SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

                [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                   For the fiscal year ended December 31, 1997

                                       OR

              [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                         Commission File Number 1-12644

                   Financial Security Assurance Holdings Ltd.
             (Exact name of registrant as specified in its charter)

                   New York                              13-3261323
        (State or other jurisdiction of               (I.R.S. Employer
        incorporation or organization)                Identification No.)

                    350 Park Avenue, New York, New York 10022
          (Address of principal executive offices, including zip code)

                                 (212) 826-0100
              (Registrant's telephone number, including area code)

           Securities registered pursuant to Section 12(b) of the Act:

        Title of each class            Name of each exchange on which registered
        -------------------            -----------------------------------------
Common Stock, par value $.01 per share       New York Stock Exchange, Inc.
   7.375% Senior Quarterly Income 
     Debt Securities Due 2097                New York Stock Exchange, Inc.

           Securities registered pursuant to Section 12(g) of the Act:

                                      None

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

      Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

      The aggregate market value of voting stock, excluding treasury shares,
held by non-affiliates of the registrant at March 11, 1998 was $1,609,291,128
(based upon the closing price of the registrant's shares on the New York Stock
Exchange on March 11, 1998, which was $53.875). For purposes of the foregoing,
only U S WEST Capital Corporation and Fund American Enterprises Holdings, Inc.
were deemed to be affiliates of the registrant.

      At March 11, 1998, there were outstanding 29,870,833 shares of Common
Stock, par value $0.01 per share, of the registrant (includes 1,107,765 shares
of Common Stock owned by a trust on behalf of the Company and excludes 2,405,468
shares of Common Stock actually held in treasury).

Documents Incorporated By Reference

      Portions of the registrant's Annual Report to Shareholders for the year
ended December 31, 1997 are incorporated by reference into Part II hereof.
Portions of the registrant's definitive Proxy Statement dated March 23, 1998 in
connection with the Annual Meeting of Shareholders to be held on May 14, 1998
are incorporated by reference into Part III hereof.
<PAGE>

                                TABLE OF CONTENTS

                                                                            Page
                                                                            ----

Item 1.  Business...........................................................   2
                                                                             
Item 2.  Properties.........................................................  23
                                                                             
Item 3.  Legal Proceedings..................................................  23
                                                                             
Item 4.  Submission of Matters to a Vote of Security Holders................  23
                                                                             
Item 5.  Market for Registrant's Common Equity and Related                   
           Stockholder Matters..............................................  24
                                                                             
Item 6.  Selected Financial Data............................................  24
                                                                             
Item 7.  Management's Discussion and Analysis of Financial                   
           Condition and Results of Operations..............................  24
                                                                             
Item 8.  Financial Statements and Supplementary Data........................  24
                                                                             
Item 9.  Changes in and Disagreements with Accountants on                    
           Accounting and Financial Disclosure..............................  24
                                                                             
Item 10. Directors and Executive Officers of the Registrant.................  25
                                                                             
Item 11. Executive Compensation.............................................  25
                                                                             
Item 12. Security Ownership of Certain Beneficial Owners and Management.....  25
                                                                             
Item 13. Certain Relationships and Related Transactions.....................  25
                                                                             
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...  26


                                       1
<PAGE>

Item 1. Business.

General

      Financial Security Assurance Holdings Ltd. (the "Company"), through its
wholly owned subsidiary, Financial Security Assurance Inc. ("FSA"), is primarily
engaged in the business of providing financial guaranty insurance on
asset-backed and municipal obligations. FSA was the first insurance company
organized to insure asset-backed obligations and has been a leading insurer of
asset-backed obligations (based on number of transactions insured) since its
inception in 1985. FSA expanded the focus of its business in 1990 to include
financial guaranty insurance of municipal obligations. For the year ended
December 31, 1997, FSA had gross premiums written of $236.4 million, of which
45% related to insurance of asset-backed obligations and 55% related to
insurance of municipal obligations. At December 31, 1997, FSA had net insurance
in force of $117.4 billion, of which 69% represented insurance of municipal
obligations and 31% represented insurance of asset-backed obligations. FSA is
licensed to engage in the financial guaranty insurance business in all 50
states, the District of Columbia and Puerto Rico.

      At December 31, 1993, the Company was owned 92.5% by U S WEST Capital
Corporation ("U S WEST") and 7.5% by The Tokio Marine and Fire Insurance Co.,
Ltd. ("Tokio Marine"). The Company completed an initial public offering (the
"IPO") of common shares on May 13, 1994, at which time Fund American Enterprises
Holdings, Inc. (together with its wholly owned subsidiaries, "Fund American")
purchased 2,000,000 shares of the Company's common stock. In connection with the
IPO, the Company, U S WEST and Fund American entered into certain agreements
providing, among other things, Fund American certain rights to acquire
additional shares of the Company from the Company and U S WEST. Pursuant to
these agreements, on September 2, 1994, the Company issued to Fund American
2,000,000 shares of Series A non-dividend paying voting convertible preferred
stock having a liquidation preference of $700,000. In December 1995, the Company
acquired Capital Guaranty Corporation ("Capital Guaranty") in a merger
transaction in which Capital Guaranty became a direct wholly owned subsidiary of
the Company (the "Merger"). Capital Guaranty, through its wholly owned
subsidiary, Capital Guaranty Insurance Corporation ("CGIC"), provided financial
guaranty insurance on municipal bonds. In 1997, FSA sold CGIC and all the
policies of CGIC were assumed by FSA. At December 31, 1997, voting control of
the Company was held 33.2% by U S WEST, 23.9% by Fund American, 6.3% by Tokio
Marine and 36.6% by the public and employees. U S WEST has previously announced
its intention to dispose of its remaining interest in the Company as part of its
strategic plan to withdraw from businesses not directly involved in
telecommunications. Most of the Company's shares owned by U S WEST are either
subject to stock options held by Fund American or potentially deliverable in
satisfaction of DECS (Debt Exchangeable for Common Stock) securities issued in
May 1996 by U S WEST, Inc.

      U S WEST is a subsidiary of U S WEST, Inc., which operates businesses
involved in communications, data solutions, marketing services and capital
assets, including the provision of telephone services in 14 states in the
western and midwestern United States. Fund American is a financial services
holding company whose operating subsidiaries include various insurance companies
and one of the largest mortgage loan servicers in the United States. Tokio
Marine is a major Japanese property and casualty insurance company.

      FSA wholly owns FSA Insurance Company ("FSAIC"), which in turn wholly owns
Financial Security Assurance of Oklahoma, Inc. ("Oklahoma"). FSAIC and Oklahoma
provide reinsurance to FSA.

      Financial Security Assurance (U.K.) Limited ("FSA-UK"), a wholly owned
subsidiary of Oklahoma, is authorized to transact an insurance business in the
United Kingdom, and provides financial guaranty insurance for transactions in
the United Kingdom and other European markets.

      FSA Portfolio Management Inc. ("FSA Portfolio Management"), a wholly owned
subsidiary of the Company, is engaged in the business of managing the investment
portfolios of the Company and its subsidiaries and of certain third parties.

      Transaction Services Corporation ("TSC"), a wholly owned subsidiary of the
Company, is engaged in the business of managing workout transactions within the
insured portfolios of the Company and its subsidiaries and of certain third
parties.


                                       2
<PAGE>

Industry Overview

      Financial guaranty insurance written by FSA typically guarantees scheduled
payments on an issuer's obligations. Upon a payment default on an insured
obligation, FSA 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. FSA's underwriting
policy is to insure asset-backed and municipal obligations that would otherwise
be investment grade without the benefit of FSA's insurance. The asset-backed
obligations insured by FSA are generally issued in structured transactions
backed by pools of assets such as residential mortgage loans, consumer or trade
receivables, securities or other assets having an ascertainable cash flow or
market value. The municipal obligations insured by FSA consist primarily of
general obligation bonds supported by the issuers' taxing power and special
revenue bonds and other special obligations of state and local governments
supported by the issuers' ability to impose and collect fees and charges for
public services or specific projects.

      The Company's business objective is to remain a leading insurer of
asset-backed obligations and to become a more prominent insurer of municipal
obligations. The Company's acquisition of Capital Guaranty in December 1995
increased the Company's presence in the insured municipal bond sector. The
Company believes that the demand for its financial guaranty insurance will grow
over the long term in response to anticipated growth in insured asset-backed and
municipal obligations. The Company expects continued growth in the insurance of
asset-backed obligations, due in part to the continued expansion of asset
securitization outside of the residential mortgage sector. In the long term, the
Company also expects continued growth in the insurance of municipal obligations,
due in part to increased issuance of municipal bonds to finance repairs and
improvements to the nation's infrastructure and increased municipal bond
purchases by individuals who generally purchase insured obligations. In
addition, the percentage of new domestic municipal bond volume which is insured
has increased each year since 1986, to 49% for the year ending 1997 according to
published sources. Financial guaranty insurance has also begun to be applied to
obligations of municipal issuers located outside of the United States.

      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.

      In addition to its domestic business, the Company pursues international
opportunities and currently operates in the European and Pacific Rim markets.
The Company was the first financial guaranty insurance company to insure
asset-backed obligations in international markets. The Company is also party to
a Cooperation Agreement with Tokio Marine, which provides an arrangement to
develop financial guaranty insurance opportunities in Japan.

Business of FSA

Insurance Markets

      FSA writes financial guaranty insurance on asset-backed obligations and
municipal obligations, a description of which follows.

Asset-Backed Obligations

      Asset-backed obligations are typically issued in connection with
structured financings or securitizations, in which the securities being issued
are secured by or payable from a specific pool of assets having an ascertainable
cash flow or market value and held by a special purpose issuing entity. While
most asset-backed obligations are secured by or represent interests in diverse
pools of assets, such as residential mortgage loans and credit card and auto
loan receivables, monoline financial guarantors have also insured asset-backed
obligations secured by less diverse payment sources, such as utility mortgage
bonds and multifamily real estate.

      In general, asset-backed obligations are payable from cash flow generated
by a pool of assets and take the form of either "pass-through" obligations,
which represent interests in the related assets, or "pay-through" obligations,
which generally are debt obligations collateralized by the related assets. Both
types of asset-backed 


                                       3
<PAGE>

obligations also generally have the benefit of overcollateralization, excess
cash flow or one or more forms of credit enhancement to cover credit risks
associated with the related assets.

      The following table sets forth certain industry information relating to
selected asset-backed obligations for the periods indicated: 

                          New Asset-Backed Obligations

            Volume of                           Combined
          Private-Label    Volume of Other       Volume      Asset-Backed Volume
           Residential         Public              of        Insured by Monoline
             Mortgage       Asset-Backed      Asset-Backed        Insurance
          Obligations(1)   Obligations(2)    Obligations(3)     Companies(4)
          --------------   ---------------   --------------  -------------------
                                (dollars in billions)
1991.....     $49.3            $ 50.6            $ 99.9           $  9.8
1992.....      89.5              51.1             140.6             10.3
1993.....      98.5              61.0             159.5             21.4
1994.....      63.2              75.5             138.7             24.7
1995.....      37.0             108.0             145.0             44.7
1996.....      38.4             151.1             189.5             74.5
1997.....      63.5             176.0             239.5             N/A(5)
               
----------
(1)   Information is from Inside Mortgage Securities, January 8, 1993, January
      14, 1994, January 20, 1995, February 2, 1996, Inside MBS & ABS, February
      14, 1997 and January 16, 1998 and includes all U.S. public and rated
      private residential first mortgage-backed transactions, except obligations
      issued or guaranteed by government related entities.
(2)   Information is from Asset Sales Report, January 18, 1993, January 25,
      1993, January 10, 1994, January 9, 1995, January 22, 1996, January 27,
      1997 and January 5, 1998 and includes all U.S. public asset-backed
      obligations (other than commercial paper transactions) backed by consumer
      receivables (including home equity loans), pooled corporate obligations
      and commercial mortgages.
(3)   Combined volume excludes both (i) private placement non-residential
      asset-backed obligations and (ii) asset-backed commercial paper.
(4)   Information for 1991 through 1992 is based on data provided in the
      Association of Financial Guaranty Insurors (AFGI), Report of Combined
      Financial Results and New Business Written for the period ended December
      31, 1992. Information for 1993 is based on data provided in the AFGI,
      Annual Report 1993. Information for 1994, 1995 and 1996 is based upon AFGI
      reporting for those years.
(5)   Not available.

      The issuance of asset-backed obligations of the type included in the table
experienced substantial growth in each year over the 1991 to 1997 period, with
the exception of 1994. The combined volume of such asset-backed obligations grew
from $99.9 billion in 1991 to $239.5 billion in 1997.

      During 1991, credit card obligations were the largest single component of
public, non-residential asset-backed obligations. Automobile loans were the
largest component in 1992 and 1993. Credit card obligations were the largest
component in 1994, 1995 and 1996. Home equity loans were the largest component
in 1997.

      The par value of new asset-backed obligations insured by monoline
financial guaranty insurance companies rose in every year from 1991 through
1996.

