Exhibit 99.1

FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES

Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm  December 31, 2004

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FINANCIAL SECURITY ASSURANCE INC. AND SUBSIDIARIES    CONSOLIDATED FINANCIAL STATEMENTS  AND REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM    YEARS ENDED DECEMBER 31, 2004, 2003 AND
2002

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

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Report of Independent Registered Public Accounting Firm

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

In
our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and comprehensive income, changes in shareholder's equity, and cash
flows present fairly, in all material respects, the financial position of Financial Security Assurance Inc. and Subsidiaries (the "Company") at December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United
States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

As
discussed in Note 20 to the consolidated financial statements, the Company changed its method of accounting for its interest in certain variable interest entities.

/s/
PricewaterhouseCoopers LLP

PricewaterhouseCoopers
LLP
New York, New York
March 23, 2005

1

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

|                                                                                                                    |                                                                  | December 31,
2004                                 |           | December 31,
2003
|------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------- | ------------------------------------------------- | --------- | -----------------
|ASSETS                                                                                                              |                                                                  |                                                   |           |                  
|Bonds at fair value (amortized cost of $3,636,790 and $3,254,503)                                                   |                                                                  | $                                                 | 3,888,586 |                  
|Equity securities at fair value (cost of $54,300)                                                                   |                                                                  |                                                   | 54,300    |                  
|Short-term investments                                                                                              |                                                                  |                                                   | 316,921   |                  
|Variable interest entities' bonds at fair value (amortized cost of $1,346,109 and $1,423,657)                       |                                                                  |                                                   | 1,346,355 |                  
|Variable interest entities' guaranteed investments contracts at fair value (amortized cost approximates fair value) |                                                                  |                                                   | 961,925   |                  
|Variable interest entities' short-term investment portfolio                                                         |                                                                  |                                                   | 1,194     |                  
|                                                                                                                    |                                                                  |                                                   |           |                  
|                                                                                                                    | Total investment portfolio                                       |                                                   |           | 6,569,281        
|Assets acquired in refinancing transactions:                                                                        |                                                                  |                                                   |           |                  
|                                                                                                                    | Bonds at fair value (amortized cost of $151,895)                 |                                                   |           | 157,036          
|                                                                                                                    | Securitized loans                                                |                                                   |           | 369,750          
|                                                                                                                    | Other                                                            |                                                   |           | 222,150          
|                                                                                                                    |                                                                  |                                                   |           |                  
|                                                                                                                    |                                                                  | Total assets acquired in refinancing transactions |           |                  
|Cash                                                                                                                |                                                                  |                                                   | 10,005    |                  
|Deferred acquisition costs                                                                                          |                                                                  |                                                   | 308,015   |                  
|Prepaid reinsurance premiums                                                                                        |                                                                  |                                                   | 759,191   |                  
|Investment in unconsolidated affiliate                                                                              |                                                                  |                                                   |          |                  
|Reinsurance recoverable on unpaid losses                                                                            |                                                                  |                                                   | 35,419    |                  
|Other assets                                                                                                        |                                                                  |                                                   | 1,145,647 |                  
|                                                                                                                    |                                                                  |                                                   |           |                  
|                                                                                                                    | TOTAL ASSETS                                                     |                                                   | $         | 9,576,494        
|                                                                                                                    |                                                                  |                                                   |           |                  
|LIABILITIES AND MINORITY INTEREST AND
SHAREHOLDER'S EQUITY                                                          |                                                                  |                                                   |           |                  
|Deferred premium revenue                                                                                            |                                                                  | $                                                 | 2,101,248 |                  
|Losses and loss adjustment expenses                                                                                 |                                                                  |                                                   | 179,941   |                  
|Variable interest entities' debt                                                                                    |                                                                  |                                                   | 3,123,118 |                  
|Deferred federal income taxes                                                                                       |                                                                  |                                                   | 253,868   |                  
|Notes payable to affiliate                                                                                          |                                                                  |                                                   | 753,614   |                  
|Surplus notes                                                                                                       |                                                                  |                                                   | 108,850   |                  
|Accrued expenses, minority interest and other liabilities                                                           |                                                                  |                                                   | 356,069   |                  
|                                                                                                                    |                                                                  |                                                   |           |                  
|                                                                                                                    | TOTAL LIABILITIES AND MINORITY INTEREST                          |                                                   |           | 6,876,708        
|                                                                                                                    |                                                                  |                                                   |           |                  
|Preferred stock (5,000.1 and 0 shares authorized; 0 shared issued and outstanding; par value of $1,000 per share)   |                                                                  |                                                   |           |                  
|Common stock (400 shares authorized; issued and outstanding; par value of $37,500 per share)                        |                                                                  |                                                   | 15,000    |                  
|Additional paid-in capitalcommon                                                                                   |                                                                  |                                                   | 839,077   |                  
|Accumulated other comprehensive income (net of deferred income taxes of $88,057 and $78,340)                        |                                                                  |                                                   | 170,620   |                  
|Accumulated earnings                                                                                                |                                                                  |                                                   | 1,675,089 |                  
|                                                                                                                    |                                                                  |                                                   |           |                  
|                                                                                                                    | TOTAL SHAREHOLDER'S EQUITY                                       |                                                   |           | 2,699,786        
|                                                                                                                    |                                                                  |                                                   |           |                  
|                                                                                                                    | TOTAL LIABILITIES AND MINORITY INTEREST AND SHAREHOLDER'S EQUITY |                                                   | $         | 9,576,494        
|                                                                                                                    |                                                                  |                                                   |           |                  

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

2

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

|                                                                      |                                                                                                                                                           | Year Ended December 31, |        
|--------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------- | -------
|
|REVENUES:                                                             |                                                                                                                                                           |                         |        
|                                                                      | Net premiums written                                                                                                                                      |                         | $      
|                                                                      |                                                                                                                                                           |                         |        
|                                                                      | Net premiums earned                                                                                                                                       |                         | $      
|                                                                      | Net investment income                                                                                                                                     |                         |        
|                                                                      | Net realized gains (losses)                                                                                                                               |                         |        
|                                                                      | Variable interest entities' net interest income                                                                                                           |                         |        
|                                                                      | Net realized and unrealized gains (losses) on derivative instruments                                                                                      |                         |        
|                                                                      | Income from assets acquired in refinancing transactions                                                                                                   |                         |        
|                                                                      | Other income                                                                                                                                              |                         |        
|                                                                      |                                                                                                                                                           |                         |        
|TOTAL REVENUES                                                        |                                                                                                                                                           |                         | 742,255
|EXPENSES:                                                             |                                                                                                                                                           |                         |        
|                                                                      | Losses and loss adjustment expenses                                                                                                                       |                         |        
|                                                                      | Interest expense                                                                                                                                          |                         |        
|                                                                      | Variable interest entities' net interest expense                                                                                                          |                         |        
|                                                                      | Policy acquisition costs                                                                                                                                  |                         |        
|                                                                      | Other operating expenses                                                                                                                                  |                         |        
|                                                                      |                                                                                                                                                           |                         |        
|TOTAL EXPENSES                                                        |                                                                                                                                                           |                         | 240,897
|                                                                      |                                                                                                                                                           |                         |        
|Minority interest                                                     |                                                                                                                                                           |                         | (7,443 
|Equity in earnings of unconsolidated affiliates                       |                                                                                                                                                           |                         | 3,761  
|                                                                      |                                                                                                                                                           |                         |        
|INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE |                                                                                                                                                           |                         | 497,676
|Provision (benefit) for income taxes:                                 |                                                                                                                                                           |                         |        
|                                                                      | Current                                                                                                                                                   |                         |        
|                                                                      | Deferred                                                                                                                                                  |                         |        
|                                                                      |                                                                                                                                                           |                         |        
|                                                                      | Total provision                                                                                                                                           |                         |        
|                                                                      |                                                                                                                                                           |                         |        
|INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE                  |                                                                                                                                                           |                         | 373,827
|Cumulative effect of accounting change, net of income taxes of $2,598 |                                                                                                                                                           |                         |       
|                                                                      |                                                                                                                                                           |                         |        
|NET INCOME                                                            |                                                                                                                                                           |                         | 373,827
|OTHER COMPREHENSIVE INCOME, NET OF TAX:                               |                                                                                                                                                           |                         |        
|                                                                      | Unrealized gains arising during period [net of deferred income tax provision of $9,175, $8,830 and $49,196]                                               |                         |        
|                                                                      | Less: reclassification adjustment for gains (losses) included in net income [net of deferred income tax (benefit) provision of ($542), $1,389 and $7,641] |                         |        
|                                                                      |                                                                                                                                                           |                         |        
|                                                                      | Other comprehensive income                                                                                                                                |                         |        
|                                                                      |                                                                                                                                                           |                         |        
|COMPREHENSIVE INCOME                                                  |                                                                                                                                                           | $                       | 392,722
|                                                                      |                                                                                                                                                           |                         |        

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

3

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

|                                                                                                     |  | Common
Stock |        | Additional
Paid-In
Capital-
Common |   | Unrealized
Gain on
Investments |   | Accumulated
Earnings |         | Total |  
|---------------------------------------------------------------------------------------------------- |  | ------------ | ------ | ---------------------------------- | - | ------------------------------ | - | -------------------- | ------- | ----- | -
|BALANCE, December 31, 2001                                                                           |  | $            | 15,000 |                                    | $ | 794,797                        |   | $                    | 62,920  |       | $
|Net income for the year                                                                              |  |              |        |                                    |   |                                |   |                      |         |       |  
|Net change in accumulated other comprehensive income (net of deferred income tax expense of $41,555) |  |              |        |                                    |   |                                |   |                      | 80,340  |       |  
|Dividends paid                                                                                       |  |              |        |                                    |   |                                |   |                      |         |       |  
|Capital contribution from Parent                                                                     |  |              |        |                                    |   | 18,205                         |   |                      |         |       |  
|                                                                                                     |  |              |        |                                    |   |                                |   |                      |         |       |  
|BALANCE, December 31, 2002                                                                           |  |              | 15,000 |                                    |   | 813,002                        |   |                      | 143,260 |       |  
|Net income for the year                                                                              |  |              |        |                                    |   |                                |   |                      |         |       |  
|Net change in accumulated other comprehensive income (net of deferred income tax expense of $7,441)  |  |              |        |                                    |   |                                |   |                      | 8,465   |       |  
|Capital contribution from Parent                                                                     |  |              |        |                                    |   | 10,521                         |   |                      |         |       |  
|Capital issuance costs                                                                               |  |              |        |                                    |   | (3,605                         | ) |                      |         |       |  
|                                                                                                     |  |              |        |                                    |   |                                |   |                      |         |       |  
|BALANCE, December 31, 2003                                                                           |  |              | 15,000 |                                    |   | 819,918                        |   |                      | 151,725 |       |  
|Net income for the year                                                                              |  |              |        |                                    |   |                                |   |                      |         |       |  
|Net change in accumulated other comprehensive income (net of deferred income tax expense of $9,717)  |  |              |        |                                    |   |                                |   |                      | 18,895  |       |  
|Dividends paid                                                                                       |  |              |        |                                    |   |                                |   |                      |         |       |  
|Capital contribution from Parent                                                                     |  |              |        |                                    |   | 20,419                         |   |                      |         |       |  
|Capital issuance costs                                                                               |  |              |        |                                    |   | (1,260                         | ) |                      |         |       |  
|Other                                                                                                |  |              |        |                                    |   |                                |   |                      |         |       |  
|                                                                                                     |  |              |        |                                    |   |                                |   |                      |         |       |  
|BALANCE, December 31, 2004                                                                           |  | $            | 15,000 |                                    | $ | 839,077                        |   | $                    | 170,620 |       | $
|                                                                                                     |  |              |        |                                    |   |                                |   |                      |         |       |  

