 39,506                                      |       | 21,290 |   | 26,936 |   |
| Cash at end of year                                                                                         |       | $                                           | 29,660     |   | $ | 39,506 |   | $ | 21,290 |   |

 

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

5

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**FINANCIAL SECURITYASSURANCE INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS, CONTINUED(in thousands)**

| ** **                                                                 | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Reconciliation of net  income to net cash flows from operating activities: |       |                                        |       |   |   |   |   |
| Net income                                                                 |       | $                                           | 389,501    |   | $ | 351,978 |   | $ | 367,288 |   |
| Increase in accrued investment income                                      |       | (10,798                                     | )          | (2,471 | ) | (4,281 | ) |
| Increase in deferred premium revenue net of prepaid  reinsurance premiums  |       | 138,199                                     |       | 173,351 |   | 192,464 |   |
| Increase in deferred acquisition costs                                     |       | (5,544                                      | )          | (27,114 | ) | (34,369 | ) |
| (Decrease) increase in current federal income taxes  payable               |       | (5,776                                      | )          | 13,581 |   | (3,113 | ) |
| Increase (decrease) in unpaid losses and loss  adjustment expenses         |       | 22,002                                      |       | 24,857 |   | (29,651 | ) |
| Provision (benefit) for deferred income taxes                              |       | 49,715                                      |       | 14,412 |   | 60,929 |   |
| Net realized (gains) losses on investments                                 |       | (10,578                                     | )          | (11,685 | ) | 970 |   |
| Depreciation and accretion of discount                                     |       | 31,927                                      |       | 7,905 |   | 9,550 |   |
| Minority interest and equity in earnings of  unconsolidated subsidiaries   |       | (48,660                                     | )          | 12,980 |   | 116,636 |   |
| Change in other assets and liabilities                                     |       | 12,644                                      |       | (7,903 | ) | (141,918 | ) |
| Cash provided by  operating activities                                     |       | $                                           | 562,632    |   | $ | 549,891 |   | $ | 534,505 |   |

 

In 2006, 2005 and 2004, the Company received a taxbenefit of $1.1 million, $4.1 million and $20.4 million,respectively, by utilizing its Parent’s losses. These amounts were recorded asa capital contribution.

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

6

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**FINANCIAL SECURITY ASSURANCE INC. ANDSUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSFOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004**

**1.**   ORGANIZATIONAND OWNERSHIP

Financial SecurityAssurance Inc. (“FSA” or, with its consolidated entities, the “Company”),a wholly owned subsidiary of Financial Security Assurance Holdings Ltd.(the “Parent”), is a New York insurance company. The Company is engaged inproviding financial guaranty insurance on public finance and asset-backedobligations. The Company’s underwriting policy is to insure public finance andasset-backed obligations that it determines would be of investment-gradequality without the benefit of the Company’s insurance. The public financeobligations insured by the Company consist primarily of general obligationbonds that are supported by the issuers’ taxing powers and of special revenuebonds and other special obligations of states and local governments that aresupported by the issuers’ abilities to impose and collect fees and charges forpublic services or specific projects. Public finance obligations includeobligations backed by the cash flow from leases or other revenues from projectsserving a substantial public purpose, including government office buildings,toll roads, health care facilities and utilities. The asset-backed obligationsinsured by the Company are generally issued in structured transactions and arebacked by pools of assets, such as residential mortgage loans, consumerreceivables, securities or other assets having an ascertainable cash flow ormarket value. The Company also insures synthetic asset-backed obligations thatgenerally take the form of credit default swap (“CDS”) obligations orcredit-linked notes that reference pools of securities or loans, with a defineddeductible to cover credit risks associated with the referenced securities orloans. Financial guaranty insurance written by the Company guarantees scheduledpayments on an issuer’s obligation. In the case of a payment default on aninsured obligation, the Company is generally required to pay the principal,interest or other amounts due in accordance with the obligation’s originalpayment schedule or, at its option, to pay such amounts on an acceleratedbasis. In addition, the Company insures guaranteed investment contracts (“GICs”)issued by FSA Capital Management Services LLC (“FSACM”), FSA Capital MarketsServices (Caymans) Ltd. and, prior to April 2003, FSA Capital MarketsServices LLC (collectively, the “GIC Affiliates”), affiliates of the Company.

The Company expects tocontinue to emphasize a diversified insured portfolio characterized byinsurance of both public finance and asset-backed obligations, with a broadgeographic distribution and a variety of revenue sources and transactionstructures. The Company’s insured portfolio consists primarily of publicfinance and asset-backed obligations originated in the United States ofAmerica, but the Company has also written and continues to pursue business inEurope and the Asia Pacific region.

The Company consolidatesthe results of certain variable interest entities (“VIEs”), including FSAGlobal Funding Limited (“FSA Global”) and Premier International Funding Co. (“Premier).The Company consolidates FSA Global in accordance with Financial AccountingStandards Board Interpretation No. 46, “Consolidation of Variable InterestEntities, an interpretation of ARB No. 51” (revised December 2003) (“FIN46”). The Company also consolidates Premier as a result of obtaining controlrights.

FSA Global is a specialpurpose funding vehicle partially owned by an affiliate of the Company. FSAGlobal issues FSA-insured medium term notes and invests the proceeds from thesale of its notes in FSA-insured obligations with a view towards realizing theyield difference between the notes issued and the obligations purchased withthe note proceeds. Premier is principally engaged in debt defeasance for publicfinance lease transactions. FSA Global and Premier comprise the FP segment (“FPSegment”).

The Company refinancedcertain defaulted transactions by employing refinancing vehicles to raise fundsfor the refinancings. These refinancing vehicles are also consolidated. TheCompany’s management believes that the assets held by FSA Global, Premier andthe refinancing vehicles, including those that are eliminated in consolidation,are beyond the reach of the Company and its creditors, even in bankruptcy or 

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otherreceivership. Substantially all of FSA Global’s assets are pledged ascollateral to secure the repayment, on a pro rata basis, of FSA Global’s debt.

On July 5, 2000, theParent completed a merger in which the Parent became a direct subsidiary ofDexia Holdings, Inc. (“Dexia Holdings”) which, in turn, is owned 90% byDexia Crédit Local S.A. (“Dexia Crédit Local”) and 10% by Dexia S.A. (“Dexia”),a Belgian corporation whose shares are traded on the Euronext Brussels andEuronext Paris markets as well as on the Luxembourg Stock Exchange.

**2.**   SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES

The accompanyingConsolidated Financial Statements have been prepared in accordance withaccounting principles generally accepted in the United States of America (“GAAP”),which differ in certain material respects from the accounting practicesprescribed or permitted by insurance regulatory authorities (see Note 21).The preparation of financial statements in conformity with GAAP requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities in the Company’s consolidated balance sheets at December 31,2006 and 2005, the reported amounts of revenues and expenses in the statementsof operations and comprehensive income during the years ended December 31,2006, 2005 and 2004 and disclosure of contingent assets and liabilities. Suchestimates and assumptions include, but are not limited to, losses and lossadjustment expenses, fair value of financial instruments and the deferral andamortization of policy acquisition costs. Actual results may differ from thoseestimates. Significant accounting policies under GAAP are as follows:

***Basis ofPresentation***

The Consolidated FinancialStatements include the accounts of the Company and its direct and indirectsubsidiaries, principally including FSA Insurance Company, Financial SecurityAssurance International Ltd. (“FSA International”), Financial SecurityAssurance (U.K.) Limited, and FSA Mexico Holdings Inc. (collectively, the “Subsidiaries”).The Consolidated Financial Statements also include the accounts of certain VIEsand refinancing vehicles as described in Note 1. All intercompany accountsand transactions have been eliminated. Certain other prior-year balances havealso been reclassified to conform to the current year presentation.

***Investments***

Investments in debt andequity securities designated as available for sale are carried at fair value.The unrealized gain or loss on investments is reflected as a separate componentof shareholders’ equity, net of applicable deferred income taxes.

Bond discounts andpremiums are amortized on the effective yield method over the remaining termsof the securities acquired. For mortgage-backed securities and any otherholdings for which prepayment risk may be significant, assumptions regardingprepayments are evaluated periodically and revised as necessary. Anyadjustments required due to the resulting change in effective yields arerecognized in current income. Short-term investments, which are thoseinvestments with a maturity of less than one year at time of purchase, arecarried at fair value. Changes in fair value of short term investments are dueto changes in foreign exchange rates. Cash equivalents are amounts deposited inmoney market funds and investments with a maturity at time of purchase of threemonths or less and are included in short-term investments. Mortgage loans are carriedat the lower of cost or market on an aggregate basis. Realized gains or losseson sale of investments are determined on the basis of specific identification.Investment income is recorded as earned. Other-than-temporary impairments arereflected in earnings as a realized loss.

Investments inunconsolidated affiliates are based on the equity method of accounting (seeNote 3). The Company records its share of unrealized gains or losses ofunconsolidated affiliates, net of applicable deferred taxes, in othercomprehensive income.

Included in assetsacquired in refinancing transactions are asset-backed senior notes thatrepresent the Company’s purchase of less than 50% of a refinanced transaction.These assets are designated as 

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availablefor sale. Certain other asset-backed securities are carried at cost, with anyreduction in carrying value recognized as an adjustment to yield in accordancewith American Institute of Certified Public Accountants  Statement of Position 03-3, “Accountingfor Certain Loans or Debt Securities Acquired in a Transfer.”

***Derivatives***

The Company enters intoderivative contracts to manage interest rate and foreign currency risksassociated with the VIE debt and VIE bond portfolio. The derivatives arerecorded at fair value and generally include interest rate and currency swapagreements, which are primarily utilized to convert the Company’s fixed rateobligations and investments on its VIE debt and VIE bond portfolio into U.S.dollar floating rate assets and liabilities. The gains and losses relating tochanges in the fair-value of derivatives are included in net realized andunrealized gains (losses) on derivative instruments in the consolidatedstatements of operations and comprehensive income. FSA Global, under the termsof its derivative agreements, is not required to pledge collateral. Itscounterparties, however, may be required to pledge collateral or transferassets to FSA Global. FSA Global is not permitted to rehypothecate any suchcollateral or assets.

The Company has also insureda number of CDS agreements that it intends, in each case, to hold for the fullterm of the agreement. It considers these agreements to be a normal extensionof its financial guaranty insurance business, although they are consideredderivatives for accounting purposes. These agreements are recorded at fairvalue. The Company believes that the most meaningful presentation of thefinancial statement impact of these derivatives is to reflect premiums asinstallments are accrued, to record losses and loss adjustment expenses asincurred and to record changes in fair value as incurred. Changes in fair valueare recorded in net realized and unrealized gains (losses) on derivativeinstruments and in either other assets or other liabilities, as appropriate. TheCompany uses quoted market prices, when available, to determine fair value. Ifquoted prices are not available, as is generally the case, management usesinternally developed estimates of fair value. Management applies judgment whendeveloping these estimates and considers factors such as current prices chargedfor similar agreements, performance of underlying assets, changes in internalshadow ratings, the level at which the deductible has been set and the Company’sability to obtain reinsurance for its insured obligations. Due to a lack of aquoted market for the CDS obligations written by the Company, estimatesgenerated from the Company’s valuation process may differ materially fromvalues that may be realized in market transactions.

***Premium Revenue Recognition***

Gross and ceded premiumsreceived in upfront payouts are earned in proportion to the expiration of therelated risk. For upfront premium transactions, premium earnings are greater inthe earlier periods when there is a higher amount of exposure outstanding. Theamount of risk outstanding is equal to the sum of the par amount of debtinsured over the expected period of coverage. Deferred premium revenue andprepaid reinsurance premiums represent the portion of gross and ceded premium,respectively, that is applicable to coverage of risk to be provided in thefuture on policies in force. When an insured issue is retired or defeased priorto the end of the expected period of coverage, the remaining deferred premiumrevenue and prepaid reinsurance premium, less any amount credited to arefunding issue insured by the Company, are recognized.

For premiums received onan installment basis, the Company earns the premium over the installmentperiod, typically less than one year, throughout the period of coverage.Typically, installment premiums are applicable to insured transactions thatinvolve CDS or special purpose vehicles (“SPVs”) structured to finance pools ofassets such as auto loans or mortgage loans. Premiums on such transactions aretypically paid in installments because premium is paid from the interest spreadavailable to the SPV (i.e. the difference in interest rate between the yield onits assets and the yield on its liabilities). The nature of the assets financedcan have uncertain debt service schedules due to prepayments. When the Company,through its ongoing credit review process, identifies transactions wherepremiums are paid on an 

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installmentbasis and certain default triggers have been breached, the Company ceases toearn premiums on such transactions.

***Losses and LossAdjustment Expenses***

*Background*

Financial guarantyinsurance generally provides an unconditional and irrevocable guaranty thatprotects the holder of a financial obligation against non-payment of principaland interest when due. Upon a payment default on an insured obligation, theCompany is generally required to pay the principal, interest or other amountsdue in accordance with the obligation’s original payment schedule or, at itsoption, to pay such amounts on an accelerated basis.

The financial guarantyindustry has emerged over the past thirty-four years. Management believes thatexisting insurance accounting under Statement of Financial Accounting StandardsNo. 60, “Accounting and Reporting by Insurance Enterprises” (“SFAS 60”),does not specifically address financial guaranty insurance. Accordingly, theaccounting for loss and loss adjustment expenses within the financial guarantyinsurance industry has developed based on analogy to the most directlycomparable elements of existing literature, including sections of SFAS 60,Statement of Financial Accounting Standards No. 5, “Accounting forContingencies” (“SFAS 5”) and Emerging Issues Task Force Issue 85-20, “Recognitionof fees for guaranteeing a loan” (“EITF 85-20”).

*Company-Specific Policy*

The Company establishesloss liabilities based on its estimate of specific and non-specific losses. TheCompany also establishes liabilities for loss adjustment expenses (“LAE”),consisting of the estimated cost of settling claims, including legal and otherfees and expenses associated with administering the claims process.

The Company calculates aloss and LAE liability based upon identified risks inherent in its insuredportfolio. If an individual policy risk has a reasonably estimable and probableloss as of the balance sheet date, a case reserve is established. For theremaining policy risks in the portfolio, a non-specific reserve is establishedto account for the inherent credit losses that can be statistically estimated.

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

The Company establishes acase reserve for the present value of the estimated loss, net of subrogationrecoveries, when, in management’s opinion, the likelihood of a future loss on aparticular insured obligation is probable and reasonably estimable at thebalance sheet date. When an insured obligation has met the criteria forestablishing a case reserve and that transaction pays a premium ininstallments, those premiums, if expected to be received prospectively, areconsidered a form of recovery and are no longer earned as premium revenue. Acase reserve is determined using cash flow or similar models that represent theCompany’s estimate of the net present value of the anticipated shortfallbetween (1) scheduled payments on the insured obligation plus anticipatedloss adjustment expenses and (2) anticipated cash flow from and proceedsto be received on sales of any collateral supporting the obligation and other anticipatedrecoveries. The estimated loss, net of recovery, on a transaction is discountedusing the risk-free rate 

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appropriatefor the term of the insured obligation at the time the reserve is establishedand is not subsequently adjusted.