      The growth in the issuance of asset-backed obligations since 1991 has been
due in part to increased capital requirements of commercial banks and insurance
companies and the contraction of credit extended to corporations. Banks have
responded to increased capital requirements by selling certain of their assets,
such as credit card receivables and automobile loans, in securitized structures
to the financial markets. Moreover, many corporations have found securitization
of their assets to be a less costly funding alternative to traditional forms of
borrowing.

      Residential mortgage-backed issuance declined in 1994 because interest
rates rose, causing a reduction in mortgage loan refinancings and therefore in
the amount of new loan originations available for securitization. The decline
continued in 1995, as interest rates stabilized, and ended in 1996. In addition,
a substantial amount of 


                                       4
<PAGE>

residential first mortgage loans were securitized in the home equity loan sector
of the asset-backed market in 1996 and 1997.

      The demand for asset securitizations continues to deepen and broaden as
issuers securitize new classes of assets through increasingly complex
structures. Properly structured credit enhancements are often attractive in
providing market acceptability, liquidity and security.

Municipal Obligations

      Municipal obligations include bonds, notes and other evidences of
indebtedness issued by states and their political subdivisions (such as
counties, cities or towns), utility districts, public universities and
hospitals, public housing and transportation authorities and other public and
quasi-public entities. Municipal obligations are supported by the issuer's
taxing power in the case of general obligation bonds, or by the issuer's ability
to impose and collect fees and charges for public services or specific projects
in the case of most special revenue bonds.

      Insurance of municipal obligations represents the largest portion of the
financial guaranty insurance business. Since the early 1980s, insured municipal
obligation volume has grown substantially in terms of insurance in force, the
number of municipalities issuing insured obligations and the types of municipal
obligations that are insured. The percentage of municipal obligations insured
has also increased substantially. From 1988 to 1993, municipal issuance
increased each year. The low market interest rates which prevailed during 1993
resulted in record levels of new issuances and refundings of municipal bonds. As
expected, these record levels of issuances and refundings were not sustained
when interest rates increased. Consequently, the volume of issuances and
refundings of municipal bonds, and opportunities to write insurance for such
bonds, fell significantly in 1994 and modestly in 1995. Both total issuance and
refundings increased in 1996 and 1997, primarily because of lower interest
rates.

      The following table sets forth certain information regarding long-term
municipal obligations, issued during the periods indicated:

                        Insured Municipal Obligations(1)

                                                                 New Insured
                                                                    Volume
                                New               New             as Percent
Year                        Total Volume    Insured Volume   of New Total Volume
----                        ------------    --------------   -------------------
                                 (dollars in billions)      
1988 .....................    $ 117.3          $ 27.1                23.1%
1989 .....................      125.0            31.1                24.9
1990 .....................      127.8            33.5                26.2
1991 .....................      172.4            51.9                30.1
1992 .....................      234.7            80.8                34.4
1993 .....................      292.2           107.9                36.9
1994 .....................      164.9            61.4                37.2
1995 .....................      160.1            68.5                42.8
1996 .....................      185.0            85.7                46.3
1997 .....................      220.5           107.3                48.7
                                                                   
----------                                                       
(1)   Information is based on data provided in The Bond Buyer, January 8, 1998.
      Volume is expressed on the basis of principal value insured.

Types of Products

      FSA's insurance is employed in both the new issue and secondary markets.
Insurance premium rates take into account the cost and the projected return to
and the risk assumed by FSA. Critical factors in assessing risk include the
credit quality of the issuer, type of issue, sources of repayment, transaction
structure and term to maturity. Each obligation is evaluated on the basis of,
and the final premium rate is a function of, such factors and subject to FSA's
underwriting guidelines.


                                       5
<PAGE>

      In the case of new issues, the insured obligations are sold with FSA
insurance at the time the obligations are issued. For both municipal and
asset-backed obligations, FSA participates in negotiated offerings, where the
investment banker and often the insurer have been selected by the sponsor or
issuer. In addition, FSA participates in competitive offerings, where
underwriting syndicates bid for securities and submit bids that may include
insurance.

      In the secondary market, FSA's Triple-A Guaranteed Secondary Securities
(TAGSS(R)) Program provides insurance for uninsured asset-backed obligations
trading in the secondary market. TAGSS-insured securities include
mortgage-backed securities and utility first mortgage bonds. FSA's Custody
Receipt Program provides insurance for uninsured municipal obligations trading
in the secondary market. The insurance of obligations outstanding in the
secondary market generally affords a wider secondary market and therefore
greater marketability to a given issue of previously issued obligations. FSA's
underwriting guidelines require it to apply the same underwriting standards on
secondary market issues that it does on new security issues, although the
evaluation procedures are typically abbreviated.

      FSA also writes portfolio insurance for securities held by investment
funds, such as unit investment trusts and mutual funds. Such insurance covers
securities either while they are held by the fund or to their maturity, whether
or not held by the fund.

      The following table indicates the percentages of par amount (net of
reinsurance) outstanding at December 31, 1997 and 1996 with respect to each type
of asset-backed and municipal program:

            Net Par Amount and Percentage Outstanding by Program Type

                                            December 31, 1997
                           -----------------------------------------------------
                             Asset-Backed Programs         Municipal Programs
                           --------------------------  -------------------------
                                         Percent of                 Percent of
                                         Total Net                  Total Net
                               Net          Par          Net           Par
                            Par Amount     Amount     Par Amount      Amount
                           Outstanding  Outstanding  Outstanding   Outstanding
                           -----------  -----------  -----------   -----------
                                           (dollars in millions)
New Issue ................   $26,989         95.5%       $39,976         87.6%
Secondary Market .........     1,244          4.4          5,652         12.4
Portfolio Insurance ......        26          0.1           --            0.0
                             -------        -----        -------        -----
     Total ...............   $28,259(1)     100.0%       $45,628(2)     100.0%
                             =======        =====        =======        =====


                                            December 31, 1996
                           -----------------------------------------------------
                             Asset-Backed Programs         Municipal Programs
                           --------------------------  -------------------------
                                         Percent of                 Percent of
                                         Total Net                  Total Net
                               Net          Par          Net           Par
                            Par Amount     Amount     Par Amount      Amount
                           Outstanding  Outstanding  Outstanding   Outstanding
                           -----------  -----------  -----------   -----------
                                           (dollars in millions)
New Issue ................   $21,455         93.7%       $29,390         85.5%
Secondary Market .........     1,417          6.2          4,986         14.5
Portfolio Insurance ......        26          0.1             13          0.0
                             -------        -----        -------        -----
     Total ...............   $22,898(1)     100.0%       $34,389(2)     100.0%
                             =======        =====        =======        =====
                                                      
----------                                          
(1)   Excludes $231 million and $302 million par amount outstanding assumed by
      FSA under reinsurance agreements at December 31, 1997 and 1996,
      respectively.
(2)   Excludes $1,361 million and $1,605 million par amount outstanding assumed
      by FSA under reinsurance agreements at December 31, 1997 and 1996,
      respectively.


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<PAGE>

Insurance in Force

      FSA has insured a variety of asset-backed obligations, including
obligations backed by residential mortgages, consumer receivables, corporate
bonds, bank loans, government debt and commercial mortgages. FSA has insured a
broad array of municipal obligations. FSA has also insured investor-owned
utility first mortgage bonds.

      FSA ceased writing insurance for commercial mortgage transactions in 1990.
In December 1993, the Company took certain steps (the "Restructuring") to reduce
its risk of loss from commercial mortgage transactions previously insured by FSA
and its subsidiaries. As part of the Restructuring, (i) the Company established
Commercial Reinsurance Company ("Commercial Re"), a special purpose reinsurance
company; (ii) the Company distributed all the outstanding shares of Commercial
Re to the existing shareholders of the Company in proportion to their ownership
interests in the Company at the time; and (iii) Commercial Re assumed
approximately 64.4% of the exposure of FSA and its subsidiaries, on a weighted
average basis, on commercial mortgage transactions previously insured by FSA and
its subsidiaries.

      FSA has selectively expanded its insured portfolio in a manner intended to
achieve diversification. At December 31, 1997, FSA and its subsidiaries had in
force 583 issues insuring approximately $38.4 billion in gross direct par amount
outstanding of asset-backed obligations and 3,568 issues insuring approximately
$60.0 billion in gross direct par amount outstanding of municipal obligations.
In addition, at December 31, 1997, FSA had assumed pursuant to certain
reinsurance contracts approximately $0.2 billion and $1.4 billion in par amount
outstanding on asset-backed and municipal obligations, respectively, resulting
in a total gross par amount outstanding of approximately $100.0 billion. At such
date, the total net par amount outstanding, determined by reducing the gross par
amount outstanding to reflect reinsurance ceded of approximately $24.5 billion,
was approximately $75.5 billion. At December 31, 1997, the weighted average life
of the direct principal insured on these policies was approximately four and
thirteen years, respectively, for asset-backed and municipal obligations.

Asset-Backed Obligations

      FSA's insured portfolio of asset-backed obligations is divided into seven
major categories:

      Residential Mortgages. Obligations primarily backed by residential
mortgages generally take the form of conventional pass-through certificates or
pay-through debt securities, but also include commercial paper obligations and
other highly structured products. Residential mortgages backing these insured
obligations include closed-end first mortgages and closed- and open-end second
mortgages or home equity loans on one-to-four family residential properties,
including condominiums and cooperative apartments.

      Consumer Receivables. Obligations primarily backed by consumer receivables
include conventional pass-through and pay-through securities as well as more
highly structured transactions. Consumer receivables backing these insured
obligations include automobile loans and leases, credit card receivables, mobile
home loans, timeshare loans and limited partnership investor notes.

      Government Securities. Obligations primarily backed by government
securities include insured investment funds that invest in government securities
and insured bonds backed by letters of credit or repurchase agreements
collateralized by government securities. Government securities include full
faith and credit obligations of the United States and obligations of public and
quasi-public agencies of the United States, such as the Federal National
Mortgage Association ("FNMA") and the Federal Home Loan Mortgage Corporation
("Freddie Mac"), as well as obligations of non-U.S. sovereigns.

      Pooled Corporate Obligations. Obligations primarily backed by pooled
corporate obligations include obligations collateralized by corporate debt
securities or corporate loans and obligations backed by cash flow or market
value of non-consumer indebtedness, and include "collateralized bond
obligations" and "collateralized loan obligations". Corporate obligations
include corporate bonds, bank loan participations, trade receivables and equity
securities.

      Investor-Owned Utility Obligations. Obligations backed by investor-owned
utilities include, most commonly, first mortgage bond obligations of for-profit
electric or water utilities providing retail, industrial and 


                                       7
<PAGE>

commercial service, and also include sale-leaseback obligation bonds supported
by such entities. In each case, these bonds are secured by a mortgage on
property owned by or leased to an investor-owned utility.

      Commercial Mortgage Portfolio. FSA ceased writing insurance in this sector
in 1990 and as part of the Restructuring obtained reinsurance from Commercial Re
relating to risk of loss in this sector. Obligations backed by commercial
mortgages are divided into commercial real estate and corporate secured
obligations. Commercial real estate obligations are primarily backed by
commercial real estate, including hotel properties, office buildings and
warehouses and consist of pay-through bonds, pass-through certificates and more
structured products, with credit protection provided by property cash flow,
property values, first loss letters of credit, cash reserves and other means.
Corporate secured obligations generally take the form of bond obligations
secured by mortgages on properties leased to one or more affiliated corporate
tenants, in which the obligations are secured primarily by the lease cash flow
and secondarily by the value of the mortgaged properties.

      Other Asset-Backed Obligations. Other asset-backed obligations insured by
FSA include bonds or other securities backed by a combination of assets that
include elements of more than one of the categories set forth above.

Municipal Obligations

      FSA's insured portfolio of municipal obligations is divided into seven
major categories:

      General Obligation Bonds. General obligation bonds are issued by states,
their political subdivisions and other municipal issuers, and are supported by
the general obligation of the issuer to pay from available funds and by a pledge
of the issuer to levy taxes sufficient in an amount to provide for the full
payment of the bonds to the extent other available funds are insufficient.

      Housing Revenue Bonds. Housing revenue bonds include both multifamily and
single family housing bonds, with multi-tiered security structures based on the
underlying mortgages, reserve funds, and various other features such as Federal
Housing Administration or private mortgage insurance, bank letters of credit,
and, in some cases, the general obligation of the issuing housing agency or a
state's "moral obligation" (that is, not a legally binding commitment) to make
up deficiencies.

      Municipal Utility Revenue Bonds. Municipal utility revenue bonds include
obligations of all forms of municipal utilities, including electric, water and
sewer utilities. Insurable utilities may be organized as municipal enterprise
systems, authorities or joint-action agencies.

      Health Care Revenue Bonds. Health care revenue bonds include both
long-term maturities for capital construction or improvements of health care
facilities and medium-term maturities for equipment purchase.