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

4

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

|                                      |                                                                    | Years Ended December 31,                  |       
|------------------------------------- | ------------------------------------------------------------------ | ----------------------------------------- | ------
|
|Cash flows from operating activities: |                                                                    |                                           |       
|                                      | Premiums received, net                                             |                                           | $     
|                                      | Policy acquisition and other operating expenses paid, net          |                                           |       
|                                      | Termination fee on derivative                                      |                                           |       
|                                      | Recoverable advances recovered (paid)                              |                                           |       
|                                      | Losses and loss adjustment expenses paid                           |                                           |       
|                                      | Net investment income received                                     |                                           |       
|                                      | Variable interest entities' net investment income received         |                                           |       
|                                      | Variable interest entities' interest paid                          |                                           |       
|                                      | Federal income taxes paid                                          |                                           |       
|                                      | Interest paid                                                      |                                           |       
|                                      | Income received from refinanced assets                             |                                           |       
|                                      | Other, net                                                         |                                           |       
|                                      |                                                                    |                                           |       
|                                      |                                                                    | Net cash provided by operating activities |       
|                                      |                                                                    |                                           |       
|Cash flows from investing activities: |                                                                    |                                           |       
|                                      | Proceeds from sales of bonds                                       |                                           |       
|                                      | Purchases of bonds                                                 |                                           |       
|                                      | Purchases of property and equipment                                |                                           |       
|                                      | Net decrease (increase) in short-term investments                  |                                           |       
|                                      | Purchases of variable interest entities' bonds                     |                                           |       
|                                      | Maturity of VIE bonds                                              |                                           |       
|                                      | Net decrease in variable interest entities' short-term investments |                                           |       
|                                      | Assets acquired through refinancing transactions                   |                                           |       
|                                      | Other investments                                                  |                                           |       
|                                      |                                                                    |                                           |       
|                                      |                                                                    | Net cash provided by investing activities |       
|                                      |                                                                    |                                           |       
|Cash flows from financing activities: |                                                                    |                                           |       
|                                      | Surplus notes issued                                               |                                           |       
|                                      | Distribution to minority shareholder                               |                                           |       
|                                      | Surplus notes repaid                                               |                                           |       
|                                      | Proceeds from issuance of variable interest entities' debt         |                                           |       
|                                      | Issuance of notes payable                                          |                                           |       
|                                      | Repayment of notes payable                                         |                                           |       
|                                      | Capital issuance costs                                             |                                           |       
|                                      | Dividends paid                                                     |                                           |       
|                                      | Repayment of VIE preferred stock                                   |                                           |       
|                                      | Repayment of VIE debt                                              |                                           |       
|                                      |                                                                    |                                           |       
|                                      |                                                                    | Net cash provided by financing activities |       
|                                      |                                                                    |                                           |       
|Net increase (decrease) in cash       |                                                                    |                                           | (1,635
|Cash at beginning of year             |                                                                    |                                           | 11,640
|                                      |                                                                    |                                           |       
|Cash at end of year                   |                                                                    | $                                         | 10,005
|                                      |                                                                    |                                           |       

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

5

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

|                                                                          |                                                                              | Years Ended December 31, |        
|------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | ------------------------ | -------
|
|Reconciliation of net income to net cash flows from operating activities: |                                                                              |                          |        
|Net income                                                                |                                                                              | $                        | 373,827
|                                                                          | Increase in accrued investment income                                        |                          |        
|                                                                          | Increase in deferred premium revenue and related foreign exchange adjustment |                          |        
|                                                                          | Increase in deferred acquisition costs                                       |                          |        
|                                                                          | (Decrease) Increase in current federal income taxes payable                  |                          |        
|                                                                          | Increase (decrease) in unpaid losses and loss adjustment expenses            |                          |        
|                                                                          | Decrease in amounts withheld for others                                      |                          |        
|                                                                          | Provision (benefit) for deferred income taxes                                |                          |        
|                                                                          | Net realized gains on investments                                            |                          |        
|                                                                          | Depreciation and accretion of discount                                       |                          |        
|                                                                          | Minority interest and equity in earnings of unconsolidated subsidiaries      |                          |        
|                                                                          | Change in other assets and liabilities                                       |                          |        
|                                                                          |                                                                              |                          |        
|Cash provided by operating activities                                     |                                                                              | $                        | 536,497
|                                                                          |                                                                              |                          |        

On
July 1, 2003, the Company consolidated $2.9 billion in assets and $2.9 billion in liabilities relating to variable interest entities with no corresponding cash
movement.

In
2004, 2003 and 2002, the Company received a tax benefit of $20.4 million, $10.5 million and $18.2 million, respectively, by utilizing its Parent's losses. These
amounts were recorded as a 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. AND SUBSIDIARIES    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS    FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

1.     ORGANIZATION AND OWNERSHIP

Financial Security Assurance Inc. ("FSA" or the "Company"), a wholly owned subsidiary of Financial Security Assurance Holdings Ltd. (the "Parent"),
is a New York insurance company. The Company is engaged in providing financial guaranty insurance on asset-backed and municipal obligations. The Company's underwriting policy is to insure asset-backed
and municipal obligations that it determines would be of investment-grade quality without the benefit of the Company's insurance. The asset-backed obligations insured by the Company are generally
issued in structured transactions and are backed by pools of assets, such as residential mortgage loans, consumer receivables, securities or other assets having an ascertainable cash flow or market
value. The Company also insures synthetic asset-backed obligations that generally take the form of credit default swap ("CDS") obligations or credit-linked notes that reference pools of securities or
loans, with a defined deductible to cover credit risks associated with the referenced securities or loans. The municipal obligations insured by the Company consist primarily of general obligation
bonds that are supported by the issuers' taxing power and special revenue bonds and other special obligations of states and local governments that are supported by the issuers' ability to impose and
collect fees and charges for public services or specific projects. Municipal obligations include obligations backed by the cash flow from leases or other revenues from projects serving a substantial
public purpose, including government office buildings, toll roads, healthcare facilities and utilities. Financial guaranty insurance written by the Company guarantees scheduled payments on an issuer's
obligation. In the case of a payment default on an insured obligation, the Company is generally required to pay the principal, interest or other amounts due in accordance with the obligation's
original payment schedule or, at its option, to pay such amounts on an accelerated basis. In addition, the Company insures guaranteed investment contracts ("GICs") issued by FSA Capital Markets
Services LLC and FSA Capital Management Services LLC (collectively, "CMS"), wholly owned subsidiaries of the Parent.

The
Company expects to continue to emphasize a diversified insured portfolio characterized by insurance of both asset-backed and municipal obligations, with a broad geographic
distribution and a
variety of revenue sources and transaction structures. The Company's insured portfolio consists primarily of asset-backed and municipal obligations originated in the United States of America, but the
Company has also written and continues to pursue business in Europe and the Asia Pacific region.

The
Company consolidates the results of certain variable interest entities ("VIEs"), including FSA Global Funding Limited ("FSA Global"), Premier International Funding Co. ("Premier")
and Canadian Global Funding Corporation ("Canadian Global"). The Company consolidated FSA Global and Canadian Global beginning in the third quarter of 2003 in accordance with Financial Accounting
Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" ("FIN 46"). The Company also began to consolidate Premier in the
third quarter of 2003 as a result of obtaining control rights. The Company refinanced certain defaulted transactions by employing refinancing vehicles to raise funds for the refinancings. These
refinancing vehicles are also consolidated.

FSA
Global is a special purpose funding vehicle 29% owned by the Company. FSA Global issues FSA-insured medium term notes and invests the proceeds from the sale of its notes
in FSA-insured obligations with a view towards realizing the yield difference between the notes issued and the obligations purchased with the note proceeds. At December 31, 2004,
the VIEs had $2.4 billion principal amount of outstanding notes, after elimination of intercompany transactions. The majority of Canadian Global's assets were liquidated and its liabilities
satisfied during the third quarter of 2004. Premier is principally engaged in debt defeasance for lease transactions.

7

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The
Company's management believes that the assets held by FSA Global, Premier and the refinancing vehicles, including those that are eliminated in consolidation, are beyond the reach of
the Company and its creditors, even in bankruptcy or other receivership.

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

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"),
which differ in certain material respects from the accounting practices prescribed or permitted by insurance regulatory authorities (see Note 5).
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities in the Company's consolidated balance sheets at December 31, 2004 and 2003 and the reported amounts of revenues and expenses in the consolidated statements of
operations and comprehensive income for the years ended December 31, 2004, 2003 and 2002. Such estimates and assumptions include, but are not limited to, losses and loss adjustment expenses,
fair value of financial instruments and the deferral and amortization of policy acquisition costs. Actual results may differ from those estimates. Significant accounting policies under GAAP are as
follows:



The consolidated financial statements include the accounts of the Company and its direct and indirect subsidiaries, principally including FSA Insurance Company,
Financial Security Assurance International Ltd. ("FSA International"), and Financial Security Assurance (U.K.) Limited (collectively, the "Subsidiaries"). The consolidated financial statements
also include the accounts of certain variable interest entities as described in Note 1. All intercompany accounts and transactions have been eliminated. Certain prior-year balances
have been reclassified to conform to the 2004 presentation.



Investments in debt and equity securities designated as available for sale are carried at fair value. The unrealized gain or loss on the investments that are not
hedged is reflected as a separate component of shareholder's equity, net of applicable deferred income taxes. The unrealized gain or loss on the investments that qualify as fair-value
hedges is recorded in income currently.

Bond
discounts and premiums are amortized on the effective yield method over the remaining terms of the securities acquired. For mortgage-backed securities and any other holdings for
which prepayment risk may be significant, assumptions regarding prepayments are evaluated periodically and revised as necessary. Any adjustments required due to the resulting change in effective
yields are recognized in current income. Short-term investments, which are those investments with a maturity of less than one year at time of purchase, are carried at cost, which
approximates fair value. Cash equivalents are amounts deposited in money market funds and investments with a maturity at time of purchase of three months or less and are included in
short-term investments. Realized gains or losses on sale of investments are determined on the basis of specific identification. Investment income is recorded as earned.
Other-than-temporary impairments are reflected in earnings as a realized loss.