The Company records anon-specific reserve to reflect the credit risks inherent in its portfolio. Thenon-specific and case reserves, together represent the Company’s estimate oftotal reserves. Generally, when an insured credit deteriorates to a point whereclaims are expected, a case reserve is established. The establishment of anon-specific reserve for credits that have not yet defaulted is a commonpractice in the financial guaranty industry, although there are differences inthe specific methodologies applied by other financial guarantors inestablishing and measuring these reserves.

The Company establishes anon-specific reserve on its portfolio of credits because management believesthat a portfolio of insured obligations will deteriorate over its life and thatthe existence of inherent loss can be proven statistically by data such asrating agency publications. The establishment of the reserve is a systematicprocess that considers this quantitative, statistical information obtainedprimarily from Moody’s Investors Service, Inc. (“Moody’s”) and Standard &Poor’s Ratings Services (“S&P”), together with qualitative factors such asoverall credit quality trends resulting from economic and political conditions,recent loss experience in particular segments of the portfolio and changes inunderwriting policies and procedures. The factors used to establish reservesare evaluated periodically by comparing the statistically computed loss amountwith the incurred losses as represented by case reserve activity to develop an experiencefactor, that is updated and applied to current-year originations. The processresults in management’s best estimate of inherent losses associated withproviding credit protection at each balance sheet date.

The non-specific reserveestablished considers all levels of protection (e.g., reinsurance andovercollateralization). Net par outstanding for policies originated in thecurrent period is multiplied by loss frequency and severity factors, with theresulting amounts discounted at the risk-free rates using the treasury yieldcurve (the “statistical calculation”). The discount rate does not change and isused to accrete the loss for the life of each policy. The loss factors used forthe calculation are the product of default frequency rates obtained from Moody’sand severity factors obtained from S&P. Moody’s is chosen for defaultfrequency rates due to its credibility, large population, statistical formatand reliability of future update. The Moody’s default information is applied toall credit sectors or asset classes as described below. In its publication ofdefault rates from 1970-2005, Moody’s tracks bonds over a 20 year horizonby credit rating at time of issuance. For the purpose of establishingappropriate severity factors, the Company’s methodology segregates theportfolio into asset classes, including health care transactions, all othermunicipal transactions, pooled corporate transactions, commercial real estate,and all other asset-backed transactions. The severity factors are derived from capitalcharge assessments provided by S&P. S&P capital charges project losslevels by asset class and are incorporated into their capital adequacy stressscenario analysis.

The product of thecurrent-year statistical calculation multiplied by the current-year experiencefactor represents the present value of loss amounts calculated for current-yearoriginations. The experience factor is based on the Company’s inception-to-datehistorical losses (starting from 1993, when the Company established thenon-specific reserve methodology). The experience factor is calculated bydividing cumulative inception-to-date actual losses incurred by the Company bythe cumulative inception-to-date losses determined by the statisticalcalculation. The experience factor that applies to the whole portfolio isreviewed, and, where appropriate, updated periodically, but no less thanannually.

The present value of lossamounts calculated for the current-year originations is established atinception of the policy and there is no subsequent change unless significantadverse or favorable loss experience is observed. In the event that theexperience factor is either increased or decreased based on adverse orfavorable loss experience, an analysis is performed of the non-specific reservebalance with particular emphasis on the asset class, if any, driving theexperience factor adjustment. The objective of such analysis is to quantify theappropriate adjustment to the overall non-specific reserve balance for the 

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changein experience. The adjustment that increases or decreases the non-specificreserve is charged or credited to loss expense.

The present value of lossamounts calculated for the current-year originations plus an amountrepresenting the accretion of discount pertaining to prior-year originationsare charged to loss expense and increase the non-specific loss reserve afteradjustments that may be made to reflect observed favorable or adverseexperience. The entire non-specific reserve is available to absorb probablelosses inherent in the portfolio. As there are no specific losses provided inthe non-specific reserve, there is no identifiable reinsurance recoverable. Atthe time that a case reserve is identified, the gross loss liability isrecognized along with the reinsurance recoverable, if any. The amount ofreinsurance recoverable depends on the policy ceded and the reinsuranceagreements covering such policy. Management cannot predict the specificpolicies that will emerge as case-basis losses from the portfolio and is not entitledto recovery from the reinsurer in advance of producing a case reserve.

Since the non-specificreserve contains the inherent losses of the portfolio, when a case reserveadjustment is deemed appropriate, whether the result of adverse or positivecredit developments, accretion or the addition of a new case reserve, a fulltransfer is made between the non-specific reserve and the case reserve balanceswith no effect to income. The adequacy of the non-specific reserve balance isreviewed periodically and at least annually. Such analyses are performed toquantify appropriate adjustments that may be either charges or benefits on thestatements of operations and comprehensive income, as occurred in 2004.

Thetable below presents the significant assumptions inherent in the calculationsof the case and non-specific reserves.

| ** **                          | ** ** | **As of December 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|
| ** **                          | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| Case reserve  discount rate         |       | 3.13%-5.90%                           |       | 3.13%-5.90% |   |
| Non-specific  reserve discount rate |       | 1.20%-7.95%                           |       | 1.20%-7.95% |   |
| Current experience  factor          |       | 1.6                                   |       | 1.8 |   |

 

*Reserving Methodology Industry Practice*

Management is aware thatthere are differences regarding the method of defining and measuring both casereserves and non-specific reserves among participants in the financial guarantyindustry. Other financial guarantors may establish case reserves only after adefault and use different techniques to estimate probable loss. Other financialguarantors may establish the equivalent of non-specific reserves, but refer tothese reserves by various terms such as, but not limited to, “unallocatedlosses,” “active credit reserves” and “portfolio reserves,” or may usedifferent statistical techniques from those the Company uses to determine lossat a given point in time.

Management believes thatexisting accounting literature does not address the unique attributes offinancial guaranty insurance. As an insurance enterprise, the Company initiallyrefers to the accounting and financial reporting guidance in SFAS 60. Inestablishing loss liabilities, the Company relies principally on SFAS 60, whichprescribes differing treatment depending on whether a contract is ashort-duration contract or a long-duration contract. Financial guarantyinsurance does not fall clearly within the definition of either short-durationor long-duration contracts. Therefore, the Company does not believe that SFAS60 alone provides sufficient guidance for financial guaranty claim liabilityrecognition.

As a result, the Companyalso analogizes to SFAS 5, which requires the establishment of liabilities whena loss is both probable and reasonably estimable. The Company also relies byanalogy on EITF 85-20, which provides general guidance on the recognitionof losses related to guaranteeing a loan. In the absence of a comprehensiveaccounting model provided by SFAS 60, industry participants, including theCompany, have looked to such other guidance referred to above to develop theiraccounting policies for the establishment and measurement of loss liabilities.The Company believes that its financial guaranty loss reserve policy isappropriate under the applicable accounting literature, and that it bestreflects the fact 

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that aportfolio of credit-based insurance, comprising irrevocable contracts thatcannot be unilaterally changed by the insurer and that match the maturity termsof the underlying insured obligation, contains probable and reasonablyestimable losses.

The Financial AccountingStandards Board (“FASB”) staff is considering additional guidance regardingfinancial guaranty insurance. When and if the FASB or SEC reaches a conclusionon this issue, the Company and the rest of the financial guaranty industry maybe required to change some aspects of their loss reserving policies, and thepotential changes could extend to premium recognition. The Company cannotpredict how the FASB will resolve this issue and the resulting impact on itsfinancial statements.

Until additional guidanceis issued, the Company intends to continue applying its existing policyregarding the establishment of both case and non-specific loss reserves.

***DeferredAcquisition Costs***

Deferred acquisition costsare comprised of expenses primarily related to the production of business,including commissions paid on reinsurance assumed, compensation and relatedcosts of underwriting and marketing personnel, certain rating agency fees,premium taxes and certain other underwriting expenses, reduced by cedingcommission received on premiums ceded to reinsurers. Deferred acquisition costsare amortized over the period in which the related premiums are earned. When aninsured issue is retired or defeased prior to the end of the expected period ofcoverage, the remaining deferred acquisition cost is recognized. A premiumdeficiency would be recognized if the present value of anticipated losses andloss adjustment expenses exceeded the sum of deferred premium revenue andestimated installment premiums.

***VIE Debt***

VIE debt is recorded atamortized cost. The Company may enter into transactions in order to reduce theCompany’s exposure to fluctuations in interest rates and foreign currencyrates. For VIE debt in a qualifying accounting hedge, the change in the fairvalue of the debt adjusts the carrying amount of the debt and is recognized inincome currently. VIE debt may include hybrid debt instruments that containembedded derivatives. Under certain conditions, GAAP requires that embeddedderivatives are required to be separated from the debt instrument and accountedfor at fair value, with all changes in fair value reflected through earnings.

***Foreign CurrencyTranslation***

Monetary assets andliabilities denominated in foreign currencies are translated at the spot rateat the balance sheet date. Non-monetary assets and liabilities are translatedat historical rates. Revenues and expenses denominated in foreign currenciesare translated at average rates prevailing during the year. Unrealized gainsand losses on available-for-sale securities, net of deferred taxes, resultingfrom translating investments denominated in foreign currencies are recorded inshareholders’ equity. Gains and losses from transactions in foreign currenciesare recorded in other income.

***Federal IncomeTaxes***

The provision for incometaxes consists of an amount for taxes currently payable and an amount fordeferred taxes arising from temporary differences between the tax bases ofassets and liabilities and the reported amounts in the financial statementsthat will result in deductible or taxable amounts in future years when thereported amounts of assets and liabilities are recovered or settled.

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

***Special PurposeEntities***

Asset-backed and, toa lesser extent, public finance transactions insured by FSA may employ specialpurpose entities for a variety of purposes. A typical asset-backedtransaction, for example, employs a 

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specialpurpose entity as the purchaser of the securitized assets and as the issuer ofthe insured obligations. FSA’s participation is typically requested by thesponsor of the special purpose entity or the underwriter, either via a bidprocess or on a sole-source basis. Special purpose entities are typically ownedby transaction sponsors or charitable trusts, although FSA may have anownership interest in some cases. FSA maintains certain contractual rights andexercises varying degrees of influence over special purpose entity issuers ofFSA-insured obligations. FSA also bears some of the “risks and rewards”associated with the performance of those special purpose entities’ assets.Specifically, as issuer of the financial guaranty insurance policy insuring agiven special purpose entity’s obligations, FSA bears the risk of assetperformance (typically, but not always, after a significant depletion ofovercollateralization, excess spread, a deductible or other credit protection).FSA’s underwriting policy is to insure only obligations that are otherwiseinvestment grade. In addition, the special purpose entity typically pays aperiodic premium to FSA in consideration of the issuance by FSA of itsinsurance policy, with the special purpose entity’s assets typically serving asthe source of such premium, thereby providing some of the “rewards” of thespecial purpose entity’s assets to FSA. Special purpose entities are alsoemployed by FSA in connection with “repackaging” of outstanding securities intonew securities insured by FSA and with refinancing underperforming, non-investment-gradetransactions insured by FSA.

The degree of influenceexercised by FSA over these special purpose entities varies from transaction totransaction, as does the degree to which “risks and rewards” associated withasset performance are assumed by FSA.

FIN 46-R addressesconsolidation of VIEs that have one or both of the following characteristics:(a) the equity investment at risk is not sufficient to permit the entityto finance its activities without additional subordinated financial supportfrom other parties, which is provided through other interests that will absorbsome or all of the expected losses of the entity; and (b) the equityinvestors lack the direct or indirect ability to make decisions about theentity’s activities through voting rights or similar rights and do not have theobligation to absorb the expected losses of the entity if they occur or theright to receive the expected residual returns of the entity if they occur. Inanalyzing special purpose entities described above, the Company considersreinsurance to be an implicit variable interest. Where the Company determinesit is required to consolidate the special purpose entity, the outstandingexposure is excluded from Note 10.

***Recently IssuedAccounting Standards***

In June 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes” (“FIN 48”), an interpretation of Statement of FinancialAccounting Standard No. 109, “Accounting for Income Taxes” (“SFAS 109”).FIN 48 clarifies the accounting for uncertainty in income taxes recognizedin an entity’s financial statements in accordance with SFAS 109 andprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. FIN 48 also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure and transition. FIN 48 is applicable for fiscal years beginningafter December 15, 2006, with early application encouraged if financialstatements, including interim financial statements, have not been issued in theperiod of adoption. The Company does not expect FIN 48 to have a materialimpact on its financial statements.

In February 2006, theFASB issued Statement of Financial Accounting Standard No. 155, “Accountingfor Certain Hybrid Financial Instruments” (“SFAS 155”), which amends Statementof Financial Accounting Standard No. 133, “Accounting for DerivativeInstruments and Hedging Activities” (“SFAS 133”) and Statement of FinancialAccounting Standard No. 140, “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishment of Liabilities.”  SFAS 155 permits hybrid financial instrumentsthat contain an embedded derivative that would otherwise require bifurcation tobe irrevocably accounted for at fair value, with changes in fair valuerecognized in the statements of operations and comprehensive income. The fair-valueelection may be applied on an instrument-by-instrument basis. SFAS 155 alsoeliminates a restriction that prevents qualifying special purpose entities 

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fromholding derivative financial instruments that pertain to beneficial intereststhat are not derivative financial instruments. SFAS 155 is effective for allfinancial instruments acquired or issued after December 31, 2006. TheCompany does not expect SFAS 155 to have a material impact on its financialstatements.

On September 15,2006, the FASB issued Statement of Financial Accounting Standard No. 157, “FairValue Measurements” (“SFAS 157”), which addresses how companies should measurefair value when required to use fair value measures for recognition ordisclosure purposes under GAAP. SFAS 157 adopted an “exit price” approach todetermining fair value and established a three-level fair value hierarchy toprioritize the inputs used in valuation techniques. Level 1 is the highestpriority and is defined as observable inputs that reflect quoted prices(unadjusted) for identical assets or liabilities in active markets. Level 2 isdefined as inputs other than quoted prices included in Level 1 that areobservable for the asset or liability through corroboration with observablemarket data. Level 3 is the lowest priority and is defined as a valuation basedon unobservable inputs such as a company’s own data. Prioritization of inputs,as well as other considerations, determine the level of disclosure required. SFAS157 is applicable to financial statements issued for fiscal years beginningafter November 15, 2007 and for interim periods within those fiscal years.The Company is in the process of evaluating the impact of SFAS 157 on itsfinancial statements.