      Tax-Supported (Non-General Obligation) Bonds. Tax-supported (non-general
obligation) bonds include a variety of bonds that, though not general
obligations, are supported by the taxing ability of the issuer, such as
tax-backed revenue bonds and lease revenue bonds. Tax-backed revenue bonds may
be secured by a first lien on pledged tax revenues, such as those from special
taxes, including those on retail sales and gasoline, or from tax increments (or
tax allocations) generated by growth in property values within a district. FSA
also insures bonds secured by special assessments, levied against property
owners, which benefit from covenants by the district to levy, collect and
enforce collections and to foreclose on delinquent properties. Lease revenue
bonds or certificates of participation (COPs) may be secured by long-term
obligations or by lease obligations subject to annual appropriation. The
financed project is generally real property or equipment that, in the case of
annual appropriation leases, FSA deems to serve an essential public purpose
(e.g., schools, prisons, courts) or, in the case of long-term leases, is
insulated from the risk of abatement resulting from nontenantability.

      Transportation Revenue Bonds. Transportation revenue bonds include a wide
variety of revenue-supported bonds, such as bonds for airports, ports, tunnels,
parking facilities, toll roads and toll bridges.

      Other Municipal Bonds. Other municipal bonds insured by FSA include
college and university revenue bonds, moral obligation bonds, resource recovery
bonds and debt issued, guarantied or otherwise supported by the national or
local governments of Australia, Denmark, Finland, France, Italy, Spain and
Sweden. 


                                       8
<PAGE>

      A summary of FSA's insured portfolio at December 31, 1997 is shown below:

                Summary of Insured Portfolio at December 31, 1997

<TABLE>
<CAPTION>
                                                                                Percent
                                          Number of     Net Par        Net      of Net
                                          Issues In      Amount      Par and    Par and
                                            Force     Outstanding   Interest    Interest
                                          ---------   -----------   --------    --------
                                                 (dollars in millions)     
<S>                                         <C>        <C>          <C>          <C>   
Asset-backed obligations
   Residential mortgages .............        305      $ 12,928     $ 17,312      14.7%
   Consumer receivables ..............        167        10,660       11,633       9.9
   Government securities .............         25           787        1,285       1.1
   Pooled corporate obligations ......         24         3,004        3,641       3.1
   Investor-owned utility obligations          44           643        1,573       1.3
   Commercial mortgage portfolio .....         10           153          189       0.2
   Other asset-backed obligations ....          8           315          470       0.4
                                         --------      --------     --------   -------
     Total asset-backed obligations ..        583        28,490       36,103      30.7
                                         --------      --------     --------   -------
Municipal obligations                                               
   General obligation bonds ..........      2,020        17,101       27,332      23.3
   Housing revenue bonds .............        230         1,770        3,776       3.2
   Municipal utility revenue bonds ...        352         5,892       10,369       8.8
   Health care revenue bonds .........        113         3,924        7,165       6.1
   Tax-supported (non-general                                       
     obligation) bonds ...............        480        11,210       20,142      17.2
   Transportation revenue bonds ......         45         1,972        3,767       3.2
   Other municipal bonds .............        328         5,120        8,775       7.5
                                         --------      --------     --------   -------
     Total municipal obligations .....      3,568        46,989       81,326      69.3
                                         --------      --------     --------   -------
         Total .......................      4,151      $ 75,479     $117,429     100.0%
                                         ========      ========     ========   =======
</TABLE>

Obligation Type

      The table below sets forth the relative percentages of net par amount
written of obligations insured by FSA by obligation type during each of the last
five years:

                 Annual New Business Insured by Obligation Type

                                                     Year Ended December 31,
                                                --------------------------------
       Obligation Type                          1997   1996   1995   1994   1993
       ---------------                          ----   ----   ----   ----   ----
Asset-backed obligations
   Residential mortgages ....................    19%    29%    26%    25%    14%
   Consumer receivables .....................    24     25     29     23     12
   Government securities ....................     2      1      0      0      0
   Pooled corporate obligations .............    10      1     10      4      1
   Commercial mortgage portfolio ............     0      0      0      0      0
   Investor-owned utility obligations .......     0      0      0      2      3
   Other asset-backed obligations ...........     0      2      1      2      3
                                                ---    ---    ---    ---    ---
     Total asset-backed obligations .........    55     58     66     56     33
Municipal obligations
   General obligations bonds ................    18     20     11     12     14
   Housing revenue bonds ....................     1      1      2      1      3
   Municipal utility revenue bonds ..........     2      4      4      8     10
   Health care revenue bonds ................     4      2      3      4      7
   Tax-supported (non-general
     obligation) bonds ......................    10      9      6     11     17
   Transportation revenue bonds .............     2      1      6      1      3
   Other municipal bonds ....................     8      5      2      7     13
                                                ---    ---    ---    ---    ---
     Total municipal obligations ............    45     42     34     44     67
                                                ---    ---    ---    ---    ---
         Total ..............................   100%   100%   100%   100%   100%
                                                ===    ===    ===    ===    ===


                                       9
<PAGE>

Terms to Maturity

      The table below sets forth the estimated terms to maturity of FSA's
policies at December 31, 1997 and 1996:

        Estimated Terms to Maturity of Net Par of Insured Obligations(1)

                                    December 31, 1997         December 31, 1996
                                  ---------------------     --------------------
                                                (in millions)
       Estimated                  Asset-                    Asset-
    Term to Maturity              Backed      Municipal     Backed     Municipal
    ----------------              ------      ---------     ------     ---------
0 to 5 Years ...............      $ 7,553      $ 2,230      $ 7,424     $ 1,571
5 to 10 Years ..............        5,637        5,683        3,920       3,841
10 to 15 Years .............        2,858        8,257        1,461       6,272
15 to 20 Years .............          524       14,340          714      11,433
20 Years and Above .........       11,917       16,479        9,681      12,877
                                  =======      =======      =======     =======
   Total ...................      $28,489      $46,989      $23,200     $35,994
                                  =======      =======      =======     =======

----------
(1)  Based on estimates made by the issuers of the insured obligations as of the
     original issuance dates of such 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.

Issue Size

      The tables below set forth information with respect to the original net
par amount of insurance written per issue insured by FSA at December 31, 1997:

                                  Asset-Backed
                      Original Net Par Amount Per Issue(1)

                                                                      Percent of
                                            Percent of                  Total
                                              Total       Net Par      Net Par
       Original                   Number      Number       Amount       Amount
    Net Par Amount             of Policies  of Issues   Outstanding  Outstanding
    --------------             -----------  ----------  -----------  -----------
                                            (dollars in millions)
Less than $10 million .....          463       40.0%      $   690        2.4%
$10 to $25 million ........          141       12.2         1,316        4.7
$25 to $50 million ........          142       12.3         1,930        6.8
$50 million or greater ....          410       35.5        24,323       86.1
                                 -------      -----       -------      -----
   Total ..................        1,156      100.0%      $28,259      100.0%
                                 =======      =====       =======      =====

----------
(1)   Does not include $231 million net par amount outstanding assumed by FSA
      and its subsidiaries under reinsurance agreements.


                                       10
<PAGE>

                                    Municipal
                      Original Net Par Amount Per Issue(1)

                                                                      Percent of
                                            Percent of                  Total
                                              Total       Net Par      Net Par
       Original                   Number      Number       Amount       Amount
    Net Par Amount             of Policies  Of Issues   Outstanding  Outstanding
    --------------             -----------  ----------  -----------  -----------
                                            (dollars in millions)
Less than $10 million .....        5,000       76.9%      $13,115       28.7%
$10 to $25 million ........          893       13.7         9,525       20.9
$25 to $50 million ........          320        4.9         7,172       15.7
$50 million or greater ....          294        4.5        15,816       34.7
                                 -------      -----       -------      -----
   Total ..................        6,507      100.0%      $45,628      100.0%
                                 =======      =====       =======      =====

----------
(1)   Does not include $1,361 million net par amount outstanding assumed by FSA
      and its subsidiaries under reinsurance agreements.

Geographic Concentration

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

      FSA seeks to maintain a diversified portfolio of insured municipal
obligations designed to spread its risk across a number of geographic areas. The
table below sets forth those jurisdictions in which municipalities issued an
aggregate of 2% or more of FSA's net par amount outstanding of insured municipal
securities:

                                    Municipal
                        Insured Portfolio by Jurisdiction
                              at December 31, 1997

                                                                Percent of Total
                                                   Net Par        Municipal Net
                                     Number         Amount         Par Amount
              Jurisdiction         of Issues     Outstanding       Outstanding
              ------------         ---------     -----------       -----------
                                             (dollars in millions)
California.......................      403          $7,832           16.7%
New York.........................      281           4,307            9.2
Pennsylvania.....................      231           3,125            6.6
New Jersey.......................      207           2,730            5.8
Florida..........................      103           2,669            5.7
Texas............................      294           2,472            5.3
Illinois.........................      274           1,851            3.9
Massachusetts....................      101           1,460            3.1
Michigan.........................      147           1,417            3.0
Minnesota........................      129           1,152            2.5
Wisconsin........................      179           1,138            2.4
All other states.................    1,190          15,575           33.1
Non-U.S..........................       29           1,261            2.7
                                     -----         -------          -----
     Total.......................    3,568         $46,989          100.0%
                                     =====         =======          =====


                                       11
<PAGE>

Issuer Concentration

      FSA has adopted underwriting and exposure management policies designed to
limit the net insurance in force for any one credit. In many cases, FSA uses
reinsurance to limit net exposure to any one credit. At December 31, 1997,
insurance of asset-backed obligations constituted 30.7% of FSA's net insurance
in force and insurance of municipal obligations constituted 69.3% of FSA's net
insurance in force. At such date, FSA's ten largest net insured asset-backed
transactions represented $5.0 billion, or 6.7%, of its total net par amount
outstanding, and FSA's ten largest net insured municipal credits represented
$3.4 billion, or 4.5%, of its total net par amount outstanding. For purposes of
the foregoing, different issues of asset-backed securities by the same sponsor
have not been aggregated. FSA has, however, adopted underwriting policies
establishing single risk guidelines applicable to asset-backed securities of the
same sponsor. FSA is also subject to certain regulatory limits and rating agency
guidelines on exposure to single credits.

      The following tables set forth the net par amount outstanding of FSA's
insurance for the ten largest asset-backed transactions and municipal credits
insured by FSA at December 31, 1997:

       Ten Largest Insured Asset-Backed Transactions at December 31, 1997

                                                                      Net Par
                                                                      Amount
          Transaction                           Asset Type          Outstanding
          -----------                           ----------          -----------
                                                                   (in millions)

IMC 1997-7 ..............................  Residential Mortgages     $  656.2
Merit Securities Corp. Series 8 .........  Residential Mortgages        559.4
IMC Home Equity 1997- 6 .................  Residential Mortgages        539.2
Arcadia Auto Receivable Trust 1997 ......  Consumer Receivables         521.2
Archimedes Funding LLC ..................  Pooled Corporate             476.5
WFS Financial 1997-C ....................  Consumer Receivables         474.5
PAMCO CLO Series 1997-1 .................  Pooled Corporate             470.5
Arcadia Auto Receivable Trust 1997 D ....  Consumer Receivables         464.6
CICB - Household Credit Cards ...........  Consumer Receivables         441.6
SERAIL P.L.C ............................  Pooled Corporate             430.8
                                                                     --------
     Total ..............................                            $5,034.5
                                                                     ========

           Ten Largest Insured Municipal Credits at December 31, 1997

                                                                      Net Par
                                                                      Amount
               Credit                      Obligation Type          Outstanding
               ------                      ---------------          -----------
                                                                   (in millions)
Washington State Public Power Supply
  System.................................  Utility Revenue           $  399.6
New York State Dormitory Agency .........  Tax-Supported                389.7
New York City ...........................  General Obligation           368.4
Puerto Rico Municipal Finance Agency ....  Other Obligation             355.3
New York City Municipal Water Finance                               
  Authority..............................  Utility Revenue              332.2
State of California .....................  General Obligation           323.0
Southern California Public Power                                    
  Authority..............................  Utility Revenue              317.0
State of New Jersey Pension Obligations .  Tax Supported                313.8
Commonwealth of Puerto Rico .............  General Obligation           305.7
Puerto Rico Electric Power Authority ....  Utility Revenue              283.7
                                                                     --------
     Total ..............................                            $3,388.4
                                                                     ========


                                       12
<PAGE>

Credit Underwriting Guidelines, Standards and Procedures

      Financial guaranty insurance, as written by FSA, relies on an assessment
of the adequacy of various payment sources to meet debt service payments or
other obligations in a specific transaction without regard to premiums paid or
income from investment of premiums. FSA'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. To this
end, each policy written or reinsured by FSA must meet the general underwriting
guidelines and specific standards for particular types of obligations approved
by its Board of Directors. In addition, the Company's Board of Directors has
established an Underwriting Committee which periodically reviews completed
transactions to ensure conformity with underwriting guidelines and standards.