Investments
in unconsolidated affiliates are based on the equity method of accounting (see Note 16). The Company records its share of unrealized gains or losses, net of applicable
deferred taxes, in other comprehensive income.

8

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Derivative instruments, which are primarily designated as fair-value hedges, are entered into to manage interest-rate and currency exchange-rate
exposure on the VIE debt and VIE bond portfolio. The derivatives are recorded at fair value. These derivatives generally include interest-rate and currency swap agreements, which are primarily
utilized to convert the Company's fixed-rate obligations and investments on its VIE debt and VIE bond portfolio into U.S. dollar floating-rate obligations. The gains and losses relating to
these fair-value hedges, including any ineffective portion, are included in variable interest entities' net interest income and variable interest entities' net interest expense, as
appropriate, along with the offsetting change in fair value of the hedged item attributable to the risk being hedged, on the consolidated statements of operations and comprehensive income. Gains and
losses relating to derivatives that fail hedge effectiveness are recorded at fair value through earnings and included in variable interest entities' net interest income and variable interest entities'
net interest expense, as appropriate.

The
Company has also insured a number of CDS agreements that it intends, in each case, to hold for the full term of the agreement. It considers these agreements to be a normal extension
of its financial guaranty insurance business, although they are considered derivatives for accounting purposes. These agreements are recorded at fair value. The Company believes that the most
meaningful presentation of the financial statement impact of these derivatives is to reflect premiums as installments are received, to record losses and loss adjustment expenses as incurred and to
record changes in fair value as incurred. Changes in fair value are recorded in net realized and unrealized gains (losses) on derivative instruments and in other assets or other liabilities, as
appropriate. The Company uses quoted market prices, when available, to determine fair value. If quoted prices are not available, management uses internally developed estimates of fair value. Due to a
lack of a quoted market for the CDS obligations written by the Company, estimates generated from the Company's valuation process may differ materially from values that may be realized in market
transactions.



Gross and ceded premiums received in upfront payouts are earned in proportion to the amount of risk outstanding over the expected period of coverage. The amount
of risk outstanding is equal to the sum of the par amount of debt insured over the expected period of coverage. Deferred premium revenue and prepaid reinsurance premiums represent the portion of
premium that is applicable to coverage of risk to be provided in the future on policies in force. When an insured issue is retired or defeased prior to the end of the expected period of coverage, the
remaining deferred premium revenue and prepaid reinsurance premium, less any amount credited to a refunding issue insured by the Company, are recognized. For premiums received on an installment basis,
the Company earns the premium over each installment period, typically less than one year, throughout the period of coverage. When the Company, through its ongoing credit review process, identifies
transactions where certain triggers have been breached, the Company ceases to earn premiums.



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

Financial
guaranty as an industry has emerged over the past thirty years. Management believes that existing insurance accounting under Statement of Financial Accounting Standards No. 60,
"Accounting and Reporting by Insurance Enterprises" ("SFAS 60"), does not specifically address financial guaranty

9

---



insurance.
Accordingly, the accounting for loss and loss adjustment expenses within the financial guaranty insurance industry has developed based on analogy to the most directly comparable elements of
existing literature including sections of Statement of Financial Accounting Standards No. 60, SFAS No. 5, "Accounting for Contingencies" ("SFAS 5") and Emerging Issues Task Force Issue 85-20,
"Recognition of fees for guaranteeing a loan ("EITF 85-20").



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

The
Company calculates a loss and LAE liability based upon identified risks inherent in its entire insured portfolio. If an individual policy risk has a probable loss as of the balance
sheet date, a case reserve is established. For the remaining policy risks in the portfolio, a non-specific reserve is established to account for the inherent credit losses that can be statistically
estimated.

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

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

The
Company records non-specific reserves to reflect the credit risks inherent in its portfolio. Non-specific reserves, in addition to case reserves, represent the Company's estimate of
total reserves. Generally, when an insured credit deteriorates to a point where claims are expected, a case reserve is established. The establishment of non-specific reserves for credits that have not
yet defaulted is a common practice in the financial guaranty industry, although the Company acknowledges that there may be differences in the specific methodologies applied by other financial
guarantors in establishing and measuring these reserves.

The
Company establishes non-specific reserves on its entire portfolio of credits because the Company believes that a portfolio of insured obligations will deteriorate over its life and
that the existence of inherent loss can be proven statistically by data such as rating agency publications. The establishment of

10

---



these
reserves is a systematic process that considers this quantitative, statistical information obtained primarily from Moody's Investors Service, Inc. ("Moody's") and Standard & Poor's Ratings
Services ("S&P"), together with qualitative factors such as overall credit quality trends resulting from economic and political conditions, recent loss experience in particular segments of the
portfolio and changes in underwriting policies and procedures. The factors used to establish reserves are evaluated periodically by comparing the statistically computed loss amount to the incurred
losses as represented by case reserve activity to develop an experience factor, which is updated and applied to future originations. The process results in management's best estimate of inherent
losses associated with providing credit protection at each balance sheet date.

The
non-specific reserve amount established considers all levels of protection (e.g. reinsurance and overcollateralization). Net par outstanding for policies originated in the current
period is multiplied by loss frequency and severity factors, with the resulting amounts discounted at the risk-free rates using the treasury yield curve ("statistical calculation"). The discount rate
does not change and is used to accrete the loss for the life of each policy. The loss factors used for the calculation are the product of default frequency rates obtained from Moody's and severity
factors obtained from S&P. Moody's is chosen due to its credibility, large population, statistical format and reliability of future update. In its publication of default rates from 1970-2003, Moody's
tracks bonds over a twenty year horizon by credit rating at time of issuance. For the purpose of establishing appropriate severity factors, the Company's methodology segregates the portfolio into
asset classes, including healthcare transactions, all other municipal transactions, pooled corporate transactions, commercial real estate, and all other asset-
backed transactions. The severity factors are derived from capital charge assessments provided by S&P. S&P capital charges project loss levels by asset class and are incorporated into their capital
adequacy stress scenario analysis.

The
product of the current year statistical calculation multiplied by the current-year experience factor represents the present value of loss amounts calculated for current-year
originations. The experience factor is based on the Company's inception-to-date historical losses (starting from 1993, when the Company established the non-specific reserve methodology).
The experience factor is calculated by dividing cumulative inception-to-date actual losses incurred by the Company by the cumulative inception-to-date
losses determined by the statistical calculation. The experience factor which applies to the whole portfolio is reviewed, and where appropriate updated periodically, but no less than annually.

The
present value of loss amounts calculated for the current-year originations is established at inception of the policy and there is no subsequent change unless significant adverse or
favorable loss experience is observed. In the event that the experience factor is either increased or decreased based on adverse or favorable loss experience, an analysis is performed of the
non-specific reserve balance with particular emphasis on the asset class, if any, driving the experience factor adjustment. The objective of such analysis is to quantify the appropriate
adjustment to the overall non-specific reserve balance for the change in experience. The adjustment that increases or decreases the non-specific reserve is charged or credited
to loss expense.

The
present value of loss amounts calculated for the current-year originations plus an amount representing the accretion of discount pertaining to prior year originations are charged to
loss expense, and increase the non-specific loss reserve after adjustments that may be made to reflect observed favorable or adverse experience. The entire non-specific reserve is
available to absorb probable losses inherent in the portfolio. As there are no specific losses provided in the non-specific reserve there is no identifiable reinsurance recoverable. At the
time that a case reserve is identified, the gross loss liability is recognized along with the reinsurance recoverable, if any. The amount of reinsurance recoverable depends on the policy ceded and the
reinsurance agreements covering such policy. Management cannot predict the specific policies that will emerge as case-basis losses from the portfolio and is not entitled to recovery from the reinsurer
in advance of producing a case reserve.

11

---



Since the non-specific reserve contains the inherent losses of the portfolio, when a case reserve adjustment is deemed appropriate, whether the result of adverse or positive credit
developments, accretion or the addition of a new case reserve, a full transfer is made between the non-specific reserve and the case reserve balances with no effect to income. The adequacy of the
non-specific reserve balance is reviewed periodically and at least annually based on a review of the Company's inception to date cumulative case based losses divided by the total inception
to date cumulative net par underwritten. This inception-to-date result is compared with the product of the non specific reserves divided by the net par outstanding as of the balance sheet date. In the
event that such ratios are not in line, then further analysis is performed to quantify appropriate adjustments that may be either income statement charges or benefits on the Statements of Operations
and Comprehensive Income as occurred in 2002, 2003 and 2004 as described in Footnote 15.

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

As of December 31,2004

2003Case reserve discount rate

3.13%5.90%

4.94%6.10%Non-specific reserve discount rate

1.20%7.95%

1.2%7.95%Current experience factor

2.0

2.4




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

Management
believes that existing accounting literature does not address the unique attributes of financial guaranty insurance. As an insurance enterprise, the Company initially refers
to the accounting and financial reporting guidance in SFAS 60. In establishing loss liabilities, the Company relies principally on SFAS 60, which prescribes differing treatment depending on whether a
contract is a short-duration contract or a long-duration contract. Financial guaranty insurance does not fall clearly within the definition of either short-duration or long-duration contracts.
Therefore, the Company does not believe that SFAS 60 alone provides sufficient guidance for financial guaranty claim liability recognition.

As
a result, the Company also analogizes to SFAS 5, which requires the establishment of liabilities when a loss is both probable and estimable. The Company also relies by analogy on EITF
85-20, which provides general guidance on the recognition of losses related to guaranteeing a loan. In the absence of a comprehensive accounting model provided by SFAS 60, industry participants,
including the Company, have looked to such other guidance referred to above to develop an accounting policy for the establishment and measurement of loss liabilities. The Company believes that its
financial guaranty loss reserve policy is appropriate under the applicable accounting literature, and that it best reflects the fact that a portfolio of credit based insurance, comprising irrevocable
contracts that cannot be unilaterally changed by the insurer and that match the maturity terms of the underlying insured obligation, contains probable and reasonably estimable losses.

In
January and February of 2005, the Securities and Exchange Commission ("SEC") staff discussed with financial guaranty industry participants, differences in loss recognition practices
among those participants. Based on discussions with the SEC staff, the Company understands that the Financial

12

---



Accounting
Standards Board ("FASB") staff is considering whether additional guidance regarding financial guaranty insurance should be provided. When and if the FASB or SEC reach a conclusion on this
issue, the Company and the rest of the financial guaranty industry may be required to change some aspects of their loss reserving policies, and the potential changes could extend to premium and
expense recognition. The Company cannot predict how the FASB or SEC will resolve this issue and the resulting impact on its financial statements.

Until
additional guidance is issued, the Company intends to continue applying its existing policy regarding the establishment of both specific and non-specific loss reserves.



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



The debt is recorded at amortized cost. The Company may enter into associated transactions in order to reduce the Company's exposure to fluctuations in interest
and foreign currency rates and its related effect on the fair value of the debt. For fair-value hedges, changes in the fair value of the hedging instrument are recognized in income currently. The
change in the fair value of the hedged item in a qualifying hedge, attributable to the hedged risk, adjusts the carrying amount of the hedged item and is recognized in income currently. VIE debt may
include hybrid debt instruments that contain embedded derivates. Under certain conditions, embedded derivatives are required to be accounted for separately, at fair value through earnings.