In February 2007, TheFASB issued Statement of Financial Accounting Standard No. 159, “The FairValue Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS159 permits reporting entities to choose to measure at fair value manyfinancial instruments and certain other items that are not currently requiredto be measured at fair value. The fair value option may be applied instrumentby instrument, is irrevocable and is applied only to entire instruments and notto portions of instruments. SFAS 159 is effective for fiscal years beginningafter November 15, 2007. Early adoption is permitted, under certaincircumstances, provided the provisions of SFAS 157 are also applied. TheCompany is currently evaluating the implication of SFAS 159 for its financialstatements.

***Revisions***

The Statement of CashFlows for the period ended December 31, 2006 appropriately segregates theeffect of changes in foreign exchange rates on cash balances into a separateline item. The effect of foreign exchange rates on cash balances hashistorically been included in cash flows from operations. As part of the reviewof these foreign cash accounts, it was determined that certain of theseaccounts are appropriately classified as cash rather than as short terminvestments at December 31, 2006. The Statements of Cash Flows for theperiods ended December 31, 2005 and 2004 have been revised to conform withthe 2006 presentation. Changes in classification of these accounts to cash fromshort term investments are also reflected in the balance sheet. The amountsrevised for 2005 and 2004 from short term investments to cash were $29.1million and $11.3 million, respectively.

**3.**   GENERAL INVESTMENTPORTFOLIO

Bonds and short-termdeposits at an amortized cost of $10.5 million and $9.9 million at December 31,2006 and 2005, respectively, were on deposit with state regulatory authoritiesas required by insurance regulations.

Netinvestment income consisted of the following:

| ** **                        | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------|------------|---------------------------------------------|------------|
| ** **                        | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                        | ** ** | **(in thousands)**                     | ** ** |
| Bonds and  short-term investments |       | $                                           | 213,959    |   | $ | 193,347 |   | $ | 173,849 |   |
| Equity investments                |       | 4,523                                       |       | 8,931 |   | — |   |
| Investment  expenses              |       | (2,887                                      | )          | (3,051 | ) | (2,907 | ) |
| Net investment income             |       | $                                           | 215,595    |   | $ | 199,227 |   | $ | 170,942 |   |

 

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Thecredit quality of bonds at December 31, 2006 was as follows:

| **Rating(1)** | ** ** | ** ** | ** ** | **Percent of  Bonds** | ** ** |
|---------------|------------|------------|------------|----------------------------|------------|
| AAA           |       |       | 85.7       | %                          |       |
| AA            |       |       | 11.3       |                       |       |
| A        |       |       | 2.9        |                       |       |
| NR       |       |       | 0.1        |                       |       |
| Total         |       |       | 100.0      | %                          |       |

 

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(1)          Ratingsare based on the lower of Moody’s or S&P ratings available atDecember 31, 2006.

Of the bonds included in the investment portfolio 6.2%were Triple-A by virtue of insurance provided by FSA (“FSA-InsuredInvestments”). Over 95% of the FSA-Insured Investments were investment gradewithout giving effect to the FSA insurance. The average shadow rating, which isthe rating without giving effect to the FSA guaranty, of the FSA-InsuredInvestments was the Double-A range.

Theamortized cost and fair value of the investment portfolio were as follows:

| ** **                                                                             | ** ** | **As of December 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                             | ** ** | **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 |       | $                                               | 150,302    |   |   | $ | 2,131 |   |   |   | $ | (1,782 | ) |   | $ | 150,651 |   |
| Obligations of  states and political subdivisions                                      |       | 3,663,821                                       |       |   | 171,563 |   |   |   | (1,182 | ) |   | 3,834,202 |   |
| Foreign                                                                                |       | 213,066                                         |       |   | 8,508 |   |   |   | (175 | ) |   | 221,399 |   |
| Mortgage-backed  securities                                                            |       | 247,690                                         |       |   | 989 |   |   |   | (4,156 | ) |   | 244,523 |   |
| Corporate  securities                                                                  |       | 208,586                                         |       |   | 1,520 |   |   |   | (2,178 | ) |   | 207,928 |   |
| Asset-backed  securities                                                               |       | 22,433                                          |       |   | 141 |   |   |   | (133 | ) |   | 22,441 |   |
| Subtotal                                                                               |       | 4,505,898                                       |       |   | 184,852 |   |   |   | (9,606 | ) |   | 4,681,144 |   |
| Short-term  investments                                                                |       | 85,980                                          |       |   | 600 |   |   |   | (77 | ) |   | 86,503 |   |
| Total                                                                                  |       | $                                               | 4,591,878  |   |   | $ | 185,452 |   |   |   | $ | (9,683 | ) |   | $ | 4,767,647 |   |

 

| ** **                                                                             | ** ** | **As of December 31, 2005** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                             | ** ** | **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 |       | $                                               | 189,368    |   |   | $ | 3,554 |   |   |   | $ | (748 | ) |   | $ | 192,174 |   |
| Obligations of  states and political subdivisions                                      |       | 3,431,046                                       |       |   | 173,279 |   |   |   | (5,457 | ) |   | 3,598,868 |   |
| Foreign                                                                                |       | 116,217                                         |       |   | 842 |   |   |   | (4,773 | ) |   | 112,286 |   |
| Mortgage-backed  securities                                                            |       | 245,783                                         |       |   | 807 |   |   |   | (4,487 | ) |   | 242,103 |   |
| Corporate  securities                                                                  |       | 185,381                                         |       |   | 1,797 |   |   |   | (2,114 | ) |   | 185,064 |   |
| Asset-backed  securities                                                               |       | 40,216                                          |       |   | 10 |   |   |   | (252 | ) |   | 39,974 |   |
| Subtotal                                                                               |       | 4,208,011                                       |       |   | 180,289 |   |   |   | (17,831 | ) |   | 4,370,469 |   |
| Short-term  investments                                                                |       | 104,153                                         |       |   | — |   |   |   | — |   |   | 104,153 |   |
| Total                                                                                  |       | $                                               | 4,312,164  |   |   | $ | 180,289 |   |   |   | $ | (17,831 | ) |   | $ | 4,474,622 |   |

 

16

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Foreign securities consist primarily of governmentissued and corporate securities which are denominated in either British poundsterling or the euro.

Thefollowing table shows the gross unrealized losses and fair value, aggregated byinvestment category and length of time that individual securities have been ina continuous unrealized loss position, at December 31, 2006:

| ** **                                                                             | ** ** | **As of December 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                             | ** ** | **Less than 12 months**          | ** ** | **12 months or more** | ** ** | **Total** | ** ** |
| ** **                                                                             | ** ** | **Fair  Value**                                 | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| ** **                                                                             | ** ** | **(in thousands)**                         | ** ** |
| U.S. Treasury  securities and obligations of U.S. government corporations and agencies |       | $                                               | 69,304     |   |   | $ | (483 | ) |   | $ | 43,912 |   |   | $ | (1,299 | ) |   | $ | 113,216 |   |   | $ | (1,782 | ) |   |
| Obligations of  states and political subdivisions                                      |       | 99,977                                          |       |   | (205 | ) |   | 69,847 |   |   | (977 | ) |   | 169,824 |   |   | (1,182 | ) |   |
| Mortgage-backed  securities                                                            |       | 40,416                                          |       |   | (396 | ) |   | 137,608 |   |   | (3,760 | ) |   | 178,024 |   |   | (4,156 | ) |   |
| Corporate  securities                                                                  |       | 44,776                                          |       |   | (209 | ) |   | 93,782 |   |   | (1,969 | ) |   | 138,558 |   |   | (2,178 | ) |   |
| Foreign                                                                                |       | 23,212                                          |       |   | (103 | ) |   | 2,683 |   |   | (72 | ) |   | 25,895 |   |   | (175 | ) |   |
| Asset-backed  securities                                                               |       | 3,009                                           |       |   | (6 | ) |   | 11,102 |   |   | (127 | ) |   | 14,111 |   |   | (133 | ) |   |
| Total                                                                                  |       | $                                               | 280,694    |   |   | $ | (1,402 | ) |   | $ | 358,934 |   |   | $ | (8,204 | ) |   | $ | 639,628 |   |   | $ | (9,606 | ) |   |

 

| ** **                                                                             | ** ** | **As of December 31, 2005** | ** ** |                                 |
|----------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------|
| ** **                                                                             | ** ** | **Less than 12 months**          | ** ** | **12 months or more** | ** ** | **Total** | ** ** |   |
| ** **                                                                             | ** ** | **Fair  Value**                                 | ** ** | **Unrealized  Losses**               | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |   |
| ** **                                                                             | ** ** | **(in thousands)**                         | ** ** |                                 |
| U.S. Treasury securities and obligations of U.S.  government corporations and agencies |       | $                                               | 65,026     |                                 |   | $ | (429 | ) |   | $ | 14,635 |   |   | $ | (319 | ) |   | $ | 79,661 |   |   | $ | (748 | ) |   |
| Obligations of states and political subdivisions                                       |       | 375,766                                         |       |                                 | (3,609 | ) |   | 108,031 |   |   | (1,848 | ) |   | 483,797 |   |   | (5,457 | ) |   |
| Mortgage-backed securities                                                             |       | 137,833                                         |       |                                 | (2,195 | ) |   | 48,060 |   |   | (2,292 | ) |   | 185,893 |   |   | (4,487 | ) |   |
| Corporate securities                                                                   |       | 102,576                                         |       |                                 | (1,482 | ) |   | 23,650 |   |   | (632 | ) |   | 126,226 |   |   | (2,114 | ) |   |
| Foreign                                                                                |       | 91,981                                          |       |                                 | (4,727 | ) |   | 409 |   |   | (46 | ) |   | 92,390 |   |   | (4,773 | ) |   |
| Asset-backed securities                                                                |       | 18,540                                          |       |                                 | (124 | ) |   | 14,813 |   |   | (128 | ) |   | 33,353 |   |   | (252 | ) |   |
| Total                                                                                  |       | $                                               | 791,722    |                                 |   | $ | (12,566 | ) |   | $ | 209,598 |   |   | $ | (5,265 | ) |   | $ | 1,001,320 |   |   | $ | (17,831 | ) |   |

 

At December 31, 2006 there were 438 investmentsin fixed income securities where the aggregate amortized cost exceeded fairvalue by $9.6 million, or 1.5%; at December 31, 2005 there were 613investments, whose aggregate amortized cost exceeded fair value and by $17.8million, or 1.8%. Management has determined that the unrealized losses in fixedincome securities at December 31, 2006 are primarily attributable to thecurrent interest rate environment and has concluded that these unrealizedlosses are temporary in nature based upon (a) no principal and interestpayment defaults on these securities; (b) analysis of the creditworthinessof the issuer; and (c) FSA’s ability and current intent to hold thesesecurities until a recovery in fair value or maturity. There were no individualsecurities with material unrealized losses as of December 31, 2006 and2005. As of December 31, 2006 and 2005, 100% of the securities that havebeen in a gross unrealized loss position were rated investment grade.

17

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Theamortized cost and fair value of bonds in the investment portfolio at December 31,2006, by contractual maturity, are shown below. Actual maturities could differfrom contractual maturities because borrowers have the right to call or prepaycertain obligations with or without call or prepayment penalties.

| ** **                                                       | ** ** | **Amortized  Cost**     | ** ** | **Fair Value** | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                                       | ** ** | **(in thousands)** | ** ** |
| Due in one year  or less                                         |       | $                       | 201,929    |                | $          | 202,282 |   |
| Due after one  year through five years                           |       | 1,160,189               |       | 1,216,936           |       |
| Due after five  years through ten years                          |       | 855,032                 |       | 884,028             |       |
| Due after ten  years                                             |       | 2,104,605               |       | 2,197,437           |       |
| Mortgage-backed  securities (stated maturities of 2 to 30 years) |       | 247,690                 |       | 244,523             |       |
| Asset-backed  securities (stated maturities of 1 to 28 years)    |       | 22,433                  |       | 22,441              |       |
| Total                                                            |       | $                       | 4,591,878  |                | $          | 4,767,647 |   |

 

Proceeds from sales ofbonds for the investment portfolio during 2006, 2005 and 2004 were $1,581.7million, $1,717.0 million and $1,155.7 million, respectively.Proceeds from maturities of bonds for the investment portfolio during 2006,2005 and 2004 were $160.8 million, $129.7 million and$267.8 million, respectively. Gross gains of $0.8 million,$10.8 million and $4.5 million and gross losses of $5.7 million, $5.6 millionand $5.5 million were realized on sales in 2006, 2005 and 2004,respectively.

***Equity Investments***

FSA’s investment in preferred shares of XL Financial Assurance Ltd (“XLFA”),a financial guaranty insurance company and indirect subsidiary of XL, isredeemable by XLFA at a price equal to the fair market value of the preferredshares, subject to a cap defined as the internal rate of return of 19% perannum from the date of the investment through the date of redemption, plusaccrued dividends as if 100% of current year earnings were distributed. Basedon this formula, in 2004, the Company adopted a policy of carrying thisinvestment at the lesser of the current calculated redemption value or theredemption value as of the next January first, which would exclude itsshare of accrued current year earnings to the extent the cap had been otherwisemet. Consistent with this policy, in the third quarter of 2004, the Companycharged $11.7 million to equity in earnings of unconsolidated affiliates andreduced its carrying value in this investment to $56.4 million.

18

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Untilthe fourth quarter of 2004 this investment was accounted for using the equitymethod of accounting because the Company has significant influence over XLFA’soperations. In the second quarter of 2004, the Emerging Issues Task Force (“EITF”)reached a consensus that under EITF Issue 02-14, “Whether an InvestorShould Apply the Equity Method of Accounting to Investments Other Than CommonStock” (“EITF 02-14”), an investor should only apply the equity method ofaccounting when it has investments in either common stock or in-substancecommon stock of a corporation, provided that the investor has the ability toexercise significant influence over the operating and financial policies of theinvestee. The EITF 02-14 consensus is applicable to reporting periodsbeginning after September 15, 2004. In accordance with this consensus, theCompany no longer accrues undistributed earnings related to its investment inXLFA.

In March 2006,the XLFA Board of Directors approved a by-law amendment changing the coupon onXLFA’s preferred shares from a participating dividend based on an internal rateof return up to 19% to a fixed rate dividend of 8.25% per annum, effective January 1,2006. Amounts recorded by the Company in connection with XLFA as of December 31,2006, 2005 and 2004 are as follows:

| ** **                              | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                              | ** ** | **(in thousands)** | ** ** |
| Equity securities                       |       | $                       | 54,016     |     | $          | 54,300   |       | $ | 54,300 |   |
| Equity in  earnings from XLFA (pre-tax) |       | —                  |       | —   |       | 3,761    |       |
| Dividends earned from  XLFA             |       | 4,518                   |       | 8,926    |       | 14,103   |       |
|                                         |            |                         |            |          |            |          |            |  |  |  |

 

**4.**   FP SEGMENT INVESTMENT PORTFOLIO

Allbonds in the FP Segment Portfolio are insured by FSA. The credit quality of theFP Segment Investment Portfolio, without the benefit of FSA’s insurance, at December 31,2006 was as follows:

| **Rating(1)** | ** ** | ** ** | ** ** | **Percent  of Bonds** | ** ** |
|---------------|------------|------------|------------|----------------------------|------------|
| AAA           |       |       | 1.5        | %                          |       |
| A             |       |       | 80.8       |                       |       |
| NR            |       |       | 17.7       |                       |       |
| Total         |       |       | 100.0      | %                          |       |

----

(1)          Ratings are based on thelower of Moody’s or S&P ratings available at December 31, 2006.Excludes VIE GICs. All VIE GICs are FSA-insured.