      FSA's underwriting guidelines for asset-backed obligations are built on
the concept of multiple layers of protection, and vary by obligation type in
order to reflect different structures and credit support. In this regard,
asset-backed obligations insured by FSA are generally issued in structured
transactions and backed by pools of assets such as consumer or trade
receivables, residential mortgage loans, securities or other assets having an
ascertainable cash flow or market value. In addition, FSA seeks to insure
asset-backed obligations that generally provide for one or more forms of
overcollateralization (such as excess collateral value, excess cash flow or
"spread," or reserves) or third-party protection (such as bank letters of
credit, guarantees, net worth maintenance agreements, indemnity agreements or
reinsurance agreements). This overcollateralization or third-party protection
need not indemnify FSA against all loss, but is generally intended to assume the
primary risk of financial loss. Overcollateralization or third-party protection
may not, however, be required in transactions in which FSA is insuring the
obligations of certain highly rated issuers that typically are regulated, have
implied or explicit government support, or are short term, or in transactions in
which FSA is insuring bonds issued to refinance other bonds insured by FSA as to
which the issuer is or may be in default. FSA's general policy has been to
insure 100% of the principal, interest and other amounts due in respect of
asset-backed insured obligations rather than providing partial or first loss
coverage sufficient to convey a triple-A rating on the insured obligations.

      FSA's underwriting guidelines for municipal obligations require that the
municipal obligor be rated investment grade by Moody's Investors Service, Inc.
("Moody's") or Standard & Poor's Ratings Services ("S&P") or, in the
alternative, such obligor is considered by FSA to be the equivalent of
investment grade. Where the municipal obligor is a governmental entity with
taxing power or providing an essential public service paid by taxes, assessments
or other charges, supplemental protections may be required if such taxes,
assessments or other charges are not projected to provide sufficient debt
service coverage. Where appropriate, the municipal obligor is required to
provide a rate or charge covenant and a pledge of additional security (e.g.,
mortgages on real property, liens on equipment or revenue pledges) to secure the
obligation.

      The rating agencies participate to varying degrees in the underwriting
process. Each asset-backed obligation insured by FSA is reviewed prior to
issuance by both S&P and Moody's to evaluate the risk proposed to be insured. In
the case of municipal obligations, prior rating agency review is a function of
the type of the insured obligation and the risk elements involved. In addition,
substantially all transactions insured by FSA are reviewed by at least one of
the major rating agencies after issuance to confirm continuing compliance with
rating agency standards. The independent review of FSA's underwriting practices
performed by the rating agencies further strengthens the underwriting process.

      The underwriting process that implements these underwriting guidelines and
standards is supported by its professional staff of analysts, underwriting
officers, credit officers and attorneys. Moreover, the approval of senior
management is required for all transactions.

      Each underwriting group in the Financial Guaranty Department has a senior
underwriting officer responsible for confirming that each transaction proposed
by the Financial Guaranty Department conforms to the underwriting guidelines and
standards. The evaluation by the senior underwriting officer is reviewed by the
chief underwriting officer for the particular sector. This review may take place
while the transaction is in its formative stages, thus facilitating the
introduction of further enhancements at a stage when the transaction is more
receptive to change.

      Final transaction approval is obtained from FSA's Management Review
Committee for asset-backed transactions and from FSA's Municipal Underwriting
Committee for municipal transactions. Approval is usually 


                                       13
<PAGE>

based upon both a written and an oral presentation by the underwriting group to
the respective committee. The Management Review Committee is comprised of FSA's
Chief Executive Officer, President, Chief Operating Officer, Chief Underwriting
Officer, Chief International Underwriting Officer and General Counsel. The
Municipal Underwriting Committee is comprised of FSA's Chief Executive Officer,
President, Chief Municipal Underwriting Officer, an Associate General Counsel
for Municipal Transactions and the Managing Director for Municipal Surveillance.
Following approval, minor transaction modifications may be approved by the
Chairs of the underwriting groups. Major changes require the concurrence of the
appropriate underwriting committee. Subject to applicable limits, secondary
market and partial maturity asset-backed transactions that meet certain credit
and return criteria may be approved by the Chief Underwriting Officer and the
head of the department involved, with a third signature from a member of the
Management Review Committee for larger transactions. Subject to applicable
limits, municipal transactions that meet certain credit and return criteria may
be approved by a committee composed of the Chief Municipal Underwriting Officer
or the Head of Municipal Surveillance, an Associate General Counsel for
Municipal Transactions and any one of certain designated managing directors of
the Municipal Department.

Corporate Underwriting and Research

      FSA's Corporate Underwriting and Research Department is comprised of a
professional staff under the direction of the Chief Underwriting Officer. The
Corporate Underwriting and Research Department is responsible for evaluating the
credit of entities participating or providing recourse in obligations insured by
FSA. The Corporate Underwriting and Research Department also provides analysis
of relevant industry segments. Members of the Corporate Underwriting and
Research Department generally report their findings directly to the appropriate
underwriting committee in the context of transaction review and approval.

Transaction Oversight and Transaction Services

      The Transaction Oversight and Transaction Services Departments are
independent of the analysts and credit officers involved in the underwriting
process. The Asset-Backed and Municipal Transaction Oversight Departments are
responsible for monitoring the performance of outstanding transactions. The
Transaction Services Department, together with the Transaction Oversight
Departments, is responsible for taking remedial actions as appropriate. The
managing directors responsible for the Transaction Oversight and Transaction
Services Departments report to an Oversight Committee comprised of the Chairman,
the President, the General Counsel, the Chief Underwriting Officer and the Chief
Financial Officer. The Transaction Oversight Departments review each insured
transaction to confirm compliance with transaction covenants, monitor credit and
other developments affecting transaction participants and collateral, and
determine the steps, if any, required to protect the interests of FSA and the
holders of FSA-insured obligations. Reviews for asset-backed transactions
typically include an examination of reports provided by, and (as circumstances
warrant) discussions with, issuers, servicers, trustees and other transaction
participants. Reviews of asset-backed transactions often include servicer
audits, site visits or evaluations by third-party appraisers, engineers or other
experts retained by FSA. The Transaction Oversight Departments review each
transaction to determine the level of ongoing attention it will require. These
judgments relate to current credit quality and other factors, including
compliance with reporting or other requirements, legal or regulatory actions
involving transaction participants and liquidity or other concerns that may not
have a direct bearing on credit quality. Transactions with the highest risk
profile are generally subject to more intensive review and, if appropriate,
remedial action. The Transaction Oversight and Transaction Services Departments
work together with the Legal Department and the Corporate Underwriting and
Research Department in monitoring these transactions, negotiating restructurings
and pursuing appropriate legal remedies.

Legal

      FSA's Legal Department is comprised of a professional staff of attorneys
and legal assistants under the direction of the General Counsel. The Legal
Department plays a major role in establishing and implementing legal
requirements and procedures applicable to obligations insured by FSA. Members of
the Legal Department serve on the Management Review Committee and the Municipal
Underwriting Committee, which provide final underwriting approval for
transactions. An attorney in the Legal Department works together with a
counterpart in the Financial Guaranty Department in determining the legal and
credit elements of each obligation proposed for insurance and in overseeing the
execution of approved transactions. Asset-backed obligations insured by FSA are
ordinarily executed with the assistance of outside counsel working closely with
the Legal Department. Municipal obligations insured by FSA are ordinarily
executed without employment of outside counsel. The Legal Department works
closely with the Transaction Oversight and Transaction Services Departments in
addressing legal issues, rights and 


                                       14
<PAGE>

remedies, as well as proposed amendments, waivers and consents, in connection
with obligations insured by FSA. The Legal Department is also responsible for
domestic and international regulatory compliance, reinsurance, secondary market
transactions, litigation and other matters.

Loss Reserves

      FSA establishes a case basis reserve for the present value of the
estimated loss when, in management's opinion, the likelihood of a future loss is
probable and determinable at the balance sheet date. A case basis reserve for a
particular insured obligation represents FSA's estimate of the present value of
the anticipated shortfall, net of reinsurance, between (i) scheduled payments on
the insured obligations plus anticipated loss adjustment expenses and (ii)
anticipated cash flow from and proceeds to be received on sales of any
collateral supporting the obligation.

      In addition to the case basis reserves, FSA maintains a general reserve in
order to account for unidentified risks inherent in its overall portfolio. FSA
does not consider traditional actuarial approaches used in the property/casualty
insurance industry to be applicable to the determination of its loss reserves
because of the absence of a sufficient number of losses in its financial
guaranty insurance activities and in the financial guaranty industry generally
to establish a meaningful statistical base. The general reserve amount was
calculated by applying a loss factor to the total net par amount of FSA's
insured obligations outstanding over the term of such insured obligations and
discounting the result at a risk-free rate. The loss factor used for this
purpose has been determined based upon an independent rating agency study of
bond defaults and FSA's portfolio characteristics and history. FSA will, on an
ongoing basis, monitor the general reserve and may periodically adjust such
reserve based on FSA's actual loss experience, its future mix of business and
future economic conditions. The general reserve is available to be applied
against future additions or accretions to existing case basis reserves or to new
case basis reserves to be established in the future. To the extent that any such
future additions to case basis reserves are applied from the available general
reserve, there will be no impact on the Company's earnings for that period. To
the extent that additions to case basis reserves for any period exceed the
remaining available general reserve or are not applied from the general reserve,
the excess will be charged against the Company's earnings for that period. Any
addition to the general reserve which results from applying the loss factor to
new par written or from replenishing amounts applied against new case basis
reserves will result in a charge to earnings at that time. Amounts released from
the general reserve as a result of the runoff of existing net insurance in force
may be applied against additions to the general reserve required for new
business written.

      FSA maintains reserves in an amount believed by its management to be
sufficient to pay its estimated ultimate liability for losses and loss
adjustment expenses with respect to obligations it has insured. At December 31,
1997 and 1996, FSA's net loss reserves totaled $44.8 million and $42.2 million,
respectively. During 1995, the Company increased its general reserve by $6.3
million, of which $3.0 million was for originations of new business and $3.3
million was to reestablish the general reserve following transfers from the
general reserve to case basis reserves. During 1995, the Company transferred
$10.8 million from its general reserve to case basis reserves associated
predominantly with certain residential mortgage and timeshare receivables
transactions. Also in December 1995, FSA recognized a one-time increase of $15.4
million to the general reserve to provide for the insured portfolio it had
assumed in the Merger in a manner consistent with the Company's reserving
methodology. Prior to the Merger, Capital Guaranty did not maintain a general
reserve. The general reserve was $31.8 million at December 31, 1995. During
1996, the Company increased its general reserve by $6.9 million, of which $5.3
million was for new business originations and $1.6 million was to reestablish
the general reserve for transfers from the general reserves to case basis
reserves. During 1996, the Company transferred $9.0 million from its general
reserve to case basis reserves associated predominantly with certain residential
mortgage transactions. The general reserve was $29.7 million at December 31,
1996. During 1997, the Company increased its general reserve by $9.2 million, of
which $5.4 million was for new business originations and $3.8 million was to
reestablish the general reserve for transfers from the general reserves to case
basis reserves. During 1997, the Company transferred $4.5 million from its
general reserve to case basis reserves associated predominantly with certain
residential mortgage transactions. The general reserve was $34.3 million at
December 31, 1997.

      Reserves for losses and loss adjustment expenses are discounted at
risk-free rates. The amount of discount taken was approximately $19.8 million
and $17.9 million at December 31, 1997 and 1996, respectively.

      Since reserves are necessarily based on estimates and because of the
absence of a sufficient number of losses in its financial guaranty insurance
activities and in the financial guaranty insurance industry generally to


                                       15
<PAGE>

establish a meaningful statistical base, there can be no assurance that the case
basis reserves or the general reserve will be adequate to cover losses in FSA's
insured portfolio.

Competition and Industry Concentration

      FSA faces competition from both other providers of third party credit
enhancement and alternatives to third party credit enhancement. The majority of
asset-backed and municipal obligations are sold without third party credit
enhancement. Accordingly, each transaction proposed to be insured by FSA must
generally compete against an alternative execution which does not employ third
party credit enhancement. FSA also faces competition from other monoline primary
financial guaranty insurers, primarily Ambac Assurance Corp. ("Ambac"),
Financial Guaranty Insurance Company ("FGIC") and MBIA Insurance Corp. ("MBIA").
There has recently been further consolidation in the financial guaranty
industry, with Capital Markets Assurance Corp. being acquired by MBIA and Connie
Lee Insurance Company being acquired by Ambac. As a result of this
consolidation, FSA is now the smallest of the major primary financial guaranty
insurers in terms of statutory capital. Traditional credit enhancers such as
bank letter of credit providers and mortgage pool insurers also provide
significant competition to FSA as providers of credit enhancement for
asset-backed obligations. While actions by securities rating agencies in recent
years have significantly reduced the number of triple-A rated banks that can
offer a product directly competitive with FSA's triple-A guaranty, and
risk-based capital guidelines applicable to banks have generally increased costs
associated with letters of credit that compete directly with financial guaranty
insurance, bank letter of credit providers and other credit enhancement, such as
cash collateral accounts, provided by banks, continue to provide significant
competition to FSA. In addition, government sponsored entities, including FNMA
and Freddie Mac, have begun to compete with the monoline financial guaranty
insurers in the mortgage-backed and multifamily sectors.