Monetary assets and liabilities denominated in foreign currencies are translated at the spot rate. Non-monetary assets and liabilities are translated at
historical rates. Revenues and expenses denominated in foreign currencies are translated at average rates prevailing during the year. Unrealized gains and losses on available-for-sale securities, net
of deferred taxes, resulting from translating investments denominated in foreign currencies are recorded in shareholder's equity. Gains and losses from transactions in foreign currencies are recorded
in income.



The provision for income taxes consists of an amount for taxes currently payable and a provision for the deferred tax consequences of temporary differences
between tax basis of assets and liabilities and the financial statement basis.

Non-interest
bearing tax and loss bonds are purchased for the tax benefit resulting from deducting contingency reserves as provided under Internal Revenue Code
Section 832(e). The Company records the purchase of tax and loss bonds as pre-payments of federal income taxes and includes them in other assets.

13

---



3.     INVESTMENTS

Bonds at amortized cost of $9.7 million and $8.9 million at December 31, 2004 and 2003, respectively, were on deposit with state regulatory
authorities as required by insurance regulations.

Consolidated
net investment income, excluding income attributable to the variable interest entities' bond and short term portfolio (the "VIE portfolio"), consisted of the following (in
thousands):

Years Ended December 31,2004

2003

2002Bonds

$
171,058

$
152,977

$
136,352Equity investments








294Short-term investments


2,791


2,986


3,337Investment expenses


(2,907
)

(2,892
)

(2,377
)Net investment income

$
170,942

$
153,071

$
137,606


The
credit quality of bonds, excluding the VIE portfolio, at December 31, 2004 was as follows:

Rating(1)

Percent of BondsAAA

75.7
%AA

19.4A

4.8NR

0.1100.0
%


---

Of
the bonds included in the investment portfolio, excluding the VIE portfolio, 13.0% were AAA by virtue of insurance provided by the Company. Without giving effect to the Company's
guaranty, the weighted-average rating of the Company's insured investments was in the A+ range, and all of the investments were investment grade.

The
amortized cost and fair value of bonds, excluding the VIE portfolio, were as follows (in thousands):

December 31, 2004

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair ValueU.S. Treasury securities and obligations of U.S. government corporations and agencies

$
143,916

$
4,984

$
(347
)
$
148,553Obligations of states and political subdivisions


2,857,641


220,875


(1,987
)

3,076,529Foreign


126,099


19,895


(714
)

145,280Mortgage-backed securities


219,834


3,619


(1,322
)

222,131Corporate securities


232,457


7,056


(504
)

239,009Asset-backed securities


56,843


312


(71
)

57,084Short-term investments


316,921








316,921Total

$
3,953,711

$
256,741

$
(4,945
)
$
4,205,507


14

---



December 31, 2003

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair ValueU.S. Treasury securities and obligations of U.S. government corporations and agencies

$
121,301

$
4,110

$
(355
)
$
125,056Foreign


108,249


69


(2,368
)

105,950Obligations of states and political subdivisions


2,506,380


218,929


(1,287
)

2,724,022Mortgage-backed securities


196,465


3,834


(1,389
)

198,910Corporate securities


240,463


10,229


(589
)

250,103Asset-backed securities


81,645


1,720


(26
)

83,339Short-term investments


222,390








222,390Total

$
3,476,893

$
238,891

$
(6,014
)
$
3,709,770


The
following table shows the gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities, excluding the VIE portfolio, have
been in a continuous unrealized loss position, at December 31, 2004:

|                                                                                      |       | Less than 12 months |         | 12 months or more |   | Total  |       
|------------------------------------------------------------------------------------- | ----- | ------------------- | ------- | ----------------- | - | ------ | ------
|
|U.S. Treasury securities and obligations of U.S. government corporations and agencies |       | $                   | 50,812  |                   | $ | (183   | )     
|Obligations of states and political subdivisions                                      |       |                     | 214,194 |                   |   | (1,266 | )     
|Mortgage-backed securities                                                            |       |                     | 32,701  |                   |   | (304   | )     
|Corporate securities                                                                  |       |                     | 26,725  |                   |   | (161   | )     
|Foreign                                                                               |       |                     | 1,722   |                   |   | (39    | )     
|Asset-backed securities                                                               |       |                     | 16,279  |                   |   | (71    | )     
|                                                                                      |       |                     |         |                   |   |        |       
|                                                                                      | Total |                     | $       | 342,433           |   | $      | (2,024
|                                                                                      |       |                     |         |                   |   |        |       

The
Company periodically monitors its investment portfolio for individual investments in an unrealized loss position in order to assess whether any investment is considered
other-than-temporarily impaired. In each case, the Company determines the nature and cause of the decline and whether the Company maintains the ability and intent to hold the security until the
unrealized loss may reverse or until maturity. At December 31, 2004, there were 113 securities that were in an unrealized loss position for a continuous 12-month period or longer.
None of the 113 securities had an unrealized loss that exceeded book value by 7% or greater at December 31, 2004. At December 31, 2004, the Company determined that no investments were
considered other-than-temporarily impaired.

15

---



The amortized cost and fair value of bonds at December 31, 2004, by contractual maturity, are shown below (in thousands). Actual maturities could differ from contractual
maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.

|                                                                |       | Amortized
Cost |           | Fair Value
|--------------------------------------------------------------- | ----- | -------------- | --------- | ----------
|Due in one year or less                                         |       | $              | 372,006   |           
|Due after one year through five years                           |       |                | 529,420   |           
|Due after five years through ten years                          |       |                | 516,763   |           
|Due after ten years                                             |       |                | 2,258,845 |           
|Mortgage-backed securities (stated maturities of 1 to 40 years) |       |                | 219,834   |           
|Asset-backed securities (stated maturities of 1 to 35 years)    |       |                | 56,843    |           
|                                                                |       |                |           |           
|                                                                | Total |                | $         | 3,953,711 
|                                                                |       |                |           |           

Proceeds
from sales of bonds, excluding the VIE portfolio, during 2004, 2003 and 2002 were $738.9 million, $921.0 million and $733.9 million, respectively. Gross
gains of $4.5 million, $11.5 million and
$29.5 million and gross losses of $5.5 million, $6.3 million and $1.1 million were realized on sales in 2004, 2003 and 2002, respectively.

In
2002, the Company purchased foreign currency call options. These calls were marked to market through earnings and, for the years ended December 31, 2004, 2003 and 2002,
resulted in net unrealized gains of $0.9 million, $0.3 million and $0.2 million, respectively.

4.     DEFERRED ACQUISITION COSTS

Acquisition costs deferred for amortization against future income and the related amortization charged to expenses are as follows (in thousands):

Years Ended December 31,2004

2003

2002Balance, beginning of period

$
273,646

$
253,777

$
240,492Costs deferred during the period:Ceding commission income, net


(65,838
)

(73,943
)

(68,464
)Premium taxes


16,551


16,773


13,401Compensation and other acquisition costs


145,857


135,430


122,441Total


96,570


78,260


67,378Costs amortized during the period


(62,201
)

(58,391
)

(54,093
)Balance, end of period

$
308,015

$
273,646

$
253,777


5.     STATUTORY ACCOUNTING PRACTICES

GAAP differs in certain significant respects from accounting practices prescribed or permitted by insurance regulatory authorities, which are applicable to the
Company's insurance company subsidiaries. The principal differences result from the following statutory accounting practices:



16

---





Reconciliations
of net income for the years ended 2004, 2003 and 2002 and shareholder's equity at December 31, 2004 and 2003, reported by the Company on a GAAP basis, to the
amounts reported by the insurance company subsidiaries on a statutory basis, is as follows (in thousands):

Net Income:

2004

2003

2002GAAP BASIS

$
373,827

$
320,940

$
182,779Premium revenue recognition


(80,169
)

(27,867
)

(19,624
)Losses and loss adjustment expenses incurred


3,889


21,813


20,585Deferred acquisition costs


(34,370
)

(19,868
)

(13,285
)Deferred income tax provision


63,465


17,303


(23,888
)Current income tax benefit


(18,706
)

(18,049
)

(8,162
)Change in fair value of derivatives


(56,927
)

(34,796
)

48,788Income and expenses of VIEs', net


(5,735
)

(5,120
)

Other


(3,193
)

8,588


7,895STATUTORY BASIS

$
242,081

$
262,944

$
195,088


December 31,Shareholder's Equity:2004

2003GAAP BASIS

$
2,699,786

$
2,307,646Premium revenue recognition


(290,204
)

(189,823
)Loss and loss adjustment expense reserves


96,380


109,237Deferred acquisition costs


(308,015
)

(273,646
)Contingency reserve


(1,099,462
)

(936,761
)Unrealized gain on investments


(258,677
)

(232,877
)Deferred income taxes


277,828


199,346Surplus notes


74,756


154,761Other


(10,971
)

29,614STATUTORY BASIS SURPLUS

$
1,181,421

$
1,167,497SURPLUS PLUS CONTINGENCY RESERVE

$
2,280,883

$
2,104,258


6.     FEDERAL INCOME TAXES

Dexia Holdings, the Parent and the Company and its Subsidiaries, except FSA International, filed a consolidated federal income tax return.

17

---



The
tax sharing agreement provides that each member's tax benefit or expense is calculated on a separate return basis and that any credits or losses available to the Parent or Dexia
Holdings be allocated to the members based on the member's taxable income. At December 31, 2004 and 2003, the Company and its Subsidiaries received benefits from utilizing the Parent's credits
and losses of $20.4 million and $10.5 million, respectively. These amounts have been recorded as capital contributions and reductions in amounts payable to the Parent in the financial
statements.

Except
as described below, federal income taxes have not been provided on all of the undistributed earnings of FSA International, since it has been the Company's practice and intent to
reinvest such earnings in the operations of this subsidiary. The cumulative amount of such untaxed earnings was $86.7 million and $57.1 million at December 31, 2003 and 2002,
respectively.

The
American Job Creation Act of 2004 (the "Act") was enacted on October 22, 2004, which added Section 965 to the Internal Revenue Code. Section 965 provides for the
repatriation of dividends from a controlled foreign corporation to its U.S. shareholder at an effective tax rate of 5.25% provided that proceeds from the repatriation are utilized for qualified
domestic investment activities. The U.S. Treasury Department issued Notice 2005-10, which provided guidance on acceptable investment activities. The Company believes it qualifies for the
beneficial treatment under Section 965 and has accordingly accrued a deferred tax liability and expense of $5.3 million at December 31, 2004. This amount represents the tax effect
on FSA International's tax dividend distribution capability at December 31, 2004. To the extent FSA International generates additional tax earnings and profits in 2005, it is probable that the
Company will distribute such amounts and, accordingly, provide taxes on such earnings as they accrue during 2005.