Theamortized cost and fair value of bonds in the FP Segment Investment Portfoliowere as follows:

| ** **                                        | ** ** | **As of December 31, 2006** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                        | ** ** | **Amortized  Cost**                             | ** ** | **Fair Value** | ** ** |
| ** **                                        | ** ** | **(in thousands)**                         | ** ** |
| Obligations of  states and political subdivisions |       | $                                               | 15,750     |   | $ | 15,750 |   |
| Foreign                                           |       | 9,086                                           |       | 9,643 |   |
| Asset-backed  securities(1)                       |       | 1,102,862                                       |       | 1,102,862 |   |
| Short-term  investments                           |       | 19,478                                          |       | 19,478 |   |
| Total                                             |       | $                                               | 1,147,176  |   | $ | 1,147,733 |   |

 

19

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| ** **                                        | ** ** | **As of December 31, 2005** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                        | ** ** | **Amortized  Cost**                             | ** ** | **Fair Value** | ** ** |
| ** **                                        | ** ** | **(in thousands)**                         | ** ** |
| Obligations of  states and political subdivisions |       | $                                               | 15,879     |   | $ | 15,879 |   |
| Corporate  securities                             |       | 20,013                                          |       | 19,327 |   |
| Foreign                                           |       | 8,995                                           |       | 9,841 |   |
| Asset-backed  securities(1)                       |       | 1,110,945                                       |       | 1,110,945 |   |
| Short-term  investments                           |       | 2,674                                           |       | 2,674 |   |
| Total                                             |       | $                                               | 1,158,506  |   | $ | 1,158,666 |   |

----

(1)          Asset-backed securitiesconsist of floating rate assets, which are valued using readily availablequoted market prices or at amortized cost if there is no readily availablevaluation. Management believes that amortized cost closely approximates fairvalue for these securities.

The Company periodically monitors its investmentportfolio for individual investments in an unrealized loss position in order toassess whether that investment is considered other-than-temporarily impaired.In each case, the Company determines the nature and cause of the decline andwhether the Company maintains the ability and intent to hold the security untilthe unrealized loss may reverse or until maturity. At December 31, 2006and 2005, there were no securities in an unrealized loss position. The Companydetermined that no investments were considered other-than-temporarily impaired.

Theamortized cost and fair value of bonds in the FP Segment Investment Portfolioat December 31, 2006, by contractual maturity, are shown below. Actualmaturities could differ from contractual maturities because borrowers have theright to call or prepay certain obligations with or without call or prepaymentpenalties.

| ** **                                                    | ** ** | **Amortized Cost** | ** ** | **Fair Value** | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                                    | ** ** | **(in thousands)** | ** ** |
| Due in one year  or less                                      |       |                    | $          | 19,478              |       |   | $ | 19,478 |   |
| Due after one  year through five years                        |       |                    | 9,086      |                |       | 9,643 |   |
| Due after ten  years                                          |       |                    | 15,750     |                |       | 15,750 |   |
| Asset-backed  securities (stated maturities of 2 to 14 years) |       |                    | 1,102,862  |                |       | 1,102,862 |   |
| Total                                                         |       |                    | $          | 1,147,176           |       |   | $ | 1,147,733 |   |

 

Theamortized cost and fair value of GICs held within the VIE guaranteed investmentportfolio were as follows:

| ** **                              | ** ** | **Amortized Cost** | ** ** | **Fair Value** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                              | ** ** | **(in thousands)** | ** ** |
| Due in one year  or less                |       |                    | $          | 392,314             |       |   | $ | 392,314 |   |
| Due after one  year through five years  |       |                    | 231,430    |                |       | 231,430 |   |
| Due after five  years through ten years |       |                    | 52,744     |                |       | 52,744 |   |
| Due after ten  years                    |       |                    | 286,327    |                |       | 286,327 |   |
| Total                                   |       |                    | $          | 962,815             |       |   | $ | 962,815 |   |

 

 

20

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***VIE Debt***

At December 31,2006, the interest rates on VIE Debt were between 1.98% and 6.20% per annum.Payments due under the VIE debt (including $1,042.1million of future interestaccretion on zero coupon obligations and excluding fair value adjustments of$146.3 million) in the remainder of 2006 and each of the next four years endingDecember 31 and thereafter, are as follows:

| **Year**   | ** ** | ** **              | ** ** | **Principal  Amount** | ** ** |
|------------|------------|-------------------------|------------|-----------------------|------------|
| ** ** | ** ** | **(in thousands)** | ** ** |
| 2007       |       |                    | $          | 561.9                 |       |   |
| 2008       |       |                    | 132.0      |                  |       |
| 2009       |       |                    | 329.7      |                  |       |
| 2010       |       |                    | 94.4       |                  |       |
| 2011       |       |                    | 13.7       |                  |       |
| Thereafter |       |                    | 2,831.8    |                  |       |
| Total      |       |                    | $          | 3,963.5               |       |   |

 

***Non-Cash Transaction***

In a non-cash transaction,FSA Global issued debt of $128.2 million and acquired assets of equalvalue from the GIC Affiliates. The proceeds of issuance of FSA Global debt weredeposited directly into the GIC Affiliates, which, in turn, issued a GIC to FSAGlobal.

**5. ASSETS ACQUIREDIN REFINANCING TRANSACTIONS AND NOTES PAYABLE TO AFFILIATES**

The Company generally has rights under its financialguaranty insurance policies and indentures that allow it to accelerate theinsured notes and pay claims under its insurance policies upon the occurrenceof predefined events of default. To mitigate future losses, the Company mayelect to purchase the outstanding insured obligation or its underlyingcollateral. Generally, refinancing vehicles reimburse FSA in whole for itsclaims payments in exchange for assignments of certain of FSA’s rights againstthe trusts. The refinancing vehicles obtain their funds from the proceeds ofFSA-insured GICs issued in the ordinary course of business by the GICAffiliates. The refinancing vehicles are consolidated into the Company’sfinancial statements. The Company maintains its reinsurance on thesetransactions.

Thefollowing table presents the balance sheet components of the assets acquired inrefinancing transactions:

| ** **              | ** ** | **As of December 31,** | ** ** |
|-------------------------|------------|---------------------------------------|------------|
| ** **              | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| ** **              | ** ** | **(in thousands)**               | ** ** |
| Securitized loans       |       | $                                     | 241,785    |   | $ | 296,965 |   |
| Bonds                   |       | 41,051                                |       | 68,421 |   |
| Equity securities       |       | 4,434                                 |       | 3,488 |   |
| Mortgage loans          |       | 34,407                                |       | 56,165 |   |
| Short term  investments |       | 12,662                                |       | 37,512 |   |
| Other                   |       | 3,533                                 |       | 5,322 |   |
| Total                   |       | $                                     | 337,872    |   | $ | 467,873 |   |

 

Securitized loans are carried at cost, net of lossesat the date of purchase. Income is recorded based on the effective yieldmethod. The accretable yield on the securitized loans at December 31,2006, 2005, and 2004 was $157.3 million, $149.7 million, and $151.3 million,respectively. The cash flows on the 

21

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securitized loans, net ofreinsurance, are monitored and the effective yield modified to reflect any changein the cash flow estimate on a prospective basis. Since the notes represent100% of the debt capitalization of the trusts and since FSA maintains all therisk of further asset decline (except as provided by reinsurance) and maintainscontrol over key decisions regarding the trusts (such as removal of theservicer, sale of the assets and liquidation of the entity), the trusts wereconsolidated with the Company for accounting purposes. The Company alsoconsolidated the refinancing vehicles.

Bonds, equity securities and mortgage loans representliquidations of previously insured obligations and subsequent purchases of theunderlying collateral. Bonds and equity securities are available for sale andcarried at fair value.

Thecredit quality of bonds within the refinanced asset portfolio at December 31,2006 was as follows:

| **Rating(1)** | ** ** | ** ** | ** ** | **Percent of Bonds** | ** ** |
|---------------|------------|------------|------------|--------------------------------|------------|
| BBB           |       |       | 13.1       | %                              |       |
| CCC           |       |       | 84.2       |                           |       |
| NR            |       |       | 2.7        |                           |       |
| Total         |       |       | 100.0      | %                              |       |

----

(1)          Ratings are based oninternal shadow ratings available at December 31, 2006.

Theamortized cost and fair-value of fixed income securities within the refinancedasset portfolio were as follows:

| ** **                | ** ** | **As of December 31, 2006** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|
| ** **                | ** ** | **Amortized  Cost**                             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
| ** **                | ** ** | **(in thousands)**                         | ** ** |
| Corporate securities |       |                                            | $          | 1,074 |   |   |   | $ | 29 |   |   |   | — |   |   |   | $ | 1,103 |   |   |
| Asset-backed  securities  |       |                                            | 39,059     |   |   |   | 889 |   |   |   | — |   |   |   | 39,948 |   |   |
| Short-term  investments   |       |                                            | 12,662     |   |   |   | — |   |   |   | — |   |   |   | 12,662 |   |   |
| Total                     |       |                                            | $          | 52,795 |   |   |   | $ | 918 |   |   |   | $ | — |   |   |   | $ | 53,713 |   |   |
|                           |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **               | ** ** | **As of December 31, 2005** | ** ** |
|--------------------------|------------|-------------------------------------------------|------------|
| ** **               | ** ** | **Amortized  Cost**                             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
| ** **               | ** ** | **(in thousands)**                         | ** ** |
| Corporate  securities    |       | $                                               | 5,946      |   |   | $ | 3,199 |   |   |   | — |   |   | $ | 9,145 |   |
| Asset-backed  securities |       | 59,920                                          |       |   | — |   |   |   | (644 | ) |   | 59,276 |   |
| Short-term  investments  |       | 37,512                                          |       |   | — |   |   |   | — |   |   | 37,512 |   |
| Total                    |       | $                                               | 103,378    |   |   | $ | 3,199 |   |   |   | $ | (644 | ) |   | $ | 105,933 |   |
|                          |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theamortized cost and fair value of equities held within the refinanced assetportfolio were as follows:

| ** **        | ** ** | **As of December 31, 2006** | ** ** |
|-------------------|------------|-------------------------------------------------|------------|
| ** **        | ** ** | **Amortized  Cost**                             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
| ** **        | ** ** | **(in thousands)**                         | ** ** |
| Equity securities |       |                                            | $          | 1,003 |   |   |   | $ | 3,431 |   |   |   | — |   |   |   | $ | 4,434 |   |   |
|                   |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

22

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| ** **        | ** ** | **As of December 31, 2005** | ** ** |
|-------------------|------------|-------------------------------------------------|------------|
| ** **        | ** ** | **Amortized  Cost**                             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair Value** | ** ** |
| ** **        | ** ** | **(in thousands)**                         | ** ** |
| Equity securities |       |                                            | $          | 2,206 |   |   |   | $ | 1,282 |   |   |   | — |   |   |   | $ | 3,488 |   |   |
|                   |            |                                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theamortized cost and fair-value of fixed income securities within the refinancedasset portfolio at December 31, 2006, are shown below by contractualmaturity. Actual maturities could differ from contractual maturities becauseborrowers have the right to call or prepay certain obligations with or withoutcall or prepayment penalties.

| ** **                             | ** ** | **Amortized Cost** | ** ** | **Fair Value** | ** ** |
|----------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                             | ** ** | **(in thousands)** | ** ** |
| Due in one year  or less               |       |                    | $          | 12,669              |       |   |   | $ | 12,689 |   |   |
| Due after one  year through five years |       |                    | 40,126     |                |       |   | 41,024 |   |   |
| Total                                  |       |                    | $          | 52,795              |       |   |   | $ | 53,713 |   |   |

 

At December 31, 2006,and 2005 there were no securities in an unrealized loss position for acontinuous 12-month period or longer. In 2006, the Company determinedthat there were three securities considered other-than-temporarilyimpaired and a $2.5 million impairment charge was recorded in the consolidatedstatements of operations and comprehensive income. In 2005, there were sixsecurities considered other-than-temporarily impaired and a $4.5 millionimpairment charge was recorded in the consolidated statements of operations andcomprehensive income.

***Notes Payable to Affiliates***

The Company has $321.4 million of notes payable to anaffiliate at December 31, 2006 and $463.6 million at December 31,2005. For the years ended December 31, 2006, 2005 and 2004 the Companyrecorded $20.1 million, $28.2 million and $24.8 million,respectively, of interest expense on the notes payable.