      Insurance law generally restricts multiline insurance companies, such as
large property/casualty insurers and life insurers, from engaging in the
financial guaranty insurance business other than through separately capitalized
affiliates. Entry requirements include (i) assembling the group of experts
required to operate a financial guaranty insurance business, (ii) establishing
the triple-A claims-paying ability ratings with the credit rating agencies,
(iii) complying with substantial capital requirements, (iv) developing name
recognition and market acceptance with issuers, investment bankers and investors
and (v) organizing a monoline insurance company and obtaining insurance licenses
to do business in the applicable jurisdictions.

      FSA's net insurance in force is the outstanding principal, interest and
other amounts to be paid over the remaining life of all obligations insured by
FSA, net of ceded reinsurance, refunded bonds secured by United States
government securities held in escrow or other qualified collateral. Qualified
statutory capital, determined in accordance with statutory accounting
principles, is the aggregate of policyholders' surplus and contingency reserves
calculated in accordance with statutory accounting principles. Set forth below
are FSA's aggregate gross insurance in force, net insurance in force, qualified
statutory capital and leverage ratio (represented by the ratio of its net
insurance in force to qualified statutory capital) and the average industry
leverage ratio at the dates indicated:

                                                          December 31,
                                                 ------------------------------
                                                   1997       1996       1995
                                                   ----       ----       ----
                                                      (dollars in millions)
Financial guaranty primary insurers,        
 excluding FSA(1)                           
  Leverage ratio ..............................    N/A(2)      151:1      146:1
                                            
FSA                                         
  Gross insurance in force ....................  $158,020   $125,423   $ 99,034
  Net insurance in force ......................  $117,429   $ 93,704   $ 75,360
  Qualified statutory capital .................  $    782   $    676   $    645
  Leverage ratio ..............................     150:1      139:1      117:1
                                            
----------                              
(1)   Financial guaranty primary insurers for which data is included in this
      table are Ambac, Capital Guaranty Insurance Company (1995 only), Capital
      Markets Assurance Corporation, Connie Lee Insurance Company, FGIC and
      MBIA. Information relating to the financial guaranty primary insurers is
      derived from data from statutory accounting financial information publicly
      available from each insurer at December 31, 1996 and 1995.
(2)   Not available


                                       16
<PAGE>

Reinsurance

      Reinsurance is the commitment by one insurance company, the "reinsurer,"
to reimburse another insurance company, the "ceding company," for a specified
portion of the insurance risks underwritten by the ceding company in
consideration for a portion of the premiums received. The ceding company also
usually receives ceding commissions to cover costs of business generation.
Because the insured party contracts for coverage solely with the ceding company,
the failure of the reinsurer to perform does not relieve the ceding company of
its obligation to the insured party under the terms of the insurance contract.

Reinsurance Ceded

      FSA obtains reinsurance to increase its policy writing capacity, both on
an aggregate risk and a single risk basis, meet state insurance regulatory,
rating agency and internal limits, diversify risks, reduce the need for
additional capital and strengthen financial ratios. At December 31, 1997, FSA
had reinsured approximately 25.0% of its direct principal amount outstanding.
Most of FSA's reinsurance is on a quota share basis, with a small portion being
provided on a first loss or excess of loss per risk basis. Reinsurance
arrangements typically require FSA to retain a specified amount of the risk.

      FSA arranges reinsurance on both a facultative
(transaction-by-transaction) and treaty basis. Treaty reinsurance provides
coverage for a portion of the exposure from all qualifying policies issued
during the term of the treaty. In addition, FSA employs "automatic facultative"
reinsurance which permits FSA to apply reinsurance to transactions selected by
it subject to certain limitations. The reinsurer's participation in a treaty is
cancelable annually upon 90 days' prior notice by either FSA or the reinsurer
and is cancelable by FSA upon specified financial deterioration of the
reinsurer. As required by applicable state law, reinsurance agreements may be
subject to certain other termination conditions.

      Treaties generally provide coverage for the full term of the policies
reinsured during the annual treaty period, except that, upon a financial
deterioration of the reinsurer and the occurrence of certain other conditions,
FSA generally has the right to reassume all of the business reinsured.

      In 1997, FSA's principal ceded reinsurance program consisted of two quota
share treaties. One treaty (the "asset-backed treaty") covered all of FSA's
approved regular lines of business, except municipal bond insurance. In 1997,
FSA ceded 9.75% of each covered policy under this treaty, up to a maximum of
$19.5 million insured principal per single risk. At its sole option, FSA was
entitled to increase the ceding percentage to 19.5% up to $39 million insured
principal per single risk which is defined by revenue source. A second treaty
(the "municipal treaty") covered FSA's municipal bond insurance business. In
1997, FSA ceded 9% of each covered policy under this treaty that is classified
by FSA as providing municipal bond insurance as defined by Article 69 of the
insurance laws of New York up to a limit of $24 million insured principal per
single risk. At its sole option, FSA was entitled to increase the ceding
percentage to 35% up to $93.3 million insured principal per single risk. These
cession percentages under both treaties were reduced on smaller-sized
transactions. Under the three automatic facultative facilities in 1997, FSA at
its option could allocate up to a specified amount for each reinsurer (ranging
from $4 million to $50 million depending on the reinsurer) for each transaction,
subject to limits and exclusions, in exchange for which FSA agreed to cede in
the aggregate a specified percentage of gross par insured by FSA. Each of the
two treaties and automatic facultative facilities allows FSA to withhold a
ceding commission to defray their expenses. In 1997, FSA also implemented
facultative first-loss reinsurance on selected asset-backed transactions.

      Primary insurers, such as FSA, are required to fulfill their obligations
to policyholders if reinsurers fail to meet their obligations. The financial
condition of reinsurers is therefore evaluated carefully by FSA, and FSA's
reinsurance is placed with high quality and financially strong reinsurers. FSA's
treaty reinsurers at December 31, 1997 were Capital Reinsurance Company,
Employers Reinsurance Company, Enhance Reinsurance Company and Tokio Marine. In
1997, four reinsurers participated in the asset-backed treaty and three
reinsurers participated in the municipal treaty.

      FSA, FSAIC and Oklahoma have entered into a quota share reinsurance
pooling agreement pursuant to which, after reinsurance cessions to other
reinsurers, FSA, FSAIC and Oklahoma share in the net retained risk insured by
each of these three companies in proportion to their policyholders' surplus and
contingency reserve as of December 31 of the prior year (with the percentages
adjusted commencing April 1 of each year) through September 30, 1996 and each
calendar quarter thereafter. For the quarter commencing October 1, 1997, FSA
retained 65.89%, 


                                       17
<PAGE>

FSAIC retained 23.36% and Oklahoma retained 10.75% of each policy issued by
these companies after cessions to all other reinsurers. FSA-UK and FSA have
entered into a quota share and stop loss reinsurance agreement pursuant to which
(i) FSA-UK reinsures with FSA its retention under its policies after third party
reinsurance based on an agreed-upon percentage that is substantially in
proportion to the policyholders' surplus and contingency reserve of FSA-UK to
the total policyholders' surplus and contingency reserves of FSA and its
subsidiary insurers (including FSA-UK) and (ii) subject to certain limits, FSA
is required to make payments to FSA-UK when FSA-UK's loss ratio and expense
exceeds 100%. Under this agreement, FSA-UK ceded to FSA 98.090% of its retention
after other reinsurance of its policies issued in 1997.

      In connection with the Restructuring, FSA is party to a quota share
reinsurance agreement with Commercial Re pursuant to which Commercial Re assumed
approximately 64.4% of FSA's exposure, on a weighted average basis, on
transactions in FSA's commercial mortgage portfolio.

Rating Agencies

      Moody's , S&P and Fitch IBCA, Inc. periodically review the business and
financial condition of FSA and other companies providing financial guaranty
insurance. These rating agency reviews focus on the insurer's underwriting
policies and procedures and the quality of the obligations insured. The rating
agencies frequently perform assessments of the credits insured by FSA, and the
reinsurers and other providers of capital support to FSA, to confirm that FSA
continues to meet the capital adequacy criteria considered necessary by the
particular rating agency to maintain FSA's triple-A claims-paying ability
rating. See "Credit Underwriting Guidelines, Standards and Procedures" above.
FSA's ability to compete with other triple-A rated financial guarantors, and its
results of operations and financial condition, would be materially adversely
affected by any reduction in its ratings.

Insurance Regulatory Matters

General

      FSA is licensed to engage in insurance business in all 50 states, the
District of Columbia and Puerto Rico. FSA is subject to the insurance laws of
the State of New York ("New York Insurance Law"), and both FSA's domestic
operating insurance company subsidiaries, FSAIC and Oklahoma, are subject to the
insurance laws of the State of Oklahoma which is their state of incorporation.
Each is also subject to the insurance laws of the other states in which it is
licensed to transact an insurance business. Each of FSA and its domestic
insurance company subsidiaries are required to file quarterly and annual
statutory financial statements in each jurisdiction in which they are licensed,
and are subject to statutory restrictions concerning the types and quality of
investments and the filing and use of policy forms and premium rates. FSA's
accounts and operations are subject to periodic examination by the New York
Superintendent of Insurance (the "New York Superintendent") (the last such
examination having been conducted in 1995 for the period ended December 31,
1994) and other state insurance regulatory authorities.

Insurance Holding Company Laws

      The Company and its domestic operating insurance company subsidiaries
(FSA, FSAIC and Oklahoma) are subject to regulation under insurance holding
company statutes of New York and Oklahoma, where these respective insurers are
domiciled, as well as other jurisdictions where these companies are licensed to
do insurance business. The requirements of holding company statutes vary from
jurisdiction to jurisdiction but generally require insurance holding companies
and their insurance subsidiaries to register and file certain reports
describing, among other information, their capital structure, ownership and
financial condition. The holding company statutes also require prior approval of
changes in control, of certain dividends and other intercorporate transfers of
assets and of transactions between insurance companies and their affiliates. The
holding company statutes generally require that all transactions with affiliates
be fair and reasonable and that those exceeding specified limits require prior
notice to or approval by insurance regulators.

      Under the insurance holding company laws in effect in New York and
Oklahoma, any acquisition of control of the Company, and thereby indirect
control of FSA, FSAIC and Oklahoma, requires the prior approval of the New York
Superintendent and the Oklahoma Insurance Commissioner. "Control" is defined as
the direct or indirect power to direct or cause the direction of the management
and policies of a person, whether through the ownership of voting 


                                       18
<PAGE>

securities, by contract or otherwise. Any purchaser of 10% or more of the
outstanding voting securities of a corporation is presumed to have acquired
control of that corporation and its subsidiaries, although the insurance
regulator may find that "control" in fact does or does not exist when a person
owns or controls either a lesser or greater amount of voting securities.

New York Financial Guaranty Insurance Law

      Article 69 ("Article 69") of the New York Insurance Law, a comprehensive
financial guaranty insurance statute, governs all financial guaranty insurers
licensed to do business in New York, including FSA. This statute limits the
business of financial guaranty insurers to financial guaranty insurance and
related lines (such as surety).

      Article 69 requires that financial guaranty insurers maintain a special
statutory accounting reserve called the "contingency reserve" to protect
policyholders against the impact of excessive losses occurring during adverse
economic cycles. Article 69 requires a financial guaranty insurer to provide a
contingency reserve (i) with respect to policies written prior to July 1, 1989
in an amount equal to 50% of earned premiums and (ii) with respect to policies
written on and after July 1, 1989, quarterly on a pro rata basis over a period
of 20 years for municipal bonds and 15 years for all other obligations, in an
amount equal to the greater of 50% of premiums written for the relevant category
of insurance or a percentage of the principal guarantied, varying from 0.55% to
2.50%, depending upon the type of obligation guarantied, until the contingency
reserve amount for the category equals the applicable percentage of net unpaid
principal. This reserve must be maintained for the periods specified above,
except that reductions by the insurer may be permitted under specified
circumstances in the event that actual loss experience exceeds certain
thresholds or if the reserve accumulated is deemed excessive in relation to the
insurer's outstanding insured obligations. Financial guaranty insurers are also
required to maintain reserves for losses and loss adjustment expenses on a
case-by-case basis and reserves against unearned premiums.

      Article 69 establishes single risk limits for financial guaranty insurers
applicable to all obligations issued by a single entity and backed by a single
revenue source. For example, under the limit applicable to qualifying
asset-backed securities, the lesser of (i) the insured average annual debt
service for a single risk or (ii) the insured unpaid principal (reduced by the
extent to which the unpaid principal of the supporting assets exceeds the
insured unpaid principal) divided by nine, net of qualifying reinsurance and
collateral, may not exceed 10% of the sum of the insurer's policyholders'
surplus and contingency reserve, subject to certain conditions. Under the limit
applicable to municipal obligations, the insured average annual debt service for
a single risk, net of qualifying reinsurance and collateral, may not exceed 10%
of the sum of the insurer's policyholders' surplus and contingency reserve. In
addition, insured principal of municipal obligations attributable to any single
risk, net of qualifying reinsurance and collateral, is limited to 75% of the
insurer's policyholders' surplus and contingency reserve. Single risk limits are
also specified for other categories of insured obligations, and generally are
more restrictive than those listed for asset-backed or municipal obligations.