The
Act provides special tax treatment only for tax dividends. Tax dividends can be made only to the extent of earnings and profits that have a different basis of calculation from that
of GAAP earnings. At December 31, 2004, GAAP earnings exceded tax earnings and profits by approximately $22.6 million. It is the Company's intention to repatriate only earnings that
qualify for the special tax treatment under the Act.

The
cumulative balance sheet effects of deferred federal tax consequences are as follows (in thousands):

December 31,2004

2003Deferred acquisition costs

$
95,736

$
85,441Deferred premium revenue adjustments


37,826


16,520Unrealized capital gains


88,902


79,186Contingency reserves


113,507


96,481Undistributed earnings





3,484Fair value adjustments


14,386


Other, net


7,751


2,802Total deferred federal income tax liabilities


358,108


283,914Loss and loss adjustment expense reserves


(35,540
)

(34,304
)Deferred compensation


(67,944
)

(64,499
)Fair value adjustments





(4,424
)Other, net


(756
)

Total deferred federal income tax assets


(104,240
)

(103,227
)Net deferred federal income tax liability

$
253,868

$
180,687


Management
believes it is more likely than not that the tax benefit of the deferred tax assets will be realized. Accordingly, no valuation allowance was necessary at December 31,
2004 or 2003.

18

---



A reconciliation of the effective tax rate with the federal statutory rate follows:

Years Ended December 31,2004

2003

2002Tax at statutory rate

35.0
%
35.0
%
35.0
%Tax-exempt interest

(8.3
)
(8.5
)
(13.2
)Income of foreign subsidiary

(1.3
)
(2.5
)
(2.3
)Other

(0.5
)


Provision for income taxes

24.9
%
24.0
%
19.5
%


7.     DIVIDENDS AND CAPITAL REQUIREMENTS

Under insurance laws of the State of New York, the Company may pay a dividend without the prior approval of the Superintendent of Insurance of the State of New
York (the "New York Superintendent") only from earned surplus subject to the maintenance of a minimum capital requirement. In addition, the dividend, together with all dividends declared or
distributed by it during the preceding 12 months, may not exceed the lesser of 10% of its policyholders' surplus shown on its last filed statement, or adjusted net investment income, as defined, for
such 12-month period. In 2004, the Company paid $30.0 million in dividends and had an additional $84.5 million available for the payment of dividends over the next 12 months. No
dividends were paid in 2003 or 2002.

8.     CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES

FSA has a credit arrangement aggregating $150.0 million, which is provided by commercial banks and intended for general application to transactions insured
by the Subsidiaries. If FSA is downgraded below Aa3 and AA-, the lenders may terminate the commitment and the commitment commission becomes due and payable. If FSA is downgraded below Baa3 and BBB-,
any outstanding loans become due and payable. At December 31, 2004, there were no borrowings under this arrangement, which expires on April 22, 2005, if not extended.

FSA
has a standby line of credit commitment in the amount of $325.0 million with a group of international banks to provide loans to FSA after it has incurred, during the term of
the facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $325.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%,
which amounted to $1,067.0 million at December 31, 2004. The obligation to repay loans made under this agreement is a limited recourse obligation payable solely from, and collateralized
by, a pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This commitment has a term expiring on
April 30, 2011 and contains an annual renewal provision subject to approval by the banks. No amounts have been utilized under this commitment as of December 31, 2004.

In
June 2003, $200.0 million of money market committed preferred trust securities (the "CPS Securities") were issued by trusts created for the primary purpose of issuing
the CPS Securities, investing the proceeds in high-quality commercial paper and providing FSA with put options for issuing to the trusts non-cumulative redeemable perpetual
preferred stock (the "Preferred Stock") of FSA. If a put option were to be exercised by FSA, the applicable trust would use the portion of the proceeds attributable to principal received upon maturity
of its assets, net of expenses, and transfer such proceeds to FSA in exchange for Preferred Stock of FSA. FSA pays a floating put premium to the trusts. The cost of the structure was
$1.3 million and $3.6 million for 2004 and 2003 respectively, and was recorded in equity. The trusts are vehicles for providing FSA access to new capital at its sole discretion through
the exercise of the put options. The Company does not consider itself to be the primary beneficiary of the trusts under FIN 46 because it does not retain the majority of the residual benefits or
expected losses.

19

---



The
Company had borrowed $108.9 million from its Parent in the form of Surplus Notes. These notes carry a simple interest rate of 5.0% per annum. Principal of and interest on the
Surplus Notes may be paid at any time at the option of the Company, subject to prior approval of the New York Superintendent and compliance with the conditions to such payments as contained in the New
York Insurance Laws. These notes have no stated maturity. The Company paid interest of $6.7 million, $9.3 million and $7.4 million in 2004, 2003 and 2002, respectively. In 2004,
2003 and 2002 respectively, with the approval of the New York Superintendent, FSA repaid $44.0 million, $60.0 million and $28.0 million of principal on such notes.

9.     EMPLOYEE BENEFIT PLANS

The Company maintains both qualified and non-qualified non-contributory defined contribution pension plans for the benefit of eligible
employees. The Company and its subsidiaries' contributions are based on a fixed percentage of employee compensation. Pension expense, which is funded annually, amounted to $5.2 million,
$4.3 million and $4.8 million for the years ended December 31, 2004, 2003 and 2002, respectively.

The
Company has an employee retirement savings plan for the benefit of all eligible employees. The plan permits employees to contribute a percentage of their salaries up to limits
prescribed by Internal Revenue Service Code, Section 401(k). The Company's contributions are discretionary, and none have been made.

Performance
shares are awarded under the Parent's 1993 Equity Participation Plan. The 1993 Equity Participation Plan authorizes the discretionary grant of performance shares by the Human
Resources Committee to key employees of the Company. The amount earned for each performance share
depends upon the attainment by the Company of certain growth rates of adjusted book value (or, in the case of performance shares issued after January 1, 2001, growth rates of adjusted book
value and book value) per outstanding share over a three-year period.

At
the election of the participant at the time of award, growth rates may be determined including or excluding realized and unrealized gains and losses on the Parent's consolidated
investment portfolio. No payout occurs if the compound annual growth rate of the Parent's consolidated adjusted book value (or in the case of performance shares issued after January 1, 2001,
growth rates of adjusted book value and book value) per outstanding share 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%.

Performance
shares granted under the 1993 Equity Participation Plan were as follows:

Outstanding
at Beginning
of Year

Granted
During
the Year

Earned
During
the Year

Forfeited
During
the Year

Outstanding
at End
of Year

Price per
Share at
Grant Date2002

1,437,231

372,775

380,279

13,901

1,415,826

$
85.632003

1,415,826

342,845

464,778

13,261

1,280,632


92.722004

1,280,632

349,506

398,292

20,038

1,211,808


109.71


The
Company applies APB Opinion 25 and related Interpretations in accounting for the Parent's performance shares. The Company estimates the final cost of these performance shares and
accrues for this expense over the performance period. The accrued expense for the performance shares was $67.0 million, $58.1 million and $55.8 million, for the years ended
December 31, 2004, 2003 and 2002, respectively.

For
obligations under the Parent's Deferred Compensation Plan ("DCP") and Supplemental Executive Retirement Plan ("SERP"), the Parent generally purchases investments expected to perform
similarly to the tracking investments chosen by the participants under the plans.

20

---



10.   COMMITMENTS AND CONTINGENCIES

Effective June 2004, the Company entered into a 20-year sublease agreement with Deutsche Bank AG for office space at 31 West 52nd
Street, New York, New York to be used as the Company's new headquarters. The Company anticipates moving from its current location at 350 Park Avenue, New York, New York to its new space in the second
quarter of 2005. The lease contains scheduled rent increases every five years after a 19-month rent-free period, as well as lease incentives for initial construction costs of up to
$6.0 million, as defined in the sublease. The lease contains provisions for rent increases related to increases in the building's operating expenses. The lease also contains a renewal option
for an additional ten-year period, and an option to rent additional office space at various points in the future, in each case at then-current market rents. In addition the Company and its
subsidiaries lease additional office space under non-cancelable operating leases, which expire at various dates through 2013. Future minimum rental payments are as follows (in thousands):

Future
minimum rental payments are as follows (in thousands):

Year Ended
December 31,2005

$
5,462.32006


7,579.72007


8,913.42008


8,156.12009


8,171.1Thereafter


114,367.5Total

$
152,650.1


Rent
expense for the years ended December 31, was $6.9 million in 2004, $6.6 million in 2003 and $5.7 million in 2002.

During
the ordinary course of business, the Company and its subsidiaries have become parties to certain litigation. The company is not subject to any material pending legal proceedings.

11.   REINSURANCE

The company obtains reinsurance to increase its policy-writing capacity on both an aggregate-risk and a single-risk basis; to meet rating
agency, internal and state insurance regulatory limits; to diversify risk; to reduce the need for additional capital; and to strengthen financial ratios. The Company reinsure portions of their risks
with affiliated (see Note 13) and unaffiliated reinsurers under quota share, first-loss and excess-of-loss treaties and on a facultative basis.

In
the event that any or all of the reinsuring companies were unable to meet their obligations to the Company, or contested such obligations, the Company would be liable for such
defaulted amounts. Certain of the reinsuring companies have provided collateral to the subsidiaries to secure their reinsurance obligations.

21

---



Amounts
of ceded and assumed business were as follows (in thousands):

Year Ended December 31,2004

2003

2002Written premiums ceded

$
244,211

$
281,542

$
270,954Written premiums assumed


11,567


3,294


2,443Earned premiums ceded


161,733


159,350


134,093Earned premiums assumed


6,608


3,832


4,079Losses and loss adjustment expense payments ceded


52,372


16,993


(2,513
)Losses and loss adjustment expense payments assumed


16








December 31,2004

2003Principal outstanding ceded

$
116,687,760

$
96,571,216Principal outstanding assumed


2,134,427


1,935,306Deferred premium revenue ceded


759,191


695,398Deferred premium revenue assumed


17,823


13,060Losses and loss adjustment expense reserves ceded


35,419


59,235Losses and loss adjustment expense reserves assumed


553


592


12.   OUTSTANDING EXPOSURE AND COLLATERAL

The Company's policies insure the scheduled payments of principal and interest on asset-backed (including insured CDS) and municipal obligations. The gross amount
of financial guarantees in force (principal and interest) was $631.3 billion at December 31, 2004 and $563.9 billion at December 31, 2003. The net amount of financial
guarantees in force (after giving effect to reinsurance) was $453.2 billion at December 31, 2004 and $408.8 billion at December 31, 2003.