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

| **Expected Withdrawal Date** | ** ** | ** **              | ** ** | **Principal  Amount** | ** ** |
|----------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **(in thousands)** | ** ** |
| 2007                                   |       |                    | $          | 22,211                |       |   |
| 2008                                   |       |                    | 24,602     |                  |       |
| 2009                                   |       |                    | 38,681     |                  |       |
| 2010                                   |       |                    | 44,195     |                  |       |
| 2011                                   |       |                    | 47,638     |                  |       |
| Thereafter                             |       |                    | 144,043    |                  |       |
| Total                                  |       |                    | $          | 321,370               |       |   |

 

23

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**6.**   DEFERRED ACQUISITION COSTS

Acquisitioncosts deferred for amortization against future income and the relatedamortization charged to expenses are as follows:

| ** **                               | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                               | ** ** | **(in thousands)**                     | ** ** |
| Balance,  beginning of period            |       | $                                           | 335,129    |   | $ | 308,015 |   | $ | 273,646 |   |
| Costs deferred  during the period:       |       |                                        |       |   |   |   |   |
| Ceded and assumed commissions            |       | (79,713                                     | )          | (63,174 | ) | (65,838 | ) |
| Premium taxes                            |       | 14,032                                      |       | 20,894 |   | 16,551 |   |
| Compensation and other acquisition costs |       | 134,237                                     |       | 137,734 |   | 145,857 |   |
| Total                                    |       | 68,556                                      |       | 95,454 |   | 96,570 |   |
| Costs amortized  during the period       |       | (63,012                                     | )          | (68,340 | ) | (62,201 | ) |
| Balance, end of period                   |       | $                                           | 340,673    |   | $ | 335,129 |   | $ | 308,015 |   |

 

**7.**   LIABILITYFOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Activityin the liability for losses and loss adjustment expenses, which consists of thecase and non-specific reserves, is summarized as follows:

| ** **                            | ** ** | **Case Reserve Activity for the  Year Ended December 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                                                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                            | ** ** | **(in millions)**                                                                        | ** ** |
| Gross balance at  January 1      |       | $                                                                                             | 90.0       |   | $ | 80.6 |   | $ | 121.9 |   |
| Less Reinsurance recoverable          |       | 36.3                                                                                          |       | 35.4 |   | 59.2 |   |
| Net balance at  January 1        |       | 53.7                                                                                          |       | 45.2 |   | 62.7 |   |
| Transfer from  non-specific reserve   |       | 1.2                                                                                           |       | 10.5 |   | 30.7 |   |
| Restructured  transactions            |       | —                                                                                        |       | — |   | (13.9 | ) |
| Paid (net of  recoveries) related to: |       |                                                                                          |       |   |   |   |   |
| Current year                          |       | —                                                                                        |       | — |   | — |   |
| Prior year                            |       | (1.9                                                                                          | )          | (2.0 | ) | (34.3 | ) |
| Total paid                            |       | (1.9                                                                                          | )          | (2.0 | ) | (34.3 | ) |
| Net balance at  December 31      |       | 53.0                                                                                          |       | 53.7 |   | 45.2 |   |
| Plus reinsurance recoverable          |       | 37.3                                                                                          |       | 36.3 |   | 35.4 |   |
| Gross balance at  December 31    |       | $                                                                                             | 90.3       |   | $ | 90.0 |   | $ | 80.6 |   |

 

| ** **                            | ** ** | **Non-Specific Reserve Activity  For the Year Ended December 31,** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                                                                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                            | ** ** | **(in millions)**                                                                                | ** ** |
| Balance at  January 1            |       | $                                                                                                     | 115.7      |   | $ | 99.3 |   | $ | 111.5 |   |
| Provision for  losses:                |       |                                                                                                  |       |   |   |   |   |
| Current year                          |       | 17.8                                                                                                  |       | 20.4 |   | 20.4 |   |
| Prior year                            |       | 5.5                                                                                                   |       | 5.0 |   | 0.2 |   |
| Transfers to case  reserves           |       | (1.2                                                                                                  | )          | (10.5 | ) | (30.7 | ) |
| Restructured  transactions            |       | —                                                                                                |       | 1.5 |   | (2.1 | ) |
| Balance at  December 31          |       | 137.8                                                                                                 |       | 115.7 |   | 99.3 |   |
| Total case and  non-specific reserves |       | $                                                                                                     | 228.1      |   | $ | 205.7 |   | $ | 179.9 |   |

 

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The gross and net par amounts outstanding ontransactions with case reserves were $483.4 million and$399.6 million, respectively, at December 31, 2006. The net casereserve consisted primarily of five CDO risks and two municipal risks, whichcollectively accounted for approximately 94.9% of the total net case reserve.The remaining eight risks were in various sectors.

During 2006, the Company charged $23.3 million to lossexpense, consisting of $17.8 million for originations of new business and $5.5million related to accretion on the reserve for in-force business. Netcase reserves decreased $0.7 million primarily due to****losspayments and some improvement in the CDO transactions, offset in part by theestablishment of a new case reserve for a municipal health care transaction.

During 2005, the Company charged $25.4 million toloss expense, consisting of $20.4 million for originations of new businessand $5.0 million for accretion related to prior-year reserves. The non-specificreserve increased $16.4 million in 2005, primarily due to loss expense of$25.4 million, partially offset by transfers from the non-specificreserve to case reserves of $10.5 million. Net reserves increased$8.5 million due to deterioration of specific CDO risks.

During 2004, the Company charged $20.6 million toloss expense, consisting of $20.4 million for originations of newbusiness, $4.6 million for accretion related to prior years and$3.2 million related to reassumptions of previously ceded business, offsetby reserve releases primarily related to a large refinancing transaction in2004.

In September 2004, the Company exercised itsrights to have the collateral of a defaulted collateralized bond obligationliquidated at a public sale, in which the Company offered the highest bid. TheCompany acquired the collateral to gain control of the portfolio in order tomitigate future losses. The previously established case reserve was drawn downto reflect the excess of the purchase amount over the fair value of the collateral.The remaining $9.5 million balance in the case reserve related to thistransaction was returned to the non-specific reserve. After reevaluatingits requirements for the CDO portion of the non-specific reserve, theCompany then reduced the non-specific reserve by $9.5 million, whichwas partially offset by normal reserve additions. The net amount transferredfrom the case reserves to the non-specific reserve was $1.4 million,which also included a transfer from the non-specific reserve to a casereserve for a municipal utility transaction. The CDO portfolio continues toperform within the expectations reflected in previously recorded provisions forCDOs.

Since case and non-specificreserves are based on estimates, there can be no assurance that the ultimateliability will not differ from such estimates. The Company will continue, on anongoing basis, to monitor these reserves and may periodically adjust suchreserves, upward or downward, based on the Company’s actual loss experience,its future mix of business and future economic conditions.

***Impact of 2005 Hurricanes***

The Company monitors its exposure to credits affectedby the 2005 hurricanes in Louisiana and Mississippi. The Company believes thatits estimate of its total loss liability is adequate given its current riskinformation and has not established a case reserve related to its 2005hurricane affected exposure.

As of December 31, 2006, FSA had not receivednotice of payment default on any 2005 hurricane-related exposures. The Company’s11 credits that have suffered the most significant economic and property lossfrom the 2005 hurricanes had an aggregate net par exposure of $181.7 million atDecember 31, 2006. FSA-insured bonds are protected by various sources ofsupport that would be invoked before FSA would incur losses. These sourcesinclude access to pledged taxes or revenues, reserve funds, property andcasualty insurance and state and federal monies. The issuers of these insuredbonds have generally continued to improve financially and management does notexpect that the Company will sustain permanent losses.

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In addition, to provide relief to local governmentsfacing difficulties meeting debt service obligations during this recoveryperiod, the State of Louisiana issued an aggregate of $400 million of Gulf TaxCredit and matching State General Obligation Bonds on July 19, 2006. Thebond proceeds funded a State Debt Service Assistance Fund to provide loans tohelp qualifying local governments meet debt service obligations for the nextseveral years. All of the qualifying entities are located in the New Orleansmetropolitan area.

Among the exposures affected by the hurricane are$38.1 million of FSA-insured Orleans Levee District (the “District”) bonds. TheDistrict has explored the possibility of seeking bankruptcy protection, but hasnot received the authority from the State that is required to do so. FSA doesnot believe that payment of the FSA-insured bonds would be impaired by abankruptcy filing. In addition, the District is a loan recipient under theState Debt Service Assistance Fund, with FSA-insured bonds receiving assistancethrough May 1, 2009.

Asset-backed transactions insured by the Company,backed by pools of geographically diverse assets, show no unusualconcentrations in the affected areas.

The loss estimationprocess involves the exercise of considerable judgment and therefore theCompany’s ultimate 2005 hurricane-related losses may be materially differentfrom the current estimate and may affect future operating results.

**8.**   OUTSTANDINGEXPOSURE AND COLLATERAL

The Company’s policies insure the scheduled paymentsof principal and interest on public finance and asset-backed (including insuredFSA-insured CDS) obligations. The gross amount of financial guarantees in force(principal and interest) was $764.8 billion at December 31, 2006 and$685.1 billion at December 31, 2005. The net amount of financialguarantees in force was $552.3 billion at December 31, 2006 and$497.1 billion at December 31, 2005.

Thenet par outstanding as of December 31, 2006 and 2005 and the contractualterms to maturity are as follows:

| ** **                         | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Terms to Maturity(1)** | ** ** | ** **                      | ** ** | **Public Finance**         | ** ** | **Asset-Backed(2)** | ** ** | **Public Finance** | ** ** | **Asset-Backed(2)** | ** ** |
| ** **                         | ** ** | **(in millions)**          | ** ** |
| 0 to 5 years                       |       |                            | $          | 48,273                          |       |   |   | $ | 41,582 |   |   |   | $ | 44,272 |   |   |   | $ | 41,955 |   |   |
| 5 to 10 years                      |       |                            | 53,242     |                            |       |   | 31,097 |   |   |   | 49,935 |   |   |   | 31,395 |   |   |
| 10 to 15 years                     |       |                            | 47,865     |                            |       |   | 12,301 |   |   |   | 44,392 |   |   |   | 12,180 |   |   |
| 15 to 20 years                     |       |                            | 41,489     |                            |       |   | 1,860 |   |   |   | 36,737 |   |   |   | 744 |   |   |
| 20 years and  above                |       |                            | 60,424     |                            |       |   | 37,985 |   |   |   | 51,724 |   |   |   | 37,612 |   |   |
| Total                              |       |                            | $          | 251,293                         |       |   |   | $ | 124,825 |   |   |   | $ | 227,060 |   |   |   | $ | 123,886 |   |   |
|                                    |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Actual maturities coulddiffer from contractual maturities because borrowers have the right to call orprepay certain obligations with or without call or prepayment penalties.

(2)          Includes related partyinsurance of $16,558 million and $13,463 million, in 2006 and 2005,respectively, relating to FSA-insured GICs issued by the GIC Affiliates.

26

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Thepar amount ceded as of December 31, 2006 and 2005 and the terms tomaturity are as follows:

| ** **                      | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Terms to Maturity** | ** ** | ** **                      | ** ** | **Public Finance**         | ** ** | **Asset-Backed** | ** ** | **Public Finance** | ** ** | **Asset-Backed** | ** ** |
| ** **                      | ** ** | **(in millions)**          | ** ** |
| 0 to 5 years                    |       |                            | $          | 14,375                          |       |   |   | $ | 9,091 |   |   |   | $ | 12,950 |   |   |   | $ | 16,180 |   |   |
| 5 to 10 years                   |       |                            | 16,635     |                            |       |   | 6,485 |   |   |   | 16,332 |   |   |   | 7,011 |   |   |
| 10 to 15 years                  |       |                            | 17,163     |                            |       |   | 1,847 |   |   |   | 16,954 |   |   |   | 1,477 |   |   |
| 15 to 20 years                  |       |                            | 17,200     |                            |       |   | 1,905 |   |   |   | 15,180 |   |   |   | 1,474 |   |   |
| 20 years and  above             |       |                            | 33,480     |                            |       |   | 3,649 |   |   |   | 29,048 |   |   |   | 4,001 |   |   |
| Total                           |       |                            | $          | 98,853                          |       |   |   | $ | 22,977 |   |   |   | $ | 90,464 |   |   |   | $ | 30,143 |   |   |
|                                 |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

| ** **                        | ** ** | **Net Par Outstanding  as of December 31,** | ** ** | **Ceded as of  December 31,** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Types of Issues**     | ** ** | ** **                                                           | ** ** | **2006**                                     | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                        | ** ** | **(in millions)**                                               | ** ** |
| General  obligation               |       | $                                                                    | 103,112    |                                         | $          | 93,284 |   | $ | 28,143 |   | $ | 26,020 |   |
| Tax-supported  bonds              |       | 46,479                                                               |       | 43,855                                       |       | 18,733 |   | 18,276 |   |
| Municipal utility  revenue        |       | 40,495                                                               |       | 37,245                                       |       | 13,367 |   | 14,091 |   |
| Health care  revenue              |       | 13,155                                                               |       | 11,789                                       |       | 10,144 |   | 8,889 |   |
| Housing revenue                   |       | 7,576                                                                |       | 7,585                                        |       | 2,039 |   | 2,153 |   |
| Transportation  revenue           |       | 16,164                                                               |       | 15,299                                       |       | 10,337 |   | 9,766 |   |
| Education                         |       | 4,378                                                                |       | 4,065                                        |       | 1,027 |   | 1,184 |   |
| Other domestic  public finance    |       | 1,628                                                                |       | 1,690                                        |       | 509 |   | 531 |   |
| International                     |       | 18,306                                                               |       | 12,248                                       |       | 14,554 |   | 9,554 |   |
| Total public  finance obligations |       | $                                                                    | 251,293    |                                         | $          | 227,060 |   | $ | 98,853 |   | $ | 90,464 |   |
|                                   |            |                                                                      |            |                                              |            |  |  |  |  |  |  |  |  |  |  |

 

TheCompany limits its exposure to losses from writing financial guarantees byunderwriting investment-grade obligations, diversifying its portfolio andmaintaining rigorous collateral requirements on asset-backed obligations, aswell as through reinsurance. The net par outstanding of insured obligations in theasset-backed insured portfolio includes the following amounts by type ofcollateral:

| ** **                               | ** ** | **Net Par Outstanding (1)  as of December 31,** | ** ** | **Ceded as of  December 31,** | ** ** |
|------------------------------------------|------------|-------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| **Types of Collateral**        | ** ** | ** **                                                                    | ** ** | **2006**                                     | ** ** | **2005** | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                               | ** ** | **(in millions)**                                                        | ** ** |
| Residential  mortgages                   |       | $                                                                             | 15,666     |                                         | $          | 18,401 |   | $ | 2,555 |   | $ | 3,056 |   |
| Consumer  receivables                    |       | 10,599                                                                        |       | 8,366                                        |       | 664 |   | 1,569 |   |
| Pooled corporate  obligations            |       | 45,914                                                                        |       | 47,253                                       |       | 8,729 |   | 11,141 |   |
| Other domestic  asset-backed obligations |       | 23,351                                                                        |       | 20,791                                       |       | 2,952 |   | 2,890 |   |
| International                            |       | 29,295                                                                        |       | 29,075                                       |       | 8,077 |   | 11,487 |   |
| Total  asset-backed obligations          |       | $                                                                             | 124,825    |                                         | $          | 123,886 |   | $ | 22,977 |   | $ | 30,143 |   |
|                                          |            |                                                                               |            |                                              |            |  |  |  |  |  |  |  |  |  |  |

----

(1)          Includes related partyinsurance of $16,558 million and $13,463 million, in 2005 and 2004,respectively, relating to FSA-insured GICs issued by the GIC Affiliates.

In its asset-backed business, the Company considersgeographic concentration as a factor in underwriting insurance coveringsecuritizations of pools of such assets as residential mortgages or consumerreceivables. However, after the initial issuance of an insurance policyrelating to such securitizations, the geographic concentration of theunderlying assets may not remain fixed over the life of 

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the policy. In addition,in writing insurance for other types of asset-backed obligations, such as securitiesprimarily backed by government or corporate debt, geographic concentration isnot deemed by the Company to be significant, given other more relevant measuresof diversification, such as issuer or industry diversification.