      Article 69 also establishes aggregate risk limits on the basis of
aggregate net liability insured as compared to statutory capital. "Aggregate net
liability" is defined as outstanding principal and interest of guarantied
obligations insured, net of qualifying reinsurance and collateral. Under these
limits, policyholders' surplus and contingency reserves must not be less than a
percentage of aggregate net liability equal to the sum of various percentages of
aggregate net liability for various categories of specified obligations. The
percentage varies from 0.33% for certain municipal obligations to 4% for certain
non-investment grade obligations.

Dividend Restrictions

      FSA's ability to pay dividends is dependent upon FSA's financial
condition, results of operations, cash requirements, rating agency approval and
other related factors and is also subject to restrictions contained in the
insurance laws and related regulations of New York and other states. Under New
York State insurance law, FSA may pay dividends out of earned surplus, provided
that, together with all dividends declared or distributed by FSA during the
preceding 12 months, the dividends do not exceed the lesser of (i) 10% of
policyholders' surplus as of its last statement filed with the New York
Superintendent of Insurance or (ii) adjusted net investment income during this
period. FSA has paid no dividends during 1997. Based upon FSA's statutory
statements for the quarter ended December 31, 1997, the maximum amount available
for payment of dividends by FSA without regulatory approval over the following
12 months is approximately $49.8 million. The New York Superintendent has
approved the 


                                       19
<PAGE>

repurchase by FSA of up to $75.0 million of its shares from its parent, pursuant
to which FSA has repurchased $66.5 million of its shares through December 31,
1997, including $39.5 million during 1997.

Financial Guaranty Insurance Regulation in Other Jurisdictions

      FSA is subject to laws and regulations of jurisdictions other than the
State of New York concerning the transaction of financial guaranty insurance.
The laws and regulations of these other jurisdictions are generally not more
stringent in any material respect than the New York Insurance Law.

      The United Kingdom's Department of Trade and Industry (the "DTI")
regulates FSA-UK. Pursuant to European Union Directives, FSA-UK has since been
authorized to provide financial guaranty insurance for transactions in France
and Ireland from its home office in the United Kingdom. FSA has received a
determination from the Australian Insurance and Superannuation Commissioner that
the financial guaranties issued by it with respect to Australian transactions do
not constitute insurance for which a license is required.

Investment Portfolio

      FSA manages its investments with the objectives of preserving its capital
and claims-paying ability, maintaining a high level of liquidity and, within
these constraints, obtaining a high long-term total return. FSA's investment
portfolio is managed in part by its affiliate, FSA Portfolio Management, and in
part by unaffiliated investment managers. The Company's investment strategy is
to emphasize total return rather than current income. To accomplish its
objectives, the Company has established guidelines for eligible investments by
FSA, requiring that each individual investment must be rated at least "single A"
at acquisition and the overall portfolio must be rated "double A" on average.
Investments falling below the minimum quality level are disposed of at such time
as management shall deem appropriate. For liquidity purposes, the Company's
policy is to invest FSA assets in investments which are readily marketable with
no legal or contractual restrictions on resale. Eligible investments include
U.S. Treasury and agency obligations, corporate bonds, tax-exempt bonds and
mortgage pass-through instruments. The Company has also invested in an equity
fund and a portfolio of convertible debt securities. In addition, the Company
has from time to time invested in sponsors of, or interests in, transactions
insured or proposed to be insured by FSA, none of which investments is material
to the Company.

      The weighted average maturity of the Company's investment portfolio at
December 31, 1997 was approximately 12.6 years. The Company's current investment
strategy is to invest in quality readily marketable instruments of intermediate
average duration so as to generate stable investment earnings with minimal
market value or credit risk.

      The following tables set forth certain information concerning the
investment portfolio of the Company:

                         Investment Portfolio by Rating
                             at December 31, 1997(1)

                                                   Percent of
                                                   Investment
                   Rating                          Portfolio
                   --------------------            ----------
                   AAA(2)..............               69.1%
                   AA  ................               16.0
                   A   ................               11.5
                   BBB ................                1.1
                   Other...............                2.3
                                                     ----- 
                                                     100.0%
                                                     ===== 

----------
(1)   Ratings are for the fixed income portfolio (96.3% of the entire investment
      portfolio as of December 31, 1997) and are based on the higher of Moody's
      or S&P ratings available at December 31, 1997.
(2)   Includes U.S. Treasury and agency obligations, which comprised 9.2% of the
      total portfolio at December 31, 1997.


                                       20
<PAGE>

                             Summary of Investments

<TABLE>
<CAPTION>
                                                             December 31,
                                    -------------------------------------------------------------
                                            1997                 1996                 1995
                                    -------------------  -------------------  -------------------
                                               Weighted             Weighted             Weighted
                                    Amortized   Average  Amortized  Average   Amortized  Average
      Investment Category              Cost    Yield(1)     Cost    Yield(1)     Cost    Yield(1)
      -------------------           ---------  --------  ---------  --------  ---------  --------
                                                         (dollars in thousands)
<S>                                 <C>          <C>     <C>          <C>     <C>          <C>  
Long-term investments:
     Taxable bonds ..............   $  453,437   6.52%   $  396,586   6.76%   $  383,790   7.00%
     Tax-exempt bonds ...........      777,042   5.58       661,831   5.70       643,624   5.62
                                    ----------           ----------           ----------   
      Total long-term investments    1,230,479   5.92     1,058,417   6.09     1,027,414   6.13
Short-term investments(2) .......      110,308   6.22        56,733   5.43        14,567   5.97
                                    ----------           ----------           ----------   
      Total investments(3) ......   $1,340,787   5.95%   $1,115,150   6.06%   $1,041,981   6.13%
                                    ==========           ==========           ==========   
</TABLE>

----------
(1)   Yields are stated on a pre-tax basis.
(2)   Includes taxable and tax-exempt investments and excludes cash equivalents
      of $22.6 million, $16.9 million and $38.1 million, respectively.
(3)   Excludes stocks at cost of $29.4 million, $8.3 million and $0,
      respectively.

                      Investment Portfolio by Security Type

<TABLE>
<CAPTION>
                                                             December 31,
                                    -------------------------------------------------------------
                                            1997                 1996                 1995
                                    -------------------  -------------------  -------------------
                                               Weighted             Weighted             Weighted
                                    Amortized   Average  Amortized  Average   Amortized  Average
      Investment Category              Cost    Yield(1)     Cost    Yield(1)     Cost    Yield(1)
      -------------------           ---------  --------  ---------  --------  ---------  --------
                                                         (dollars in thousands)
<S>                                 <C>          <C>     <C>          <C>     <C>          <C>  
U.S. government securities ......   $  122,817   6.20%   $   55,619   6.63%   $   45,139   6.27%
Mortgage-backed securities ......      195,567   6.62       177,818   6.88       265,213   7.15
Municipal bonds .................      777,042   5.58       661,831   5.70       643,624   5.62
Asset-backed securities .........       20,961   6.69        71,370   6.82        43,493   6.83
Corporate securities ............       66,014   5.72        76,760   6.55         1,254   6.86
Foreign securities ..............       48,078   7.62        15,019   6.50        28,691   7.04
                                    ----------           ----------           ----------   
     Total fixed maturities .....    1,230,479   5.92     1,058,417   6.09     1,027,414   6.13
Short-term investments(2) .......      110,308   6.22        56,733   5.43        14,567   5.97
                                    ----------           ----------           ----------   
     Total investments(3) .......   $1,340,787   5.95%   $1,115,150   6.06%   $1,041,981   6.13%
                                    ==========           ==========           ==========   
</TABLE>

----------
(1)   Yields are stated on a pre-tax basis.
(2)   Includes taxable and tax-exempt investments and excludes cash equivalents
      of $22.6 million, $16.9 million and $38.1 million, respectively.
(3)   Excludes stocks of $29.4 million, $8.3 million and $0, respectively.


                                       21
<PAGE>

                     Distribution of Investments by Maturity

<TABLE>
<CAPTION>
                                                             December 31,
                               ---------------------------------------------------------------------------
                                        1997                      1996                      1995
                               -----------------------   -----------------------   -----------------------
                                            Estimated                 Estimated                 Estimated
                               Amortized      Market     Amortized      Market     Amortized      Market
  Investment Category             Cost        Value         Cost        Value        Cost         Value
                               ----------   ----------   ----------   ----------   ----------   ----------
                                                            (in thousands)
<S>                            <C>          <C>          <C>          <C>          <C>          <C>       
Due in one year or less(1) .   $  114,317   $  114,315   $   95,038   $   95,359   $   17,343   $   17,345
Due after one year through
  five years ...............       70,283       70,007       57,531       57,712       26,036       26,375
Due after five years through
  ten years ................      208,986      208,170      105,495      105,848      157,161      162,573
Due after ten years ........      730,673      766,912      607,898      620,031      532,735      551,239
Mortgage-backed securities .      195,567      197,753      177,818      178,344      265,213      271,087
Asset-backed securities ....       20,961       21,309       71,370       71,878       43,493       44,024
                               ----------   ----------   ----------   ----------   ----------   ----------
     Total investments(2) ..   $1,340,787   $1,378,466   $1,115,150   $1,129,172   $1,041,981   $1,072,643
                               ==========   ==========   ==========   ==========   ==========   ==========
</TABLE>

----------
(1)   Includes short-term investments in the amount of $110.3 million, $56.7
      million and $14.6 million at December 31, 1997, 1996 and 1995,
      respectively, but excludes cash equivalents of $22.6 million, $16.9
      million, and $38.1 million, respectively.
(2)   Excludes stocks of $29.4 million, $8.3 million and $0, respectively.

                           Mortgage-Backed Securities
                  Cost and Market Value by Investment Category

                                                      December 31, 1997
                                              ----------------------------------
                                                         Amortized   Estimated
         Investment Category                  Par Value     Cost    Market Value
         -------------------                  ---------     ----    ------------
                                                       (in thousands)
Pass-through securities--U.S. Government
  agency ...................................   $145,087   $145,915   $147,575
CMO's--U.S. Government agency ..............     17,934     17,961     18,116
CMO's--non-agency ..........................     31,625     31,691     32,062
                                               --------   --------   --------
     Total mortgage-backed securities ......   $194,646   $195,567   $197,753
                                               ========   ========   ========

      The Company's investments in mortgage-backed securities consisted of
pass-through certificates and collateralized mortgage obligations ("CMO's")
which are secured by mortgage loans guarantied or insured by agencies of the
federal government. These securities are highly liquid with readily determinable
market prices. The Company also held triple-A rated CMO's which are not
guarantied by government agencies. Secondary market quotations are available for
these securities, although they are not as liquid as the government
agency-backed securities.

      At December 31, 1997, the Company held sequential pay CMO tranches and
Planned Amortization Classes (PAC) of CMO's. The CMO's held at December 31, 1997
have stated maturities ranging from 16 to 30 years, and expected average lives
ranging from 0.5 to 17.9 years based on anticipated prepayments of principal.
None of the Company's holdings of CMO's is subject to extraordinary interest
rate sensitivity. At December 31, 1997, the Company did not own any
interest-only stripped mortgage securities or inverse floating rate CMO
tranches.

      Mortgage-backed securities differ from traditional fixed income bonds
because they are subject to prepayments at par value without penalty at the
borrower's option. Prepayment rates on mortgage-backed securities are influenced
primarily by the general level of prevailing interest rates, with prepayments
increasing when prevailing interest rates are lower than the rates on the
underlying mortgages. When prepayments occur, the proceeds must be re-invested
at then current market rates, which are generally below the yield on the prepaid
securities. Prepayments on mortgage-backed securities purchased at a premium to
par will result in a loss to the Company to the extent of the unamortized
premium.


                                       22
<PAGE>

Employees

      At December 31, 1997, the Company and its subsidiaries had 217 employees.
None of its employees are covered by collective bargaining agreements. The
Company considers its employee relations to be satisfactory.

Forward-Looking Statements

      The Company relies upon the safe harbor for forward looking statements
provided by the Private Securities Litigation Reform Act of 1995. This safe
harbor requires that the Company specify important factors that could cause
actual results to differ materially from those contained in forward-looking
statements made by or on behalf of the Company. Accordingly, forward-looking
statements by the Company and its affiliates are qualified by reference to the
following cautionary statements.

      In its filings with the SEC, reports to shareholders, press releases and
other written and oral communications, the Company from time to time makes
forward-looking statements. Such forward-looking statements include, but are not
limited to, (i) projections of revenues, income (or loss), earnings (or loss)
per share, dividends, market share, or other financial forecasts, (ii)
statements of plans, objectives or goals of the Company or its management,
including those related to growth in adjusted book value per share or return on
equity and (iii) expected losses on, and adequacy of loss reserves for, insured
transactions. Words such as "believes", "anticipates", "expects", "intends" and
"plans" and similar expressions are intended to identify forward-looking
statements but are not the exclusive means of identifying such statements.