The
maturities below are based on estimated made by the issuers of the insured obligations. Actual maturities could differ from contractual maturities because borrowers have the right to
call or prepay
certain obligations with or without call or prepayment penalties. The net par outstanding (in millions) as of December 31, 2004 and 2003 and the terms to maturity are as follows:

December 31, 2004

December 31, 2003Terms to MaturityAsset-Backed(1)

Municipal

Asset-Backed(1)

Municipal0 to 5 Years

$
46,800

$
39,448

$
58,500

$
34,2745 to 10 Years


29,155


43,165


32,998


38,40110 to 15 Years


10,772


37,174


6,644


32,89515 to 20 Years


1,084


30,857


1,450


27,13320 Years and Above


41,682


44,748


23,144


38,235Total

$
129,493

$
195,392

$
122,736

$
170,938


---

22

---



The
par amount ceded as of December 31, 2004 and 2003 and the terms to maturity are as follows (in millions):

December 31, 2004

December 31, 2003Terms to MaturityAsset-Backed

Municipal

Asset-Backed

Municipal0 to 5 Years

$
21,662

$
11,443

$
9,372

$
9,9525 to 10 Years


6,909


14,707


7,567


13,35510 to 15 Years


2,228


14,630


2,454


12,66215 to 20 Years


1,373


12,870


1,971


12,22320 Years and Above


4,862


26,004


3,583


23,432Total

$
37,034

$
79,654

$
24,947

$
71,624


The
Company limits its exposure to losses from writing financial guarantees by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous collateral
requirements on asset-backed obligations, as well as through reinsurance. The net par outstanding of insured obligations in the asset-backed insured portfolio are backed by the following types of
collateral (in millions):

Net of Amounts
Ceded(1) as of
December 31,

Ceded as of
December 31,Types of Collateral2004

2003

2004

2003Residential mortgages

$
35,641

$
20,643

$
4,997

$
4,024Consumer receivables


9,540


14,039


2,241


5,033Pooled corporate obligations


68,340


77,921


26,223


11,690Other asset-backed obligations


15,972


10,133


3,573


4,200Total asset-backed obligations

$
129,493

$
122,736

$
37,034

$
24,947


---

The
net par outstanding of insured obligations in the municipal insured portfolio includes the following types of issues (in millions):

Net of Amounts
Ceded as of
December 31,

Ceded as of
December 31,Types of Issues2004

2003

2004

2003General obligation bonds

$
77,865

$
67,212

$
24,278

$
20,184Housing revenue bonds


7,628


7,597


2,224


2,074Municipal utility revenue bonds


33,544


30,024


13,761


14,270Health care revenue bonds


9,261


7,051


7,784


6,971Tax-supported bonds (non-general obligation)


36,631


33,835


14,564


13,526Transportation revenue bonds


12,834


10,744


7,584


7,376Other municipal bonds


17,629


14,475


9,459


7,223Total municipal obligations

$
195,392

$
170,938

$
79,654

$
71,624


In
its asset-backed business, the Company considers geographic concentration as a factor in underwriting insurance covering securitizations of pools of such assets as residential
mortgages or consumer receivables. However, after the initial issuance of an insurance policy relating to such securitizations, the geographic concentration of the underlying assets may not remain
fixed over the life of the policy. In addition, in writing insurance for other types of asset-backed obligations, such as securities

23

---



primarily
backed by government or corporate debt, geographic concentration is not deemed by the Company to be significant, given other more relevant measures of diversification, such as issuer or
industry diversification.

The
Company seeks to maintain a diversified portfolio of insured municipal obligations designed to spread its risk across a number of geographic areas. The following table sets forth
those states in which municipalities located therein issued an aggregate of 2% or more of the Company's net par amount outstanding (in millions) of insured municipal securities as of
December 31, 2004:

State

Number
of Issues

Net Par
Amount
Outstanding

Percent of Total
Municipal Net Par
Amount
Outstanding

Ceded Par
Amount
OutstandingCalifornia

934

$
26,501

13.6
%
$
8,897New York

622


17,917

9.2


9,362Texas

701


13,297

6.8


4,815Pennsylvania

704


12,276

6.3


3,418Florida

274


10,881

5.6


3,820Illinois

633


9,337

4.8


3,699New Jersey

548


9,053

4.6


4,176Washington

297


7,272

3.7


2,867Michigan

399


5,896

3.0


2,096Massachusetts

194


4,933

2.5


2,639Wisconsin

425


4,713

2.4


1,299Ohio

265


4,412

2.3


2,199Georgia

106


4,288

2.2


1,417All other U.S. jurisdictions

2,747


56,283

28.7


21,740International

85


8,333

4.3


7,210Total

8,934

$
195,392

100.0
%
$
79,654


13.   RELATED PARTY TRANSACTIONS

Allocable expenses are shared by the Company and its Parent on a basis determined principally by estimates of respective usage as stated in an expense sharing
agreement. The agreement is subject to the provisions of the New York Insurance Law. Amounts included in other assets at December 31, 2004 and 2003 are $11.2 million and
$31.5 million respectively, for unsettled expense allocations due from the Parent.

The
Company ceded premiums of $35.2 million, $48.8 million and $23.4 million to subsidiaries of XL Capital Ltd ("XL"), which owns an interest in FSA
International, for the years ended December 31, 2004, 2003 and 2002, respectively. The amounts included in prepaid reinsurance premiums at December 31, 2004 and 2003 for reinsurance
ceded to subsidiaries of XL were $84.6 million and $60.8 million, respectively. Reinsurance recoverable for unpaid losses at December 31, 2004 and 2003 for reinsurance ceded to
subsidiaries of XL were $8.2 million and $10.9 million, respectively.

The
Company had premiums earned of $2.5 million and $5.0 million in the first half of 2003 and the year ended 2002, respectively, relating to the guarantees of debt issued
or assets purchased by the VIEs. Intercompany premiums earned relating to the VIEs have been eliminated in consolidation for periods subsequent to July 1, 2003.

The
VIE portfolio contains $961.9 million at December 31, 2004 and $955.9 million at December 31, 2003 of GICs issued by CMS. The Company recognized
$20.7 million and $7.4 million in VIE net interest income during 2004 and 2003 respectively, related to these investments.

24

---



The
Company had premiums earned of $28.0 million, $20.5 million and $17.3 million for the years ended December 31, 2004, 2003 and 2002, respectively, relating
to business with affiliates of Dexia. Deferred premium revenue relating to those transactions was $17.0 million and $6.9 million at December 31, 2004 and 2003, respectively. Gross
par outstanding relating to those transactions was $24.0 billion and $16.8 billion at December 31, 2004 and 2003, respectively.

For
the years ended December 31, 2004 and 2003, the Company, via its interest in VIE holdings, recorded pre-tax income of $89.8 million and $57.4 million relating to
swaps where Dexia was the counterparty. The Company recorded other assets of $339.7 million at December 31, 2004 and $240.9 million at December 31, 2003, primarily relating
to swaps where Dexia was the counterparty. In addition, at December 31, 2004 and 2003 the Company had $163.0 million and $154.3 million in VIE debt relating to debt issued to
Dexia. During 2004 and 2003, the Company recorded $8.8 million and $3.3 million in VIE net interest expense relating to such debt.

The
Company had premiums earned of $15.4 million, $7.5 million and $3.3 million at December 31, 2004, 2003 and 2002, respectively, relating to the guaranty of
GICs issued by CMS.

14.   DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company determines fair values using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to
interpret the data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amount the Company could realize in a current market
exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair-value amounts.

For
bonds, equity securities and VIE bond portfolio, the carrying amount represents fair value. The fair value is based on quoted market price or redemption value for the Company's
investment in XLFA.

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

For
cash, receivable for investments sold and payable for investments purchased, the carrying amount is cost, which approximates fair value 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 quoted market prices as of the reporting date.

For
deferred premium revenue, net of prepaid reinsurance premiums, the carrying amount represents the Company's future premium revenue, net of reinsurance, on policies where the premium
was received at the inception of the insurance policy. The fair value of deferred premium revenue, net of prepaid reinsurance premiums, is an estimate of the premiums that would be paid under a
reinsurance agreement with a third party to transfer the Company's financial guaranty risk, net of that portion of the premiums retained by the Company to compensate it for originating and servicing
the insurance contract.

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

For
installment premiums, consistent with industry practice, there is no carrying amount since the Company will receive premiums on an installment basis over the term of the insurance
contract. Similar to the treatment of deferred premium revenue, the fair value of installment premiums is the estimated present value of the future contractual premium revenues that would be received
under a reinsurance agreement with a third party to transfer the Company's financial guaranty risk, net of that portion of the premium retained by the Company to compensate it for originating and
servicing the insurance contract.

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

25

---



For
losses and loss adjustment expenses, net of reinsurance recoverable on unpaid losses, the carrying amount is net present value of the expected cash flows for specifically identified
claims and inherent losses in the Company's insured portfolio, which management believes is a reasonable proxy for fair value.

For
fair-value adjustments on derivatives, the carrying amount represents fair value. The Company uses quoted market prices when available, but if quoted market prices are
not available, management uses internally developed estimates.

The
table below shows the carrying amount and fair value of the Company's financial instruments (in thousands):

|                               |                                                                                      | December 31, 2004 |   | December 31, 2003
|------------------------------ | ------------------------------------------------------------------------------------ | ----------------- | - | -----------------
|
|Assets:                        |                                                                                      |                   |   |                  
|                               | Bonds                                                                                |                   | $ | 3,888,586        
|                               | Equity securities                                                                    |                   |   | 54,300           
|                               | Variable interest entities' bonds                                                    |                   |   | 1,346,355        
|                               | Variable interest entities' GICs                                                     |                   |   | 961,925          
|                               | Short-term investments                                                               |                   |   | 316,921          
|                               | VIE short-term investments                                                           |                   |   | 1,194            
|                               | Cash                                                                                 |                   |   | 10,005           
|                               | Assets acquired in refinancing transactions                                          |                   |   | 748,936          
|                               | Fair value adjustments on derivatives                                                |                   |   | 637,423          
|                               | Receivable for securities sold                                                       |                   |   | 161              
|Liabilities:                   |                                                                                      |                   |   |                  
|                               | Deferred premium revenue, net of prepaid reinsurance premiums                        |                   |   | 1,342,057        
|                               | Losses and loss adjustment expenses, net of reinsurance recoverable on unpaid losses |                   |   | 144,522          
|                               | Notes payable to affiliate                                                           |                   |   | 753,614          
|                               | VIE debt                                                                             |                   |   | 3,123,118        
|                               | Surplus notes                                                                        |                   |   | 108,850          
|                               | Payable for investments purchased                                                    |                   |   | 16,533           
|                               | Fair value adjustments on derivatives                                                |                   |   |                 
|Off-balance-sheet instruments: |                                                                                      |                   |   |                  
|                               | Installment premiums                                                                 |                   |   |                 

26

---



15.   LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the liability for losses and loss adjustment expenses, which consists of the case and non-specific reserves, is summarized as follows (in
millions):

Case Reserve Activity for the Year Ended2004

2003

2002(dollars in millions)Gross balance at January 1

$
121.9

$
134.0

$
45.4Less Reinsurance recoverable


59.2


76.0


28.9Net balance at January 1


62.7


58.0


16.5Transfer from non-specific reserve


30.7


12.7


45.0Restructured transactions


(13.9
)

(2.2
)

Paid (net of recoveries) related to:Current year








Prior year


(34.3
)

(5.8
)

(3.5
)Total paid


(34.3
)

(5.8
)

(3.5
)Net balance at December 31


45.2


62.7


58.0Plus reinsurance recoverable


35.4


59.2


76.0Gross balance at December 31

$
80.6

$
121.9

$
134.0


Non-Specific Reserve Activity For the Year Ended2004

2003

2002(dollars in millions)Balance at January 1

$
111.5

$
89.7

$
69.1Provision for lossesCurrent year


20.4


22.4


21.1Prior year


0.2


12.1


44.5Transfers to case reserves


(30.7
)

(12.7
)

(45.0
)Restructured transactions


(2.1
)




Balance at December 31


99.3


111.5


89.7Total case and non-specific reserves

$
179.9

$
233.4

$
223.7


The
gross and net par outstanding on transactions with case reserves were $791.4 million and $682.6 million at December 31, 2004. The net case reserve consisted
primarily of six CDO transactions and one municipal transaction, which collectively accounted for approximately 95% of the total net case reserve. The remaining 11 exposures were in various sectors.