TheCompany seeks to maintain a diversified portfolio of insured municipalobligations designed to spread its risk across a number of geographic areas.The following table sets forth those states in which municipalities locatedtherein issued an aggregate of 2% or more of the Company’s net par amountoutstanding of insured municipal securities as of December 31, 2006:

| **State**                     | ** ** | ** **             | ** ** | **Number  of Risks** | ** ** | **Net Par  Amount  Outstanding** | ** ** | **Percent of Total  Net Par Amount  Outstanding** | ** ** | **Ceded Par  Amount  Outstanding** | ** ** |
|-------------------------------|------------|------------------------|------------|---------------------------|------------|---------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                    | ** ** | **(in millions)** | ** ** |
| California                    |       |                   | 1,022      |                      |       |                                  | $          | 31,724                                                                |       |                                    |       | 12.7 | % |   |   | $ | 10,753 |   |   |
| New York                      |       |                   | 703        |                      |       |                                  | 19,800     |                                                                  |       |                                    | 7.9        |   |   |   | 9,172 |   |   |
| Texas                         |       |                   | 760        |                      |       |                                  | 17,123     |                                                                  |       |                                    | 6.8        |   |   |   | 5,578 |   |   |
| Pennsylvania                  |       |                   | 782        |                      |       |                                  | 16,429     |                                                                  |       |                                    | 6.5        |   |   |   | 4,197 |   |   |
| Florida                       |       |                   | 270        |                      |       |                                  | 13,061     |                                                                  |       |                                    | 5.2        |   |   |   | 4,764 |   |   |
| Illinois                      |       |                   | 682        |                      |       |                                  | 12,641     |                                                                  |       |                                    | 5.0        |   |   |   | 6,140 |   |   |
| New Jersey                    |       |                   | 609        |                      |       |                                  | 10,817     |                                                                  |       |                                    | 4.3        |   |   |   | 5,710 |   |   |
| Michigan                      |       |                   | 542        |                      |       |                                  | 10,173     |                                                                  |       |                                    | 4.0        |   |   |   | 2,266 |   |   |
| Washington                    |       |                   | 332        |                      |       |                                  | 9,067      |                                                                  |       |                                    | 3.6        |   |   |   | 3,715 |   |   |
| Massachusetts                 |       |                   | 210        |                      |       |                                  | 6,304      |                                                                  |       |                                    | 2.5        |   |   |   | 3,513 |   |   |
| Ohio                          |       |                   | 376        |                      |       |                                  | 6,160      |                                                                  |       |                                    | 2.5        |   |   |   | 2,034 |   |   |
| Indiana                       |       |                   | 271        |                      |       |                                  | 5,451      |                                                                  |       |                                    | 2.2        |   |   |   | 1,277 |   |   |
| Georgia                       |       |                   | 114        |                      |       |                                  | 5,050      |                                                                  |       |                                    | 2.0        |   |   |   | 1,426 |   |   |
| Wisconsin                     |       |                   | 453        |                      |       |                                  | 4,982      |                                                                  |       |                                    | 2.0        |   |   |   | 1,326 |   |   |
| All other U.S.  jurisdictions |       |                   | 2,767      |                      |       |                                  | 64,205     |                                                                  |       |                                    | 25.5       |   |   |   | 22,428 |   |   |
| International                 |       |                   | 143        |                      |       |                                  | 18,306     |                                                                  |       |                                    | 7.3        |   |   |   | 14,554 |   |   |
| Total                         |       |                   | 10,036     |                      |       |                                  | $          | 251,293                                                               |       |                                    |       | 100.0 | % |   |   | $ | 98,853 |   |   |

 

**9.**   FEDERALINCOME TAXES

Dexia Holdings, the Parent and the Company and itsSubsidiaries, except FSA International, file a consolidated federal income taxreturn.

Prior to 2006, a tax-sharing agreement between themprovided that each member’s tax benefit or expense is calculated on a separatereturn basis and that any credits or losses available to the Parent or DexiaHoldings be allocated among the members based on each member’s taxable income.Effective for the tax year beginning January 1, 2006, the tax sharingagreement was amended so that the Parent or Dexia Holdings’ credits are nolonger available to the members. At December 31, 2006 and 2005, theCompany and its Subsidiaries received benefits from utilizing the Parent’s creditsand losses of $1.1 million and $4.1 million, respectively, in connectionwith the 2005 tax year. These amounts have been recorded as capitalcontributions and reductions in amounts payable to the Parent in the financialstatements.

Except as described below, federal income taxes werenot provided on all of the undistributed earnings of FSA International, sinceit was the Company’s practice and intent to reinvest such earnings in theoperations of this subsidiary. The cumulative amount of such untaxed earningswas $22.6 million at December 31, 2004.

The American Jobs Creation Act of 2004 (the “Act”),enacted on October 22, 2004, added Section 965 to the InternalRevenue Code. Section 965 provides for the repatriation of dividends froma 

28

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controlled foreigncorporation to its U.S. shareholder at an effective tax rate of 5.25%, providedthat proceeds from the repatriation are utilized for qualified domesticinvestment activities. The U.S. Treasury Department issued Notice 2005-10,which provided guidance on acceptable investment activities. The Companybelieves it qualifies for the beneficial treatment under Section 965 andaccordingly accrued a tax liability and expense of $5.3 million at December 31,2004. This amount approximated the tax effect on FSA International’s taxdividend distribution made in the fourth quarter of 2005.

In December 2005, the Company repatriatedearnings from FSA International to avail itself of the reduced effective taxrate of 5.25% (compared with the normal effective tax rate of 35%). Inconnection with such repatriation, the Company recapitalized FSA Internationalin October of 2005 to become a wholly owned subsidiary and declared thatit no longer intends to leave future earnings of that subsidiary permanentlyoffshore. FSA International is subject to an increased effective U.S. tax rateon its 2005 and future income. The impact on earnings reflects (a) a taxliability of $15.1 million in respect of undistributed earnings of FSAInternational that have previously been recognized for GAAP but not yet for taxand (b) $14.2 million related to 2005 earnings.

Thecumulative balance sheet effects of deferred federal tax consequences are asfollows:

| ** **                                    | ** ** | **December 31,**   | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|
| ** **                                    | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                    | ** ** | **(in thousands)** | ** ** |
| Deferred  acquisition costs                   |       | $                       | 106,316    |   | $ | 104,335 |   |
| Deferred premium  revenue adjustments         |       | 57,992                  |       | 36,302 |   |
| Unrealized  capital gains                     |       | 63,063                  |       | 58,204 |   |
| Contingency  reserves                         |       | 135,992                 |       | 114,166 |   |
| Undistributed  earnings                       |       | 18,297                  |       | 16,613 |   |
| Derivative  fair-value adjustments            |       | 125,361                 |       | 86,743 |   |
| Other                                         |       | 4,135                   |       | 3,817 |   |
| Total deferred federal income tax liabilities |       | 511,156                 |       | 420,180 |   |
| Loss and loss  adjustment expense reserves    |       | (49,079                 | )          | (41,533 | ) |
| Deferred  compensation                        |       | (69,203                 | )          | (67,277 | ) |
| Foreign currency  transaction loss            |       | (59,098                 | )          | (12,300 | ) |
| Minority interest                             |       | (39,265                 | )          | (56,437 | ) |
| Other                                         |       | (1,606                  | )          | (4,291 | ) |
| Total deferred federal income tax assets      |       | (218,251                | )          | (181,838 | ) |
| Net deferred federal  income tax liability    |       | $                       | 292,905    |   | $ | 238,342 |   |

 

Management believes it is more likely than not thatthe tax benefit of the deferred tax assets will be realized. Accordingly, novaluation allowance was necessary at December 31, 2006 or 2005.

Areconciliation of the effective tax rate with the federal statutory ratefollows:

| ** **                    | ** ** | **Years Ended  December 31,** | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|
| ** **                    | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| Tax at statutory  rate        |       | 35.0                                    | %          | 35.0 | % | 35.0 | % |
| Tax-exempt  investments       |       | (11.6                                   | )          | (9.0 | ) | (8.3 | ) |
| Income of foreign  subsidiary |       | —                                  |       | 2.5 |   | (1.3 | ) |
| Minority interest             |       | 3.6                                     |       | (0.4 | ) | — |   |
| Other                         |       | 0.1                                     |       | 0.1 |   | (0.2 | ) |
| Provision for income  taxes   |       | 27.1                                    | %          | 28.2 | % | 25.2 | % |

 

29

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**10.**   EMPLOYEEBENEFIT PLANS

The Company maintains both qualified and non-qualified,non-contributory defined contribution pension plans for the benefit ofeligible employees. Contributions are based on a fixed percentage of employeecompensation. Pension expense, which is funded annually, amounted to $6.6million, $6.1 million and $5.2 million for the years ended December 31,2006, 2005 and 2004, respectively.

The Company has an employee retirement savings planfor the benefit of eligible employees. The plan permits employees to contributea percentage of their salaries up to limits prescribed by Internal Revenue CodeSection 401(k). Contributions by the Company are discretionary, and nonehave been made.

Through 2004, performance shares were awarded underthe Parent’s 1993 Equity Participation Plan (the “1993 Equity Plan”). The 1993Equity Plan authorized the discretionary grant of performance shares by theHuman Resources Committee to key employees. The amount earned for eachperformance share depends on the attainment of certain growth rates of adjustedbook value and book value per outstanding share over a three-year period.

Performance shares issued prior to January 1,2005 permitted the participant to elect, at the time of award, growth ratesincluding or excluding realized and unrealized gains and losses on the Parent’sconsolidated investment portfolio excluding invested assets in the ParentCompany’s Financial Products Segment. Performance shares issued after January 1,2005 do not offer the option to include the impact of unrealized gains andlosses on the investment portfolio. No payout occurs if the compound annualgrowth rate of the Parent’s consolidated adjusted book value and book value peroutstanding 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 ParticipationPlan (the “2004 Equity Plan”), which continues the incentive compensationprogram formerly provided under the Company’s 1993 Equity Participation Plan.The 2004 Equity Plan provides for performance share units comprised 90% ofperformance shares (which provide for payment based upon the Parent’sconsolidated performance over specified three-year performance cycles asdescribed above) and 10% of shares of Dexia restricted stock. Performanceshares have generally been awarded on the basis of two sequential three-yearperformance cycles, with 1/3 of each award allocated to the first cycle whichcommences on date of grant and 2/3 of each award allocated to the second cyclewhich commences one year after date of grant. The total number of performanceshares authorized under this plan was 3.3 million. At December 31, 2006,2.7 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 forthe amount paid, which is amortized over 2.5-year and 3.5-yearvesting periods. In 2006 and 2005, FSA purchased shares to economically defeaseits liability for $4.6 million and $4.4 million, respectively. Theseamounts are being amortized to expense over the employees’ vesting periods. Forthe year ended December 31, 2006 and 2005, the after-tax amounts amortizedinto income were $1.7 million and $0.8 million, respectively.

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

| ** ** | ** ** | **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 )**                | ** ** |
| 2004       |       |                                         | 1,280,632  |                               |       | 355,459                                  |       | 398,292                              |       |                                       | 20,038     | ** **                                     |       |                                | 1,217,761  | ** ** |   | $ | 109.71 |   |   | $ | 64,278 | ** ** |   |
| 2005       |       |                                         | 1,217,761  |                               |       | 316,638                                  |       | 313,987                              |       |                                       | 24,434     | ** **                                     |       |                                | 1,195,978  | ** ** |   | 131.30 |   |   | 61,584 | ** ** |   |
| 2006       |       |                                         | 1,195,978  |                               |       | 370,441                                  |       | 340,429                              |       |                                       | 15,696     | ** **                                     |       |                                | 1,210,294  | ** ** |   | 139.22 |   |   | 60,993 | ** ** |   |
|            |            |                                              |            |                                    |            |                                          |            |                                      |            |                                            |            |                                                |            |                                     |            |  |  |  |  |  |  |  |  |  |  |

 

At December 31, 2006, 364,510 outstandingperformance shares were fully vested, with a value of $61.9 million. Theseamounts were paid in the first quarter of 2007. At December 31, 2006, thetotal compensation cost related to non-vested performance shares not yetrecognized was $73.9 million. This amount is expected to be recognized asexpense over a weighted-average period of 1.14 years.

The estimated final cost of these performance sharesis accrued over the performance period. The after-tax expense for theperformance shares was $36.0 million, $32.9 million and$43.6 million, for the years ended December 31, 2006, 2005 and 2004,respectively.

Awardsof Dexia restricted stock remain restricted for an additional six months afterthe year end of the vesting periods. Shares of Dexia restricted stock purchasedunder the 2004 Equity Plan are as follows:

| ** ** | ** ** | **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  Date** | ** ** |
|------------|------------|----------------------------------------------|------------|--------------------------------------|------------|-----------------------------------|------------|--------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------------|------------|
| 2005       |       |                                         | —     |                                 |       |                              | 194,202    |                                 |       |                                       | 8,756      |                                              |       |   | 5,150 |   |   |   | 180,296 |   |   |   | $ | 22.69 |   |   |
| 2006       |       |                                         | 180,296    |                                 |       |                              | 190,572    |                                 |       |                                       | 22,146     |                                              |       |   | 4,574 |   |   |   | 344,148 |   |   |   | 24.17 |   |   |

 

Statement of FinancialAccounting Standards No. 123 (revised 2004), “Share-Based Payment,” didnot have any impact on the consolidated statements of operations andcomprehensive income.

31

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**11.**   DERIVATIVEINSTRUMENTS

***Credit Default Swaps***

The Company has insured a number of CDS with theexpectation that these transactions will not be subject to a market valuetermination for which the Company would be liable. The Company recorded$87.2 million, $89.2 million and $69.1 million of net earnedpremium under these agreements for the years ended 2006, 2005 and 2004,respectively.

Changes in the fair valueof CDS, which were gains of $31.8 million, $11.1 million and$56.4 million for the years ended December 31, 2006, 2005, and 2004respectively, were recorded in net realized and unrealized gains on derivativeinstruments in the consolidated statements of operations and comprehensiveincome The Company’s net par outstanding of $74.7 billion and$66.6 billion relating to these CDS transactions at December 31, 2006and December 31, 2005, respectively, are included in the asset-backedinsured balances in Note 8. The gains or losses recognized by recordingthese contracts at fair value are determined each quarter based on quotedmarket prices, if available. If quoted market prices are not available, thenthe determination of fair value is based on internally developed estimates. TheCompany does not believe that the fair-value adjustments are an indication ofpotential claims under FSA’s guarantees or an indication of potential gains tobe realized from the derivative transactions. The average remaining life ofthese contracts was 3.1 years. The inception-to-date gain on the balancesheet was $89.2 million at December 31, 2006 and $57.4 millionat December 31, 2005, and was recorded in other assets.

***Interest Rate and Foreign Exchange Rate Derivatives***

The Company enters into derivative contracts to manageinterest rate and foreign currency exposure in its VIE debt and VIE bondportfolio. The derivative contracts are recorded at fair value. These derivativesgenerally include interest rate and currency swap agreements, which areprimarily utilized to convert fixed rate debt and investments into U.S. dollarfloating rate debt and investments. The gains and losses related to the fairvalue of derivatives are included in net realized and unrealized gains (losses)on derivative instruments. The inception-to-date net unrealized gain on theoutstanding derivatives held by the VIE’s of $516.8 million and$433.7 million at December 31, 2006 and December 31, 2005,respectively, was recorded in other assets and accrued expenses and otherliabilities as applicable.