      The Company cautions that a number of important factors could cause actual
results to differ materially from the plans, objectives, expectations, estimates
and intentions expressed in forward-looking statements made by the Company.
These factors include: (i) changes in capital requirements or other criteria of
securities rating agencies applicable to financial guaranty insurers in general
or to FSA specifically; (ii) competitive forces, including the conduct of other
financial guaranty insurers in general; (iii) changes in domestic or foreign
laws or regulations applicable to the Company, its competitors or its clients;
(iv) an economic downturn or other economic conditions (such as a rising
interest rate environment) adversely affecting transactions insured by FSA or
its investment portfolio; (v) inadequacy of loss reserves established by the
Company; (vi) temporary or permanent disruptions in cash flow on structured
transactions attributable to legal challenges to such structures; and (vii)
downgrade or default of one or more of FSA's reinsurers. The Company cautions
that the foregoing list of important factors is not exhaustive. In any event,
such forward-looking statements made by the Company speak only as of the date on
which they are made, and the Company does not undertake any obligation to update
or revise such statements as a result of new information, future events or
otherwise.

Item 2. Properties.

      The principal executive offices of the Company and FSA are located at 350
Park Avenue, New York, New York 10022. The principal executive offices, which
consist of approximately 53,000 square feet of office space, are under lease
agreements which expire in 2005. The Company's telephone number at its principal
executive offices is (212) 826-0100. FSA also maintains leased office space in
San Francisco, Dallas, London (England), Paris (France), Madrid (Spain),
Singapore and Sydney (Australia). The Company and its subsidiaries do not own
any real property.

Item 3. Legal Proceedings.

      In the ordinary course of business, certain subsidiaries of the Company
have become party to certain litigation. The Company believes that these matters
will be resolved with no material financial impact on the Company.

Item 4. Submission of Matters to a Vote of Security Holders.

      No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of 1997.


                                       23
<PAGE>

                                     Part II

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.

      Information relating to the principal market on which the Company's common
stock is tradable, the high and low sales prices per share for each quarterly
period for the past two years and the frequency and amount of any cash dividends
declared in the past two years is set forth on page 48 of the Company's 1997
Annual Report to Shareholders and such information is incorporated herein by
reference. Information concerning restrictions on the payment of dividends is
set forth in Item 1 above under the caption "Insurance Regulatory Matters --
Dividend Restrictions." At February 23, 1998, there were approximately 2,900
holders of the Company's Common Stock, which is listed on the New York Stock
Exchange.

Item 6. Selected Financial Data.

      Selected financial data for the Company and its subsidiaries for each of
the last five years is set forth under the caption "Financial Highlights" on
page 16 of the Company's 1997 Annual Report to Shareholders. Such information is
incorporated herein by reference and should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto contained on pages 26 to
44 of such Annual Report.

Item 7. Management's Discussion and Analysis of Financial Condition and Results
        of Operations.

      Management's Discussion and Analysis of Financial Condition and Results of
Operations is set forth under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations" on pages 18 through 24 of the
Company's 1997 Annual Report to Shareholders. Such information is incorporated
herein by reference and should be read in conjunction with the Consolidated
Financial Statements and the Notes thereto contained on pages 26 to 44 of such
Annual Report.

Item 8. Financial Statements and Supplementary Data.

      The 1997 Consolidated Financial Statements, together with the Notes
thereto and the Report of Independent Accountants thereon, are set forth on
pages 25 through 44 of the Company's 1997 Annual Report to Shareholders. Such
information is incorporated herein by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and
        Financial Disclosure.

      None.


                                       24
<PAGE>

                                    Part III

Item 10. Directors and Executive Officers of the Registrant.

      Information relating to the Company's directors and executive officers is
set forth under the captions "Election of Directors" on pages 1 through 5,
"Section 16(a) Beneficial Ownership Reporting Compliance" on page 16, and
"Executive Officers of the Company" on page 6 of the Company's 1998 Proxy
Statement. Such information is incorporated herein by reference.

Item 11. Executive Compensation.

      Information relating to compensation of the Company's directors and
executive officers is set forth under the captions "Executive Compensation" on
pages 10 through 12, "Report of the Human Resources Committee of the Board of
Directors of Financial Security Assurance Holdings Ltd." on pages 13 through 16,
and "Stock Price Performance" on page 17 of the Company's 1998 Proxy Statement.
Such information is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management.

      Information relating to security ownership of certain beneficial owners of
the Company's equity securities and by the Company's directors and executive
officers is set forth under the caption "Ownership of the Company" on pages 6
through 9 of the Company's 1998 Proxy Statement. Such information is
incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions.

      Information relating to certain relationships and related transactions is
set forth under the captions "Compensation Committee Interlocks and Insider
Participation" on page 16 and "Certain Relationships and Related Transactions"
on pages 18 through 21 of the Company's 1998 Proxy Statement. Such information
is incorporated herein by reference.


                                       25
<PAGE>

                                     Part IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

      (a)   Financial Statements and Financial Statement Schedules and Exhibits.

      1.    Financial Statements

            The Registrant has incorporated by reference from the 1997 Annual
            Report to Shareholders the following consolidated financial
            statements of Financial Security Assurance Holdings Ltd. and
            Subsidiaries:

                                                           1997 Annual Report to
                                                            Shareholders (Pages)
                                                            --------------------
            Report of Independent Accountants                       25

            Consolidated Balance Sheets at
            December 31, 1997 and 1996                              26

            Consolidated Statements of Income
            for the Years Ended
            December 31, 1997, 1996 and 1995                        27

            Consolidated Statements of Changes in
            Shareholders' Equity for the Years Ended
            December 31, 1997, 1996 and 1995                        28

            Consolidated Statements of Cash Flows
            for the Years Ended
            December 31, 1997, 1996 and 1995                        29

            Notes to Consolidated Financial Statements              30-44

      2.    Financial Statement Schedules

            The following financial statement schedule is filed as part of this
            Report.

            Schedule    Title
            --------    -----

            II          Condensed Financial Statements of the Registrant for the
                        Years Ended December 31, 1997, 1996 and 1995.

            The report of the Registrant's independent auditors with respect to
            the above listed financial statement schedule is set forth on page
            33 of this Report.

            All other schedules are omitted because they are either inapplicable
            or the required information is presented in the consolidated
            financial statements of the Company or the notes thereto.


                                       26
<PAGE>

      3.    Exhibits

   The following are annexed as exhibits to this Report:

Exhibit No.                        Exhibit
-----------                        -------

  3.1             Restated Certificate of Incorporation of the Company.
                  (Previously filed as Exhibit 3.1 to the Company's Annual
                  Report on Form 10-K (Commission File No. 1-12644) for the
                  fiscal period ended December 31, 1994 (the "1994 Form 10-K"),
                  and incorporated herein by reference.)

  3.1(A)          Certificate of Amendment of the Amended and Restated
                  Certificate of Incorporation of the Company. (Previously filed
                  as Exhibit 3.1(A) to the Company's Registration Statement on
                  Form S-1 (Reg. No. 33-70230), as such Registration Statement
                  has been amended (the "Form S-1"), and incorporated herein by
                  reference.)

  3.2             Amended and Restated By-laws of the Company, as amended and
                  restated on February 14, 1996. (Previously filed as Exhibit 5
                  to the Company's Quarterly Report on Form 10-Q (Commission
                  File No. 1-12644) for the quarterly period ended March 31,
                  1996 (the "March 31, 1996 10-Q"), and incorporated herein by
                  reference.)

  4.1             Indenture dated as of September 15, 1997 (the "Senior QUIDS
                  Indenture") between the Company and First Union National Bank,
                  as Trustee. (Previously filed as Exhibit 2 to the Company's
                  Current Report on Form 8-K (Commission File No. 1-12644) dated
                  September 15, 1997 (the "Form 8-K"), and incorporated herein
                  by reference.)

  4.1(A)          Form of 7.375% Senior Quarterly Income Debt Securities due
                  2097. (Previously filed as Exhibit 3 to the Form 8-K, and
                  incorporated herein by reference.)

  4.1(B)          Officers' Certificate pursuant to Section 2.01 and 2.03 of the
                  Senior QUIDS Indenture. (Previously filed as Exhibit 5 to the
                  Company's Quarterly Report on Form 10-Q (Commission File No.
                  1-12644) for the quarterly period ended September 30, 1997,
                  and incorporated herein by reference.)

  9               Voting Trust Agreement dated as of September 2, 1994 among
                  Fund American, U S WEST Capital Corporation ("USWCC") and
                  First Chicago Trust Company of New York, as voting trustee.
                  (Previously filed as Exhibit 9 to the 1994 Form 10-K, and
                  incorporated herein by reference.)

  10.1            Credit Agreement dated as of November 23, 1994 among FSA,
                  Various Banks and Swiss Bank Corporation, New York Branch, as
                  agent. (Previously filed as Exhibit 10.2(B) to the 1994 Form
                  10-K, and incorporated herein by reference.)

  10.2            Facility Agreement dated as of August 30, 1994, among FSA,
                  Canadian Global Funding Corporation and Hambros Bank Limited.
                  (Previously filed as Exhibit 2 to the Company's Quarterly
                  Report on Form 10-Q (Commission File No. 1-12644) for the
                  quarterly period ended September 30, 1994, and incorporated
                  herein by reference.)

  10.3            Credit Agreement dated as of April 30, 1996, among FSA,
                  Financial Security Assurance of Maryland Inc., Financial
                  Security Assurance of Oklahoma, Inc., the Banks signatory
                  thereto and Bayerische Landesbank Girozentrale, New York
                  Branch, as Agent. (Previously filed as Exhibit 2 to the
                  Company's Quarterly Report on Form 10-Q (Commission File No.
                  1-12644) for the quarterly period ended June 30, 1996, and
                  incorporated herein by reference.)


                                       27
<PAGE>

  10.4+           Money Purchase Pension Plan and Trust Agreement dated as of
                  January 1, 1989 between FSA and Transamerica, with Adoption
                  Agreement No. 001 and Addendum. (Previously filed as Exhibit
                  10.7 to the Form S-1, and incorporated herein by reference.)

  10.5+           Supplemental Executive Retirement Plan as amended and restated
                  as of January 1, 1995. (Previously filed as Exhibit 10.8(A) to
                  the 1994 Form 10-K, and incorporated herein by reference.)

  10.6+*          Amended and Restated 1993 Equity Participation Plan (as
                  amended and restated on February 26, 1998).

  10.7+           Deferred Compensation Plan (Effective as of June 1, 1995).
                  (Previously filed as Exhibit No. 3 to the Company's Quarterly
                  Report on Form 10-Q (Commission File No. 1-12644) for the
                  quarterly period ended June 30, 1995 (the "June 30, 1995
                  10-Q"), and incorporated herein by reference.)

  10.8+           Severance Policy for Senior Management (Effective as of
                  February 8, 1995). (Previously filed as Exhibit No. 3 to the
                  March 31, 1996 10-Q, and incorporated herein by reference.)

  10.9            Cooperation Agreement dated as of December 27, 1990 among
                  Tokio Marine, the Company and FSA. (Previously filed as
                  Exhibit 10.17 to the Form S-1, and incorporated herein by
                  reference.)

  10.10           Tokio Marine Stockholders Agreement dated December 27, 1990
                  among Tokio Marine, the Company and USWCC. (Previously filed
                  as Exhibit 10.18 to the Form S-1, and incorporated herein by
                  reference.)

  10.10(A)        Letter Agreement dated as of September 2, 1994 concerning the
                  Tokio Marine Stockholders Agreement between U S WEST, Inc.,
                  and the Company. (Previously filed as Exhibit 10.18(A) to the
                  1994 Form 10-K, and incorporated herein by reference.)

  10.10(B)        Amendment No. 1 dated December 23, 1993 to Tokio Marine
                  Stockholders Agreement. (Previously filed as Exhibit 10.19 to
                  the Form S-1, and incorporated herein by reference.)

  10.11           Master Reinsurance Placement Memorandum dated December 27,
                  1991 between Tokio Marine and FSA. (Previously filed as
                  Exhibit 10.20 to the Form S-1, and incorporated herein by
                  reference.)

  10.12           Amended and Restated Interests and Liabilities Contract
                  concerning the Quota Share Treaty effective as of January 1,
                  1991 among Tokio Marine and FSA and its identified
                  subsidiaries and affiliates, with Amendment No. 1 thereto.
                  (Previously filed as Exhibit 10.21(A) to the 1994 Form 10-K,
                  and incorporated herein by reference.)

  10.13           Amended and Restated Interests and Liabilities Contract
                  concerning the Municipal Bond Insurance Quota Share Treaty
                  effective as of January 1, 1991 among Tokio Marine, FSA and
                  its identified subsidiaries and affiliates, with Amendment No.
                  1 thereto. (Previously filed as Exhibit 10.22(A) to the 1994
                  Form 10-K, and incorporated herein by reference.)