During
2004, the Company charged $20.6 million to loss expense, comprised of $25.0 million for originations of new business and $3.2 million related to reassumptions
of previously ceded business, offset by reserve releases primarily related to a large refinancing transaction in 2004. The non-specific reserve decreased $12.2 million in 2004, primarily due to
transfers from the non-specific reserve to the case reserves of $30.7 million offset by loss expense of $20.6 million. Case reserves decreased $17.5 million due to (1) a
large, voluntarily accelerated transaction that had a $34.3 million payment and (2) reclassifications from reserves to asset valuation accounts for refinanced transactions of
$13.9 million offset by transfers from the non-specific reserve of $30.7 million. (See Note 18).

In
September 2004, FSA exercised its rights to have the collateral of a defaulted collateralized bond obligation liquidated at a public sale, in which the Company offered the
highest bid. The Company acquired the collateral to gain control of the portfolio in order to mitigate future losses. The previously

27

---



established
case reserve was drawn down to reflect the excess of the purchase amount over the fair value of the collateral. The remaining $9.5 million balance in the case reserves related to
this transaction was returned to the non-specific reserve. After reevaluating its requirements for the CDO portion of the non-specific reserve, the Company then reduced the
non-specific reserve by $9.5 million, which was partially offset by normal reserve additions. The net amount transferred from the case reserves to the non-specific
reserve was $1.4 million, which also included a transfer from the non-specific to the case reserves for a municipal utility transaction. The CDO portfolio continues to perform
within the expectations reflected in previously recorded provisions for CDOs.

During
2003, the Company charged $34.5 million to loss expense, comprising $9.2 million related to the CDO portfolio discussed below, $22.4 million for origination
of new business and $2.9 million for the accretion of the discount on prior years' reserves. The non-specific reserve increased by $21.8 million in 2003, consisting of the
loss expense, a transfer to the non-specific reserve of $1.4 million representing recoveries received on prior-year transactions and a transfer of $14.1 million
from the non-specific reserve to case reserves. In addition, the Company reclassified $2.2 million of case reserves relating to a restructured transaction to securitized loans on
the balance sheet (see Note 22).

In
the second quarter of 2002, as part of the Company's ongoing credit review process, management identified certain transactions not performing as expected in its portfolio of insured
CDOs. As a result, management undertook a quantitative analysis of all CDO transactions in its insured portfolio that breached senior overcollateralization triggers, which were included in such
transactions as one measure of adverse performance. A present value "deterministic" approach was utilized to estimate the loss inherent in this portfolio. The deterministic model takes the average
cumulative default rate produced by a Monte Carlo simulation and applies those defaults to a cash flow model using (1) a timing sequence dependent on the portfolio's rating and maturity
composition, (2) an estimate of collateral recovery values for severity and (3) the LIBOR forward curve as a predictor of interest rates. Management assumed that current default rates on
CDO collateral would improve in a manner consistent with an economic recovery following a period of significant credit deterioration similar to that experienced in 1991 and 1992 and, as a result,
management utilized the Moody's idealized default curve, adjusted by a factor consistent with the relationship between the 1992 cohort experience and the Moody's 30-year average default
rate. The per-period default rate was calculated based on the Moody's weighted-average rating factor for each piece of surviving collateral. Recovery rates were judgmentally established by
the Company. In considering the recovery rates to be utilized, management adjusted Moody's average recovery rates (observed since 1982) downward to reflect more recent adverse observations.

At
June 30, 2002, this analysis produced a present value of expected losses of $51.5 million, net of reinsurance recoveries and net of unearned premiums and future ceding
commissions. Management addressed this net present value of expected loss ($51.5 million) through (1) an increase in the Company's non-specific reserve ($31.0 million)
and (2) amounts already existing in its non-specific reserve ($20.5 million), including non-specific reserve amounts reallocated to case reserves
($11.3 million). The $31.0 million increase in the Company's non-specific reserve resulted in a corresponding increase to losses and loss adjustment expenses in the statement
of operations of $31.0 million. An additional adjustment of $10.1 million was made in the fourth quarter of 2002 as a result of further deterioration of the CDO portfolio. Management
established a methodology of recording case reserves on CDO transactions based on the extent to which the overcollateralization ratio (non-defaulted collateral at par value divided by the
debt insured) has fallen below 100%, since management believes that claims on such transactions are probable and that the amount of the undercollateralization is a reasonable estimate of such claims.
Such transactions may benefit from excess cash flow attributable in part to higher interest rates on the underlying collateral than on the insured securities. In addition, such transactions generally
require insured payments of principal only at the ultimate maturity of such transactions. Application of this methodology resulted in recording $68.8 million in gross case reserves and
$29.8 million in reinsurance recoverable on unpaid losses, resulting in a $39.0 million increase in net case reserves in 2002. Management, beginning in

28

---



the
second quarter of 2002, has refined the loss factor it applies to its net par underwritten when calculating the non-specific reserve in order to reflect its recent adverse experience.
As a result, the non-specific reserve accrual for the year ended December 31, 2002 was $65.6 million, rather than approximately $14.9 million that would have been
accrued using the prior assumptions.

During
2002, the Company increased its non-specific reserve by $65.6 million, of which $41.1 million related to the CDO portfolio discussed above,
$21.1 million was for origination of new business and $3.4 million was for accretion of the discount on prior years' reserves. Also during 2002, the Company transferred to the
non-specific reserve $0.8 million representing recoveries received on prior-year transactions and transferred $45.8 million from the non-specific
reserve to case reserves.

The
cumulative amount of net discount taken was approximately $59.5 million, $65.9 million and $44.7 million at December 31, 2004, 2003 and 2002,
respectively.

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

16.   EQUITY INVESTMENTS

FSA's 13% investment in preferred shares of XL Financial Assurance Co. ("XLFA"), a financial guaranty insurance subsidiary of XL, is redeemable by XLFA at a price
equal to the fair market value of the preferred shares, subject to a cap defined as the internal rate of return of 19% per annum from the date of the investment through the date of redemption, plus
accrued dividends as if 100% of current year earnings were distributed. Based on this formula, the Company recently adopted a policy of carrying this investment at the lesser of the current calculated
redemption value or the redemption value as of the next January first, which would exclude its share of accrued current year earnings to the extent the cap had been otherwise met. Consistent with this
policy, in the third quarter of 2004, the Company charged $11.7 million to equity in earnings of unconsolidated affiliates and reduced its carrying value in this investment to $56.4 million. In the
fourth quarter of 2004, the Company recorded a return of capital of $2.1 million.

Until
the fourth quarter of 2004 this investment was accounted for using the equity method of accounting because the Company has significant influence over XLFA's operations. In the
second quarter of 2004, the Emerging Issues Task Force reached a consensus that under EITF Issue 02-14, "Whether an Investor Should Apply the Equity of Method of Accounting to Investments Other Than
Common Stock" ("EITF 02-14"), an investor should only apply the equity method of accounting when it has investments in either common stock or in-substance common stock of a corporation, provided that
the investor has the ability to exercise significant influence over the operating and financial policies of the investee. The EITF 02-14 consensus is applicable to reporting periods beginning after
September 15, 2004. In accordance with this consensus, the Company will no longer accrue undistributed earnings related to its investment in XLFA. Amounts recorded by the Company in connection with
XLFA as of December 31, 2004, 2003 and 2002 are as follows (in thousands):

2004

2003

2002Equity securities

$
54,300



Investment in XLFA




64,440

52,206Equity in earnings from XLFA


3,761

19,077

9,145Dividends received from XLFA


12,003

6,640

6,665


At
December 31, 2003, the Company's retained earnings included $25.7 million of accumulated undistributed earnings of XLFA.

29

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17.   MINORITY INTEREST IN SUBSIDIARY

In November 1998, FSA International, a Bermuda-based financial guaranty subsidiary of the Company, sold to XL $20.0 million of preferred shares
representing a minority interest in FSA International. In December 1999, FSA International sold to XL an additional $10.0 million of preferred shares to enable XL to maintain its
minority ownership percentage. The preferred shares are Cumulative Participating Voting Preferred Shares, that in total have a minimum fixed dividend of $1.5 million per annum. In 2004 and
2003, FSA International paid preferred dividends of $4.9 million and $3.3 million respectively, to XL. For the years ended December 31, 2004, 2003 and 2002, the Company recognized
minority interest of $6.9 million, $9.3 million and $6.7 million, respectively.

18.   REFINANCED TRANSACTIONS AND NOTES PAYABLE TO AFFILIATES

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

At
December 31, 2004, FSA has reclassified all of the assets acquired in refinancing transactions into one balance sheet caption, "Assets acquired in refinancing transactions" and
the related revenues from those assets into one revenue caption, "Income from assets acquired in refinancing transactions."

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

As of December 31,2004

2003Assets acquired in refinancing transactionsSecuritized loans

$
369,750

$
433,948Bonds


157,036


Asset-backed senior notes


89,913


70,273Equity securities


15,659


Mortgage loans


77,462


Short term investments


27,749


Other


11,367


912Total

$
748,936

$
505,133


Securitized
loans are carried at cost, net of losses at the date of purchase. Income is recorded based on the effective yield method. The cash flows on the securitized loans, net of
reinsurance, are monitored and the effective yield modified to reflect any change in the cash flow estimate on a prospective basis (see Note 22). Since the notes represent 100% of the debt
capitalization of the trusts and since FSA
maintains all the risk of further asset decline (except as provided by reinsurance) and maintains control over key decisions regarding the trusts (such as removal of the servicer, sale of the assets
and liquidation of the entity), the trusts were consolidated with FSA for accounting purposes. FSA also consolidated the refinancing vehicles.

Asset-backed
senior notes represent the Company's purchase of less than 50% of a certain refinanced transaction. Asset-backed senior notes are carried at cost, with any reduction in
carrying value recognized as an adjustment to yield.