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**12.**   MINORITYINTEREST IN SUBSIDIARY

In 1998, the Company andXL entered into a joint venture, establishing two Bermuda domiciled financialguaranty insurance companies—FSA International and XLFA. At December 31,2004, XL owned a minority interest in FSA International and the Company owned aminority interest in XLFA. In October 2005, FSA purchased all thepreferred shares of FSA International owned by XL Insurance (Bermuda), Ltd. fora cash purchase price of $39.1 million in anticipation of the repatriation ofearnings and profits of FSA International. Giving effect to such purchase, FSAInternational became an indirect wholly owned subsidiary of the Company. Thepreferred shares were Cumulative Participating Voting Preferred Shares that, intotal, had a minimum fixed dividend of $1.5 million per annum. In 2005 and2004, FSA International paid preferred dividends $16.3 million and$7.0 million, respectively, to XL. For the years ended December 31,2005 and 2004, the Company recognized minority interest $6.9 million and $7.0million, respectively.

**13.**   REINSURANCE

The Company obtains reinsurance to increase itspolicy-writing capacity on both an aggregate-risk and a single-risk basis; tomeet rating agency, internal and state insurance regulatory limits; todiversify risk; to reduce the need for additional capital; and to strengthenfinancial ratios. The Company reinsures portions of its risks with affiliated(see Note 19) and unaffiliated reinsurers under quota share, first-lossand excess-of-loss treaties and on a facultative basis.

In the event that any or all of the reinsuringcompanies are unable to meet their obligations, or contest such obligations,the Company would be unable to recover for such defaulted amounts. Certain ofthe reinsuring companies have provided collateral to secure their reinsuranceobligations.

Amountsof ceded and assumed business were as follows:

| ** **                                           | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                    | ** ** |
| Written premiums  ceded                              |       | $                                          | 288,780    |   | $ | 256,087 |   | $ | 244,211 |   |
| Written premiums  assumed                            |       | 12,066                                     |       | 9,474 |   | 11,567 |   |
| Earned premiums  ceded                               |       | 154,997                                    |       | 150,087 |   | 161,733 |   |
| Earned premiums  assumed                             |       | 4,627                                      |       | 3,521 |   | 6,608 |   |
| Losses and loss  adjustment expense payments ceded   |       | 3,486                                      |       | 1,465 |   | 52,372 |   |
| Losses and loss  adjustment expense payments assumed |       | 8                                          |       | 8 |   | 16 |   |
|                                                      |            |                                            |            |  |  |  |  |  |  |  |

 

| ** **                                           | ** ** | **December 31,**   | ** **  |
|------------------------------------------------------|------------|-------------------------|-------------|
| ** **                                           | ** ** | **2006**                | ** **  | **2005** | ** ** |
| ** **                                           | ** ** | **(in thousands)** | ** **  |
| Principal  outstanding ceded                         |       | $                       | 121,830,282 |   | $ | 120,607,468 |   |
| Principal  outstanding assumed                       |       | 3,757,565               |        | 2,597,375 |   |
| Deferred premium  revenue assumed                    |       | 31,216                  |        | 23,777 |   |
| Losses and loss  adjustment expense reserves assumed |       | 610                     |        | 643 |   |
|                                                      |            |                         |             |  |  |  |  |

 

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**14.**   OTHER ASSETS

Thedetailed balances that comprise other assets at December 31, 2006 and 2005are as follows:

| **Other assets:**         | ** ** | ** **              | ** ** | **2006** | ** ** | **2005**  | ** ** |
|--------------------------------|------------|-------------------------|------------|----------|------------|-----------|------------|
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Fair value of VIE  swaps       |       | $                       | 516,762    |     | $          | 433,670   |       |
| Fair-value  adjustments on CDS |       | 89,195                  |       | 57,372   |       |
| VIE other  invested assets     |       | 418,677                 |       | 266,978  |       |
| Tax and loss  bonds            |       | 127,150                 |       | 105,324  |       |
| Accrued interest  on VIE swaps |       | 136,975                 |       | 108,421  |       |
| Accrued interest  income       |       | 60,500                  |       | 53,101   |       |
| Other assets                   |       | 146,911                 |       | 137,696  |       |
| Total other  assets            |       | $                       | 1,496,170  |     | $          | 1,162,562 |       |

 

**15.**   COMMITMENTSAND CONTINGENCIES

EffectiveJune 2004, the Company entered into a 21-year sublease agreementwith Deutsche Bank AG for office space at 31 West 52nd Street, New York, New York to be used as theCompany’s new headquarters. The Company moved to this new space in June 2005.The lease contains scheduled rent increases every five years after a 19-monthrent-free period, as well as lease incentives for initial construction costs ofup to $6.0 million, as defined in the sublease. The lease contains provisionsfor rent increases related to increases in the building’s operating expenses.The lease also contains a renewal option for an additional ten-year period, andan option to rent additional office space at various points in the future, ineach case at then-current market rents. In addition the Company and itssubsidiaries lease additional office space under non-cancelable operatingleases, which expire at various dates through 2013. Future minimum rentalpayments are as follows:

| **Year Ended December 31,** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** |
|--------------------------------------------|------------|------------|------------|-------------------------|------------|
| 2007                                       |       |       | 9,163.6    |                    |       |
| 2008                                       |       |       | 8,217.4    |                    |       |
| 2009                                       |       |       | 8,204.7    |                    |       |
| 2010                                       |       |       | 8,141.2    |                    |       |
| 2011                                       |       |       | 8,125.3    |                    |       |
| Thereafter                                 |       |       | 111,723.1  |                    |       |
| Total                                      |       |       | $          | 153,575.3               |       |   |
|                                            |            |            |            |                         |            |  |  |  |

 

Rent expense was $9.4 million in 2006,$9.2 million in 2005 and $6.9 million in 2004. Rent expense in 2005includes a $1.1 million lease termination fee related to the Company’s formerheadquarters.

In the ordinary course of business, the Company and certainSubsidiaries are parties to litigation. The Company is not a party to anymaterial pending litigation.

On November 15, 2006,the Parent received a subpoena from the Antitrust Division of the U.S.Department of Justice issued in connection with an ongoing criminalinvestigation of bid rigging of awards of municipal GICs. On November 16,2006, FSA received a subpoena from the SEC related to an ongoing industry-widecivil investigation of brokers of municipal GICs. The Parent issues municipalGICs through the FP segment, but does not serve as a GIC broker. The subpoenasrequest that the Parent furnish to the DOJ and SEC records and otherinformation with respect to the Company’s municipal GIC business. The Parent iscooperating with the investigations by the DOJ and the SEC. 

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**16.**   DIVIDENDSAND CAPITAL REQUIREMENTS

FSA’s ability to pay dividends depends on FSA’sfinancial condition, results of operations, cash requirements, rating agencycapital adequacy and other related factors, and is also subject to restrictionscontained in the insurance laws and related regulations of New York and otherstates. Under the insurance laws of the State of New York, FSA may paydividends out of earned surplus, provided that, together with all dividendsdeclared or distributed by FSA during the preceding 12 months, thedividends do not exceed the lesser of (a) 10% of policyholders’ surplus asof its last statement filed with the Superintendent of Insurance of the Stateof New York (the “New York Superintendent”) or (b) adjusted net investmentincome during this period. FSA paid $140.0 million of dividends in 2006,$87.0million in 2005 and $30.0 million in 2004. Based upon FSA’s statutorystatements for December 31, 2006, the maximum amount normally availablefor payment of dividends by FSA without regulatory approval over the following12 months would be approximately $156.6 million.

FSA may repurchase sharesof its common stock from its shareholders subject to the New YorkSuperintendent’s approval. The New York Superintendent has approved therepurchase by the Company of up to $500.0 million of its shares from itsParent through December 31, 2008. In 2006, the Company repurchased $100.0million of shares of its common stock from FSA Holdings and retired such shares.

**17.**   CREDITARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES

FSA has a credit arrangement aggregating$150.0 million, that is provided by commercial banks and intended forgeneral application to insured transactions. If FSA is downgraded below Aa3 andAA-, the lenders may terminate the commitment and the commitment commissionbecomes due and payable. If FSA is downgraded below Baa3 and BBB-, anyoutstanding loans become due and payable. At December 31, 2006, there wereno borrowings under this arrangement, which expires on April 21, 2011, ifnot extended.

FSA has a standby line of credit commitment in theamount of $350.0 million with a group of international banks to provideloans to FSA after it has incurred, during the term of the facility, cumulativemunicipal losses (net of any recoveries) in excess of the greater of$350.0 million or the average annual debt service of the covered portfoliomultiplied by 5.00%, which amounted to $1,328.3 million at December 31,2006. The obligation to repay loans made under this agreement is a limitedrecourse obligation payable solely from, and collateralized by, a pledge ofrecoveries realized on defaulted insured obligations in the covered portfolio,including certain installment premiums and other collateral. This commitmenthas a term expiring on April 30, 2015 and contains an annual renewalprovision, commencing April 30, 2008, subject to approval by the banks. Noamounts have been utilized under this commitment as of December 31, 2006.

In June 2003, $200.0 million of money marketcommitted preferred trust securities (the “CPS Securities”) were issued bytrusts created for the primary purpose of issuing the CPS Securities, investingthe proceeds in high-quality commercial paper and providing FSA with putoptions for issuing to the trusts non-cumulative redeemable perpetual preferredstock (the “Preferred Stock”) of FSA. If FSA were to exercise a put option, theapplicable trust would transfer the portion of the proceeds attributable toprincipal received upon maturity of its assets, net of expenses, to FSA inexchange for Preferred Stock of FSA. FSA pays a floating put premium to thetrusts. The cost of the structure was $1.0 million and $1.3 millionfor 2006 and 2005 respectively, and was recorded in equity. The trusts arevehicles for providing FSA access to new capital at its sole discretion throughthe exercise of the put options. The Company does not consider itself to be theprimary beneficiary of the trusts under FIN 46R because it does not retain themajority of the residual benefits or expected losses.

The Company had borrowed $108.9 million from itsParent in the form of Surplus Notes. These notes carry a simple interest rateof 5.0% per annum. Principal and interest on the Surplus Notes may be paid at 

35

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any time at the option ofthe Company, subject to prior approval of the New York Superintendent andcompliance with the conditions to such payments as contained in the New YorkInsurance Laws. These notes have no stated maturity. The Company paid interestof $5.4 million, $5.4 million and $6.7 million in 2006, 2005 and2004, respectively. In 2004, with the approval of the New York Superintendent,FSA repaid $44.0 million of principal on such notes. There were norepayments in 2006 and 2005.

Certain FSA Global debt issuancescontain provisions that could extend the stated maturities of those notes. Toensure FSA Global will have sufficient cash flow to repay its fundingrequirements, it has entered into four liquidity facilities with Dexia aggregating$419.4 million.

**18.**   SEGMENT REPORTING

TheCompany operates in two business segments: financial guaranty and financialproducts. The financial guaranty segment is primarily in the business ofproviding financial guaranty insurance on public finance and asset-backedobligations. The FP Segment includes the VIEs’ operations, reflecting theCompany’s management of the VIEs’ operations. The results of the VIEs areincluded in the FP Segment beginning in 2006. Prior year disclosures have beenreclassified to conform to the 2006 presentation. The following tablessummarize the financial information by segment as of and for the years ended December 31,2006, 2005 and 2004:

| ** **                                                                 | ** ** | **For the Year Ended December 31, 2006** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **Financial  Guaranty**                                                | ** ** | **Financial  Products** | ** ** | **Intersegment  Eliminations** | ** ** | **Total** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**                                                | ** ** |
| Revenues:                                                                  |       |                                                                   |       |   |   |   |   |   |   |   |   |
| External                                                                   |       | $                                                                      | 714,085    |   | $ | 238,146 |   |   | $ | — |   |   | $ | 952,231 |   |
| Intersegment                                                               |       | 3,584                                                                  |       | — |   |   | (3,584 | ) |   | — |   |
| Expenses:                                                                  |       |                                                                   |       |   |   |   |   |   |   |   |   |
| External                                                                   |       | (201,705                                                               | )          | (282,946 | ) |   | — |   |   | (484,651 | ) |
| Intersegment                                                               |       | —                                                                 |       | (3,584 | ) |   | 3,584 |   |   | — |   |
| Less:                                                                      |       |                                                                   |       |   |   |   |   |   |   |   |   |
| SFAS 133 fair-value adjustments for CDS and economic  interest rate hedges |       | 31,823                                                                 |       | (48,496 | ) |   | — |   |   | (16,673 | ) |
| Pre-tax segment  operating earnings                                        |       | 484,141                                                                |       | 112 |   |   | — |   |   | 484,253 |   |
| Segment assets                                                             |       | $                                                                      | 6,966,379  |   | $ | 3,212,845 |   |   | $ | — |   |   | $ | 10,179,224 |   |

 

| ** **                                                                 | ** ** | **For the Year Ended December 31, 2005** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **Financial  Guaranty**                                                | ** ** | **Financial  Products** | ** ** | **Intersegment  Eliminations** | ** ** | **Total** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**                                                | ** ** |
| Revenues:                                                                  |       |                                                                   |       |   |   |   |   |   |   |   |   |
| External                                                                   |       | $                                                                      | 699,681    |   | $ | (28,354 | ) |   | $ | — |   |   | $ | 671,327 |   |
| Intersegment                                                               |       | 3,663                                                                  |       | — |   |   | (3,663 | ) |   | — |   |
| Expenses:                                                                  |       |                                                                   |       |   |   |   |   |   |   |   |   |
| External                                                                   |       | (201,248                                                               | )          | 37,902 |   |   | — |   |   | (163,346 | ) |
| Intersegment                                                               |       | —                                                                 |       | (3,663 | ) |   | 3,663 |   |   | — |   |
| Less:                                                                      |       |                                                                   |       |   |   |   |   |   |   |   |   |
| SFAS 133 fair-value adjustments for CDS and economic  interest rate hedges |       | 11,106                                                                 |       | 5,751 |   |   | — |   |   | 16,857 |   |
| Pre-tax segment  operating earnings                                        |       | 490,990                                                                |       | 134 |   |   | — |   |   | 491,124 |   |
| Segment assets                                                             |       | $                                                                      | 6,599,078  |   | $ | 3,016,972 |   |   | $ | — |   |   | $ | 9,616,050 |   |

 

36

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| ** **                                                                 | ** ** | **For the Year Ended December 31, 2004** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **Financial  Guaranty**                                                | ** ** | **Financial  Products** | ** ** | **Intersegment  Eliminations** | ** ** | **Total** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**                                                | ** ** |
| Revenues:                                                                  |       |                                                                   |       |   |   |   |   |   |   |   |   |
| External                                                                   |       | $                                                                      | 675,755    |   | $ | 321,784 |   |   | $ | — |   |   | $ | 997,539 |   |
| Intersegment                                                               |       | 4,855                                                                  |       | — |   |   | (4,855 | ) |   | — |   |
| Expenses:                                                                  |       |                                                                   |       |   |   |   |   |   |   |   |   |
| External                                                                   |       | (186,630                                                               | )          | (203,567 | ) |   | — |   |   | (390,197 | ) |
| Intersegment                                                               |       | —                                                                 |       | (4,855 | ) |   | 4,855 |   |   | — |   |
| Plus:                                                                      |       |                                                                   |       |   |   |   |   |   |   |   |   |
| Equity in earnings of unconsolidated affiliates                            |       | 3,761                                                                  |       | — |   |   | — |   |   | 3,761 |   |
| Less:                                                                      |       |                                                                   |       |   |   |   |   |   |   |   |   |
| SFAS 133 fair-value adjustments for CDS and economic  interest rate hedges |       | 56,400                                                                 |       | 112,900 |   |   | — |   |   | 169,300 |   |
| Pre-tax segment  operating earnings                                        |       | 441,341                                                                |       | 462 |   |   | — |   |   | 441,803 |   |
| Segment assets                                                             |       | $                                                                      | 6,393,888  |   | $ | 3,162,578 |   |   | $ | — |   |   | $ | 9,556,466 |   |

 

Thefollowing tables present reconciliations of segments’ pre-tax operatingearnings to net income.

| ** **                                                                 | ** ** | **For the Year  Ended December 31, 2006** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **Financial  Guaranty**                                                      | ** ** | **Financial  Products** | ** ** | **Intersegment  Eliminations** | ** ** | **Total** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**                                                      | ** ** |
| Pre-tax operating  earnings                                                |       | $                                                                            | 484,141    |   | $ | 112 |   |   | $ | — |   |   | $ | 484,253 |   |
| SFAS 133  fair-value gain (loss) for CDS and economic interest rate hedges |       | 31,823                                                                       |       | (48,496 | ) |   | — |   |   | (16,673 | ) |
| Taxes                                                                      |       |                                                                         |       |   |   |   |   |   |   | (126,739 | ) |
| Minority interest                                                          |       |                                                                         |       |   |   |   |   |   |   | 48,660 |   |
| Net income                                                                 |       |                                                                         |       |   |   |   |   |   |   | $ | 389,501 |   |
|                                                                            |            |                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                                 | ** ** | **For the Year  Ended December 31, 2005** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **Financial  Guaranty**                                                      | ** ** | **Financial  Products** | ** ** | **Intersegment  Eliminations** | ** ** | **Total** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**                                                      | ** ** |
| Pre-tax operating  earnings                                                |       | $                                                                            | 490,990    |   |   | $ | 134 |   |   |   | $ | — |   |   | $ | 491,124 |   |
| SFAS 133  fair-value gain (loss) for CDS and economic interest rate hedges |       | 11,106                                                                       |       |   | 5,751 |   |   |   | — |   |   | 16,857 |   |
| Taxes                                                                      |       |                                                                         |       |   |   |   |   |   |   |   |   | (143,023 | ) |
| Minority interest                                                          |       |                                                                         |       |   |   |   |   |   |   |   |   | (12,980 | ) |
| Net income                                                                 |       |                                                                         |       |   |   |   |   |   |   |   |   | $ | 351,978 |   |
|                                                                            |            |                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                                 | ** ** | **For the Year  Ended December 31, 2004** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **Financial  Guaranty**                                                      | ** ** | **Financial  Products** | ** ** | **Intersegment  Eliminations** | ** ** | **Total** | ** ** |
| ** **                                                                 | ** ** | **(in thousands)**                                                      | ** ** |
| Pre-tax operating  earnings                                                |       | $                                                                            | 441,341    |   | $ | 462 |   |   | $ | — |   |   | $ | 441,803 |   |
| SFAS 133  fair-value gain (loss) for CDS and economic interest rate hedges |       | 56,400                                                                       |       | 112,900 |   |   | — |   |   | 169,300 |   |
| Taxes                                                                      |       |                                                                         |       |   |   |   |   |   |   | (123,418 | ) |
| Minority interest                                                          |       |                                                                         |       |   |   |   |   |   |   | (120,397 | ) |
| Net income                                                                 |       |                                                                         |       |   |   |   |   |   |   | $ | 367,288 |   |
|                                                                            |            |                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

The amount of SFAS 133fair-value adjustments for CDS is a reconciling item between pre-tax segmentoperating earnings and net income. In addition, management subtracts the impactof economic interest rate hedges when analyzing the segments. By removing theeffect of the one-sided accounting caused by marking the derivatives to fairvalue, but not the hedged assets or liabilities, the measure will more closelyreflect the underlying performance of segment operations.

**19.**   RELATEDPARTY TRANSACTIONS

Thetable below summarizes amounts included in the financial statements resultingfrom transaction types executed with related parties:

| ** **                                                | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| ** **                                                | ** ** | **(in millions)**                | ** ** |
| **XL(1)**                                                 |       |                                  |       |   |   |
| Prepaid reinsurance                                       |       | $                                     | 109.7      |   | $ | 84.4 |   |
| Reinsurance recoverable for unpaid losses                 |       | 3.2                                   |       | 1.8 |   |
| **Dexia(2)**                                              |       |                                  |       |   |   |
| Other assets(3)                                           |       | 344.5                                 |       | 306.4 |   |
| Deferred premium revenue                                  |       | 18.2                                  |       | 22.5 |   |
| Variable Interest Entities debt                           |       | 181.8                                 |       | 172.1 |   |
| Gross Par Outstanding                                     |       | 17,034.4                              |       | 22,846.6 |   |
| Other liabilities                                         |       | 2.1                                   |       | 2.3 |   |
| **GIC  Affiliates(4)**                                    |       |                                  |       |   |   |
| Guaranteed investment contracts                           |       | 962.8                                 |       | 1,021.8 |   |
| Guaranteed  investment contracts included in other assets |       | 260.9                                 |       | 120.3 |   |
|                                                           |            |                                       |            |  |  |  |  |

 

| ** **                                      | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(in millions)**                                        | ** ** |
| **XL(1)**                                       |       |                                                          |       |   |   |   |   |
| Ceded premiums                                  |       | $                                                             | 46.1       |   | $ | 31.6 |   | $ | 35.2 |   |
| Dividends paid                                  |       | —                                                        |       | 16.3 |   | 7.0 |   |
| **Dexia(2)**                                    |       |                                                          |       |   |   |   |   |
| Gross premiums earned                           |       | 26.4                                                          |       | 29.5 |   | 29.3 |   |
| Derivative (gains/loss)                         |       | 8.3                                                           |       | (7.2 | ) | 96.3 |   |
| Variable Interest Entities net interest expense |       | 9.8                                                           |       | 9.3 |   | 8.8 |   |
| **GIC  Affiliates(4)**                          |       |                                                          |       |   |   |   |   |
| Net interest  income                            |       | 55.5                                                          |       | 37.5 |   | 28.9 |   |
|                                                 |            |                                                               |            |  |  |  |  |  |  |  |

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(1)          The Company cededbusiness to XL Capital Ltd. (“XL”), a major Bermuda-based insuranceholding company, which owned an interest in FSA International prior to October 2005.

(2)          Represents business withaffiliates of Dexia.

(3)          Represents primarilyderivative fair value adjustments and accrued interest.

(4)          In addition to therelated party transactions described above, all of the guaranteed investmentcontracts within the Financial Products Segment Investment Portfolio are issuedby the GIC Affiliates.

FSA Global maintainsliquidity facilities with Dexia (see Note 17).

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**20.**   DISCLOSURESABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company determines fair value using availablemarket information and appropriate valuation methodologies. However,considerable judgment is necessary to interpret the data to develop theestimates of fair value. Accordingly, the estimates presented herein are notnecessarily indicative of the amount the Company could realize in a currentmarket exchange. The use of different market assumptions and/or estimationmethodologies may have a material effect on the estimated fair-value amounts.

For bonds, equity securities and the VIE bondportfolio, the carrying amount represents fair value. The fair value is basedon quoted market price or redemption value for the Company’s investment inXLFA.

For short-term investments, including the VIEshort-term investments, the carrying amount is cost, which approximates fairmarket value due to the short maturity of the instruments.

For cash, receivable for investments sold and payablefor investments purchased, the carrying amount is cost, which approximates fairvalue because of the short maturity of these instruments.

For assets acquired under refinancing transactions,the fair value is either the present value of the expected cash flows or quotedmarket prices as of the reporting date.

For deferred premium revenue, net of prepaidreinsurance premiums, the carrying amount represents the Company’s futurepremium revenue, net of reinsurance, on policies where the premium was receivedat the inception of the insurance policy. The fair value of deferred premiumrevenue, net of prepaid reinsurance premiums, is an estimate of the statutorypremiums that would be paid under a reinsurance agreement with a third party totransfer the Company’s financial guaranty risk, net of that portion of thepremiums retained by the Company to compensate it for originating and servicingthe insurance contract.

The Company could not determine the fair value of the surplusnotes because the related party debt does not contain normal commercial termssuch as a maturity date. 

For notes payable to affiliate, the fair value is thepresent value of the expected cash flows as of the reporting date.

For installment premiums, consistent with industrypractice, there is no carrying amount since the Company will receive premiumson an installment basis over the term of the insurance contract. Similar to thetreatment of deferred premium revenue, the fair value of installment premiumsis the estimated present value of the future contractual premium revenues thatwould be received under a reinsurance agreement with a third party to transferthe Company’s financial guaranty risk, net of that portion of the premiumretained by the Company to compensate it for originating and servicing theinsurance contract.

For VIE debt, the fair value is the present value ofthe expected cash flows as of the reporting date.

For losses and loss adjustment expenses, net ofreinsurance recoverable on unpaid losses, the carrying amount is net presentvalue of the expected cash flows for specifically identified claims andinherent losses in the Company’s insured portfolio, which management believesis a reasonable proxy for fair value.

For fair-value adjustments on derivatives, thecarrying amount represents fair value. The Company uses quoted market priceswhen available, but if quoted market prices are not available, management usesinternally developed estimates.

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Thetable below shows the carrying amount and fair value of the Company’s financialinstruments:

| ** **                                                                            | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                                            | ** ** | **Carrying  Amount**            | ** ** | **Fair Value**             | ** ** | **Carrying  Amount** | ** ** | **Fair Value** | ** ** |
| ** **                                                                            | ** ** | **(in thousands)**         | ** ** |
| Assets:                                                                               |       |                            |       |                            |       |   |   |   |   |
| Bonds                                                                                 |       | $                               | 4,681,144  |                            | $          | 4,681,144 |   | $ | 4,370,469 |   | $ | 4,370,469 |   |
| Equity securities                                                                     |       | 54,325                          |       | 54,325                          |       | 54,370 |   | 54,370 |   |
| Variable interest entities’ bonds                                                |       | 1,128,255                       |       | 1,128,255                       |       | 1,155,992 |   | 1,155,992 |   |
| Variable interest entities’ GICs                                                 |       | 962,815                         |       | 962,815                         |       | 1,021,791 |   | 1,021,791 |   |
| Short-term investments                                                                |       | 86,503                          |       | 86,503                          |       | 104,153 |   | 104,153 |   |
| VIE short-term investments                                                            |       | 19,478                          |       | 19,478                          |       | 2,674 |   | 2,674 |   |
| Cash                                                                                  |       | 29,660                          |       | 29,660                          |       | 39,506 |   | 39,506 |   |
| Assets acquired in refinancing transactions                                           |       | 337,872                         |       | 333,389                         |       | 467,873 |   | 460,770 |   |
| Fair value adjustments on derivatives                                                 |       | 605,957                         |       | 605,957                         |       | 491,041 |   | 491,041 |   |
| Receivable for securities sold                                                        |       | 161                             |       | 161                             |       | 1,382 |   | 1,382 |   |
| Liabilities:                                                                          |       |                            |       |                            |       |   |   |   |   |
| Deferred premium revenue, net of prepaid reinsurance  premiums                        |       | 1,653,607                       |       | 1,449,526                       |       | 1,515,408 |   | 1,295,312 |   |
| Losses and loss adjustment expenses, net of  reinsurance recoverable on unpaid losses |       | 190,780                         |       | 190,780                         |       | 169,379 |   | 169,379 |   |
| Notes payable to affiliate                                                            |       | 321,371                         |       | 313,580                         |       | 463,575 |   | 455,814 |   |
| VIE debt                                                                              |       | 3,067,745                       |       | 3,144,519                       |       | 2,708,773 |   | 2,960,686 |   |
| Surplus notes                                                                         |       | 108,850                         |       | N/A                             |       | 108,850 |   | N/A |   |
| Payable for investments purchased                                                     |       | 3,257                           |       | 3,257                           |       | 28,947 |   | 28,947 |   |
| Fair value adjustments on derivatives                                                 |       | 592                             |       | 592                             |       | 1,060 |   | 1,060 |   |
| Off-balance-sheet  instruments:                                                       |       |                            |       |                            |       |   |   |   |   |
| Installment  premiums                                                                 |       | —                          |       | 579,541                         |       | — |   | 538,951 |   |
|                                                                                       |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |

 

**21.**   STATUTORYACCOUNTING PRACTICES

GAAP differs incertain significant respects from statutory accounting practices applicable tothe Company and its insurance company subsidiaries, that are prescribed orpermitted by insurance authorities. The principal differences result from thefollowing statutory accounting practices:

·       upfrontpremiums are recognized as earned when related principal and interest haveexpired rather than over the expected coverage period;

·       acquisitioncosts are charged to operations as incurred rather than as related premiums areearned;

·       acontingency reserve (rather thana non-specific reserve) is computed based on the following statutoryrequirements:

1)            Forall policies written prior to July 1, 1989, an amount equal to 50% ofcumulative earned premiums less permitted reductions plus

2)            For all policieswritten on or after July 1, 1989, an amount equal to the greater of 50% ofpremiums written for each category of insured obligation or a designatedpercentage of principal guaranteed for that category. These amounts areprovided each quarter as either  1¤60thor  1¤80thof the total required for each category, less permitted reductions;

·       certainassets designated as “non-admittedassets” are charged directly to statutory surplus but are reflected as assetsunder GAAP;

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·       deferredtax assets are generally admittedto the extent reversals of existing temporary differences in the subsequentyear can be recovered through carry back;

·       insuredCDS are considered to be insurance contracts, not derivative contracts recordedat fair value;

·       bondsare carried at amortized cost;

·       VIEsand refinancing vehicles are not consolidated under statutory accountingstandards; and

·       surplusnotes are recognized as surplus rather than as a liability unless approved forrepayment

Consolidated statutory net income was $339.6 millionfor 2006, $293.0 for 2005 and $242.1 million for 2004. Combined statutorysurplus plus contingency reserves was $2,554.1 million for 2006, $2,417.5million for 2005 and $2,280.9 million for 2004.

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