30

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Bonds
and equity securities and mortgage loans represent liquidations of previously insured obligations and subsequent purchase of the underlying collateral. Bonds and equity securities
are available for sale and carried at fair value. Mortgage loans are carried at net realizable value. Investment income is recorded as earned. Other-than-temporary impairments are reflected in
earnings as a realized loss. At December 31, 2004, there were no securities in an unrealized loss position for a continuous 12-month period or longer. At December 31, 2004, the Company determined that
no investments were considered other-than-temporarily impaired.

Other
assets consist primarily of real estate, prepaid assets, accrued interest and fair value adjustments on derivatives used to hedge interest rate risk related to certain of the
refinanced transactions.

The
Company has recorded $753.6 million of notes payable to an affiliate at December 31, 2004 and $504.7 million at December 31, 2003. For the years ended
December 31, 2004, 2003 and 2002 the Company recorded $24.8 million, $24.1 million and $4.9 million, respectively, of interest expense on the notes payable.

Principal
payments due under these notes for each of the next four years ending December 31 and thereafter are as follows (in thousands):

Expected
Withdrawal Date

Principal
Amount2005

$
73,7322006


90,6452007


115,8132008


137,3252009


68,488Thereafter


267,611Total

$
753,614


19.   DERIVATIVE INSTRUMENTS



The Company has insured a number of CDS with the expectation that these transactions will not be subject to a market value termination for which the Company would
be liable. It considers these agreements to be a normal extension of its financial guaranty insurance business, although they are considered derivatives for accounting purposes. These agreements are
recorded at fair value. The Company believes that the most meaningful presentation of the financial statement impact of these derivatives is to reflect premiums as installments are received, to record
losses and loss adjustment expenses as incurred and to record changes in fair value as incurred. The Company recorded $69.1 million, $57.7 million and $35.0 million of net earned
premium under these agreements for the years ended 2004, 2003 and 2002 respectively.

Changes
in the fair value of CDS, which were gains of $56.4 million and $34.8 million for the years ended December 31, 2004 and 2003 respectively, and losses of
$50.2 million in 2002, were recorded in
net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income. The Company included net par outstanding of
$66.0 billion and $63.8 billion relating to these CDS transactions at December 31, 2004 and December 31, 2003, respectively, in the asset-backed balances in Note 12.
The gains or losses recognized by recording these contracts at fair value are determined each quarter based on quoted market prices, if available. If quoted market prices are not available then the
determination of fair value is based on internally developed estimates. Management applies judgment when developing these estimates and considers factors such as current prices charged for similar
agreements, performance of underlying assets, changes in internal shadow ratings, the level at which the deductible has been set and the Company's ability to obtain reinsurance for its insured
obligations. The Company does not believe that the fair value adjustments are an indication of potential claims under FSA's guarantees. The average life of these contracts is 2.9 years. The
inception to date gain (loss) on the CDS portfolio was $46.6 million at December 31, 2004 and $(9.8) million at December 31, 2003.

31

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In August 2002, the Company terminated its exposure under its single-corporate-name CDS program in exchange for paying termination costs of $43.0 million, which
were included in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income.

Designated Hedges

The Company enters into derivative contracts designated as fair-value hedges, to manage interest-rate and foreign currency exposure in its
VIE debt and VIE bond portfolio. The derivative contracts are recorded at fair value. These derivatives generally include interest-rate and currency swap agreements, which are primarily
utilized to convert fixed-rate debt and investments into U.S. dollar floating-rate debt and investments. The gains and losses relating to these fair-value hedges
are included in net interest income from VIEs and net interest expense from VIEs, as appropriate, along with the offsetting change in fair value of the hedged item attributable to the risk being
hedged. The inception-to-date net unrealized gain on the outstanding derivatives used to hedge the VIE debt and VIE bond portfolio of $590.8 million and
$407.7 million at December 30, 2004 and December 31, 2003, respectively, was recorded in other assets.

20.   VARIABLE INTEREST ENTITIES

The
Company adopted FIN 46 and consolidated for financial reporting purposes, effective July 1, 2003, FSA Global and Canadian Global. In addition, as a result of the Company
obtaining control rights of another VIE, Premier, on July 1, 2003, the Company consolidated Premier beginning July 1, 2003. FIN 46R requires that, upon consolidation, the Company
initially measure the VIE's assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the entity had been consolidated from the time the Company was considered its
primary beneficiary (or parent). The increase in total assets and total liabilities related to the consolidation of these entities was $2.9 billion. Any differences upon consolidation were
reflected as a cumulative effect of a change in accounting principle. The cumulative effect of a change in accounting principle for Canadian Global resulted in additional income of
$4.8 million, net of income tax. There were no cumulative income statement effects from consolidating FSA Global and Premier.

FSA
Global is managed as a "matched funding vehicle," in which the proceeds from the issuance of FSA-guaranteed notes are invested in obligations having cash flows
substantially matched to those of, and maturing prior to, such notes. In certain cases, investments of FSA Global consist of GICs issued by CMS. Similarly, Canadian Global and Premier have GICs issued
by CMS in their investment portfolios. At December 31, 2004, $961.9 million was eliminated as a result of such consolidation. The Company's management believes that the assets held by
the VIEs, including those that are eliminated in consolidation, are beyond the reach of the Company and its creditors, even in bankruptcy or other receivership. All intercompany insured amounts
between FSA and FSA Global and Canadian Global previously included in the Company's outstanding exposure are excluded from the Notes to the Condensed Consolidated Financial Statements for
December 31, 2004 and 2003. During the third quarter of 2004, the majority of the assets and liabilities of Canadian Global were satisfied.

Twelve months ended
December 31, 2004

Six months ended
December 31, 2003VIE net interest income

$
68,754

$
27,483FSA's net premiums earned on VIE bonds and debt


(5,351
)

(2,690
)Total revenues

$
63,403

$
24,793VIE net interest expense

$
63,733

$
24,093Other operating expenses


(825
)

381Total expenses

$
62,908

$
24,474


32

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VIE Investments

All bonds in the VIE Portfolio are insured by FSA. The credit quality of the VIE Portfolio, without the benefit of FSA's insurance, at December 31, 2004
was as follows:

Rating(1)

Percent of BondsAAA

2.6
%AA

5.3A

71.6BBB

20.5100.0
%


---

The
amortized cost and fair value of bonds in the VIE Portfolio were as follows (in thousands):

December 31, 2004

Amortized Cost

Fair ValueObligations of states and political subdivisions

$
16,007

$
16,007Corporate securities


158,106


157,990Foreign


57,621


57,983Asset-backed securities(1)


1,114,375


1,114,375Short-term investments


1,194


1,194Total

$
1,347,303

$
1,347,549


December 31, 2003

Amortized Cost

Fair ValueObligations of states and political subdivisions

$
16,200

$
16,200Corporate securities


181,165


180,380Foreign


61,541


61,207Asset-backed securities(1)


1,164,751


1,164,751Short-term investments


11,102


11,102Total

$
1,434,759

$
1,433,640


---

The
Company periodically monitors its investment portfolio for individual investments in an unrealized loss position in order to assess whether that investment is
considered other-than-temporarily impaired. In each case, the Company determines the nature and cause of the decline and whether the Company maintains the ability and intent to
hold the security until the unrealized loss may reverse or until maturity. At December 31, 2004, there were no securities in an unrealized loss position for a continuous 12-month
period or longer. At December 31, 2004, the Company determined that no investments were considered other-than-temporarily impaired.

The
amortized cost and fair value of bonds in the VIE Portfolio at December 31, 2004, by contractual maturity, are shown below (in thousands). Actual maturities could differ from
contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.

33

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Amortized Cost

Fair ValueDue in one year or less

$
185,970

$
186,182Due after one year through five years


30,951


30,985Due after five years through ten years





Due after ten years


16,007


16,007Asset-backed securities (stated maturities of 1 to 18 years)


1,114,375


1,114,375Total

$
1,347,303

$
1,347,549


At
December 31, 2004, the interest rates on VIE Debt were between 1.12% and 7.75% per annum.

The
amortized cost and fair value of GICs held within the VIE guaranteed investment portfolio were as follows (in thousands):

Amortized Cost

Fair ValueDue in one year or less

$
71,000

$
71,000Due after one year through five years


570,668


570,668Due after five years through ten years


27,744


27,744Due after ten years


292,513


292,513Total

$
961,925

$
961,925


Payments
due under the VIE Debt (including $1,331.0 million of interest accretion on zero coupon obligations and excluding $272.2 million of hedge accounting adjustments)
in each of the next five years ending December 31 and thereafter, are as follows (in thousands):

Year

Principal
Amount2005

$
208.12006


87.72007


562.32008


141.92009


20.2Thereafter


3,161.7Total

$
4,181.9


21.   OTHER ASSETS

The
detailed balances that comprise other assets at December 31, 2004 and 2003 are as follows (in thousands):

Other Assets:

2004

2003Fair value of VIE derivatives

$
590,792

$
407,742VIE other invested assets


156,540


150,410Tax and loss bonds


102,193


85,512Accrued interest on VIE derivatives


99,794


76,295Accrued interest income


50,632


46,351Other assets


145,696


169,085Total other assets

$
1,145,647

$
935,395


34

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22.   RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position
03-3: "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash
flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part,
to credit quality. SOP 03-3 supersedes Practice Bulletin 6 for transactions entered into after the initial application of SOP 03-3. For loans acquired in fiscal years prior to
the effective date of SOP 03-3 and within the scope of Practice Bulletin 6 (such as certain assets acquired via refinancing transactions, see Note 18), SOP 03-3 amends
the application of Practice Bulletin 6 with regard to accounting for decreases in cash flows expected to be collected.

SOP
03-3 requires that the investor recognize the excess of all cash flows expected at acquisition over the investor's initial investment in the loan as interest income on a
level-yield basis over the life of the loan. SOP 03-3 prohibits investors from displaying differences from expected cash flows in the balance sheet. Subsequent increases in cash flows
expected to be collected generally should be recognized prospectively through adjustment of the loan's yield over its remaining life. Decreases in cash flows expected to be collected should be
recognized as impairments.

SOP
03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004. For loans acquired in fiscal years beginning on or before
December 15, 2004 and that fall within the scope of Practice Bulletin 6 as it applies to decreases in cash flows expected to be collected, SOP 03-3 should be applied prospectively
for fiscal years beginning after December 15, 2004. Management believes that the implementation of SOP 03-3 will not have a material effect on the Company's financial position,
results of operations or cash flows.

In
December 2004, the FASB issued Statement of Financial Accounting Standards 123-R, "Share-Based Payment" ("SFAS 123-R"). This Statement is a revision of SFAS 123, "Accounting for
Stock-Based Compensation" and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
its related implementation guidance. SFAS 123-R requires entities to recognize compensation cost for all equity-classified awards after the effective date using the fair-value measurement method. SFAS
123-R is effective for interim or annual periods beginning after June 15, 2005. The adoption of SFAS 123-R is not expected to have a material impact on the Company's financial position or results of
operations.

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