  10.14           Investment Management Agreement dated as of December 1, 1995
                  between FSA Portfolio Management Inc. and Charter Indemnity
                  Company. (Previously 


                                       28
<PAGE>

                  filed as Exhibit 10.23 to the 1995 Form 10-K, and incorporated
                  herein by reference.)

  10.15           Investment Management Agreement dated as of December 1, 1995
                  between FSA Portfolio Management Inc. and Northern County
                  Mutual Insurance Company. (Previously filed as Exhibit 10.24
                  to the 1995 Form 10-K, and incorporated herein by reference.)

  10.16           Investment Management Agreement dated as of December 1, 1995
                  between FSA Portfolio Management Inc. and Valley Insurance
                  Company. (Previously filed as Exhibit 10.25 to the 1995 Form
                  10-K, and incorporated herein by reference.)

  10.17+          Promissory Note between the Company and Sean W. McCarthy dated
                  December 20, 1993. (Previously filed as Exhibit 10.30(A) to
                  the Form S-1, and incorporated herein by reference.)

  10.18           Quota Share Reinsurance Agreement dated December 22, 1993,
                  among Commercial Re, FSA and International. (Previously filed
                  as Exhibit 10.17 to the Form S-1, and incorporated herein by
                  reference.)

  10.19           Share Purchase Agreement dated as of December 23, 1993 among
                  Commercial Re, U S WEST and the Company. (Previously filed as
                  Exhibit 10.32 to the Form S-1, and incorporated herein by
                  reference.)

  10.20           Federal Income Tax Allocation Agreement dated as of December
                  23, 1993 among Commercial Re, U S WEST and the Company.
                  (Previously filed as Exhibit 10.33 to the Form S-1, and
                  incorporated herein by reference.)

  10.21           Liquidity Facility dated as of December 23, 1993 among U S
                  WEST, Inc., Commercial Re and the Company. (Previously filed
                  as Exhibit 10.34 to the Form S-1, and incorporated herein by
                  reference.)

  10.22           Investment Management Agreement dated as of December 23, 1993
                  among FSA Portfolio Management, Commercial Re and the Company.
                  (Previously filed as Exhibit 10.35 to the Form S-1, and
                  incorporated herein by reference.)

  10.23           Agreement for Management and the Provision of Personnel,
                  Property and Services dated as of December 23, 1993 between
                  Commercial Re and the Company. (Previously filed as Exhibit
                  10.36 to the Form S-1, and incorporated herein by reference.)

  10.24           Securities Purchase Agreement among U S WEST, Inc., USWCC,
                  Fund American and the Company (including Exhibit A thereto).
                  (Previously filed as Exhibit 10.38 to the Form S-1, and
                  incorporated herein by reference.)

  10.24(A)        Amendment dated as of May 6, 1994 to Securities Purchase
                  Agreement among U S WEST, Inc., USWCC, Fund American and the
                  Company. (Previously filed as Exhibit 10.38(A) to the 1994
                  Form 10-K, and incorporated herein by reference.)

  10.25           Registration Rights Agreement dated as of May 13, 1994 among
                  the Company, USWCC and Fund American. (Previously filed as
                  Exhibit 10.39 to the 1994 Form 10-K, and incorporated herein
                  by reference.)

  10.26           Fund American Shareholders Agreement dated as of September 2,
                  1994 among USWCC, Fund American and the Company. (Previously
                  filed as Exhibit 10.40 to the 1994 Form 10-K, and incorporated
                  herein by reference.)


                                       29
<PAGE>

  10.27           Five-Year Option dated as of September 2, 1994. (Previously
                  filed as Exhibit 10.41 to the 1994 Form 10-K, and incorporated
                  herein by reference.)

  10.28           Ten-Year Option dated as of September 2, 1994. (Previously
                  filed as Exhibit 10.42 to the 1994 Form 10-K, and incorporated
                  herein by reference.)

  13*             Annual Report to Shareholders for the Year Ended December 31,
                  1997. Such report is furnished for the information of the
                  Securities and Exchange Commission only and, except for those
                  portions thereof which are expressly incorporated by reference
                  in the Annual Report on Form 10-K, is not to be deemed filed
                  as part of this Report.

  21*             List of Subsidiaries.

  23*             Consent of Coopers & Lybrand L.L.P.

  24*             Powers of Attorney. (Previously filed as Exhibit 24 to the
                  Company's Annual Report on Form 10-K (Commission File No.
                  1-12644) for the fiscal period ended December 31, 1996, and
                  incorporated herein by reference, other than the power of
                  attorney for Mr. Post, which is filed herewith).

  27*             Financial Data Schedules

  99*             Financial Security Assurance Inc. and Subsidiaries 1997
                  Consolidated Financial Statements and Report of Independent
                  Accountants.

----------
+     Management contract or compensatory plan or arrangement required to be
      filed as an exhibit to this Form 10-K pursuant to Item 14(c).

*     Filed herewith.

(b)  Reports on Form 8-K

      The Company did not file any Reports on Form 8-K during the fourth quarter
of 1997.


                                       30
<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.

                                  FINANCIAL SECURITY ASSURANCE
                                         HOLDINGS LTD. (Registrant)


                                  By: /s/ ROBERT P. COCHRAN
                                      -----------------------------
                                  Name:  Robert P. Cochran
                                  Title: Chairman and Chief Executive Officer
                                  Dated: March 23, 1998

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.

        Signature                         Title                       Date
---------------------------       -----------------------        ---------------


/s/ ROBERT P. COCHRAN*
--------------------------
     Robert P. Cochran           Chairman, Chief                  March 23, 1998
                                 Executive Officer
                                 and Director (Principal
                                 Executive Officer)


/s/ JOHN J. BYRNE*
--------------------------
     John J. Byrne               Vice Chairman of the             March 23, 1998
                                 Board and Director


/s/ ROGER K. TAYLOR*
--------------------------
       Roger K. Taylor           President,                       March 23, 1998
                                 Chief Operating
                                 Officer and Director


/s/ JOHN A. HARRISON*
--------------------------
      John A. Harrison           Managing Director                March 23, 1998
                                 and Chief Financial
                                 Officer (Principal
                                 Financial Officer)


/s/ JEFFREY S. JOSEPH*
--------------------------
      Jeffrey S. Joseph          Managing Director                March 23, 1998
                                 and Controller (Principal
                                 Accounting Officer)


/s/ MICHAEL DJORDJEVICH*
--------------------------
       Michael Djordjevich       Director                         March 23, 1998


/s/ ROBERT N. DOWNEY*
--------------------------
      Robert N. Downey           Director                         March 23, 1998


/s/ ANTHONY M. FRANK*
--------------------------
       Anthony M. Frank          Director                         March 23, 1998


/s/ TOSHIKI KANEDA*
--------------------------
       Toshiki Kaneda            Director                         March 23, 1998


                                       31
<PAGE>

/s/ K. THOMAS KEMP*
--------------------------
      K. Thomas Kemp             Director                         March 23, 1998


/s/ DAVID O. MAXWELL*
--------------------------
     David O. Maxwell            Director                         March 23, 1998


/s/   JAMES M. OSTERHOFF*
--------------------------
      James M. Osterhoff         Director                         March 23, 1998


/s/ JAMES H. OZANNE*
--------------------------
       James H. Ozanne           Director                         March 23, 1998


/s/ STAATS M. PELLETT, JR.*
--------------------------
       Staats M. Pellett, Jr.    Director                         March 23, 1998


/s/ RICHARD A. POST*
--------------------------
        Richard A. Post          Director                         March 23, 1998


/s/ HOWARD M. ZELIKOW*
--------------------------
       Howard M. Zelikow         Director                         March 23, 1998


----------
* Robert P. Cochran, by signing his name hereto, does hereby sign this Annual
Report on Form 10-K on behalf of each of the Directors and Officers of the
Registrant named above after whose typed names asterisks appear pursuant to
powers of attorney duly executed by such Directors and Officers and filed with
the Securities and Exchange Commission as exhibits to this Report.


                                           By: /s/ ROBERT P. COCHRAN
                                              --------------------------
                                                   Robert P. Cochran,
                                                    Attorney-in-fact


                                       32
<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS

To the Shareholders and Board of Directors
of Financial Security Assurance Holdings Ltd.:

Our report on the consolidated financial statements of Financial Security
Assurance Holdings Ltd. and Subsidiaries has been incorporated by reference in
this Form 10-K from page 25 of the 1997 Annual Report to Shareholders of
Financial Security Assurance Holdings Ltd. and Subsidiaries. In connection with
our audits of such financial statements, we have also audited the related
financial statement schedule listed in the index on page 26 of this Form 10-K.

In our opinion, the financial statement schedule, referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.


                                            /s/ COOPERS & LYBRAND L.L.P.
                                            ----------------------------
                                              COOPERS & LYBRAND L.L.P.

New York, New York
January 26, 1998


                                       33
<PAGE>

Schedule II

Parent Company Condensed Financial Information

                            Condensed Balance Sheets
                             (Dollars in thousands)

                                                             December 31,
                                                          -------------------
                                                          1997           1996
                                                          ----           ----
Assets:
   Investments                                         $   65,044     $   28,741
   Investment in and advances to subsidiary,
     at equity in net assets                              947,860        785,332
   Deferred taxes                                           2,995            515
   Other assets                                            25,287          7,071
                                                       ----------     ----------
                                                       $1,041,186     $  821,659
                                                       ==========     ==========
Liabilities and Shareholders' Equity:
   Notes payable                                       $  130,000     $       --

   Other liabilities                                       28,826         20,399
   Shareholders' equity                                   882,360        801,260
                                                       ----------     ----------
                                                       $1,041,186     $  821,659
                                                       ==========     ==========


                         Condensed Statements of Income
                             (Dollars in thousands)

                                                   Year Ended December 31,
                                                ------------------------------
                                                1997          1996        1995
                                                ----          ----        ----

Dividends received from subsidiary          $      --     $  18,000    $  19,000
Other revenue                                   6,470         3,469        1,089
                                            ---------     ---------    ---------
Total revenue                                   6,470        21,469       20,089
Total expenses                                  6,087         3,672        1,333
                                            ---------     ---------    ---------
                                                  383        17,797       18,756
Equity in undistributed net
   income of subsidiary                       100,259        62,855       35,988
                                            ---------     ---------    ---------
Income before income taxes                    100,642        80,652       54,744
Income tax benefit (provision)                   (140)          108          294
                                            ---------     ---------    ---------
Net income                                  $ 100,502     $  80,760    $  55,038
                                            =========     =========    =========

      The Parent Company Condensed Financial Information should be read in
conjunction with the Consolidated Financial Statements and Notes to Consolidated
Financial Statements as incorporated by reference in Item 8 Financial Statements
and Supplementary Data.


                                       34
<PAGE>

Schedule II

Parent Company Condensed Financial Information (Continued)

                       Condensed Statements of Cash Flows
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                   Year Ended December 31,
                                                                ------------------------------
                                                                1997         1996         1995
                                                                ----         ----         ----
<S>                                                         <C>          <C>          <C>      
Cash flows from operating activities:
   Other operating expenses recovered, net                  $   6,767    $  16,995    $      10
   Dividends from subsidiary                                                18,000       19,000
   Net investment income received                               2,455        3,610        1,779
   Federal income taxes received (paid)                         7,283       (1,298)       1,405
   Interest paid                                               (5,158)      (2,093)         (57)
   Other                                                       (4,159)      (5,583)      12,973
                                                            ---------    ---------    ---------
      Net cash provided by operating activities                 7,188       29,631       35,110
                                                            ---------    ---------    ---------
Cash flows from investing activities:
   Proceeds from sales of bonds                                 2,813       21,544       21,257
   Purchases of bonds                                         (33,495)     (10,895)     (27,815)
   Purchases of property and equipment                           (112)        (107)         (41)
   Investment in affiliate                                                              (11,646)
   Net increase in short-term securities                       (9,890)     (14,911)     (38,038)
   Other                                                       (1,500)
                                                            ---------    ---------    ---------
      Net cash used for investing activities                  (42,184)      (4,369)     (56,283)
                                                            ---------    ---------    ---------
Cash flows from financing activities:
   Issuance of notes payable, net                             125,905
   Net return of capital (investment in) subsidiaries         (40,500)      27,000       50,000
   Dividends paid                                             (12,099)     (10,536)      (8,275)
   Treasury stock purchases                                   (36,246)     (41,660)     (14,444)
   Payment of management notes                                                           (5,624)
   Other                                                       (1,453)
                                                            ---------    ---------    ---------
     Net cash provided by (used for) financing activities      35,607      (25,196)      21,657
                                                            ---------    ---------    ---------
Net increase in cash                                              611           66          484
Cash at beginning of year                                         629          563           79
                                                            ---------    ---------    ---------
Cash at end of year                                         $   1,240    $     629    $     563
                                                            =========    =========    =========

Reconciliation of net income to net cash provided by
     operating activities:
Net income                                                  $ 100,502    $  80,760    $  55,038
   Equity in undistributed net income of subsidiary          (100,259)     (62,855)     (35,988)
   Decrease (increase) in accrued investment income              (693)         264          110
   Increase (decrease) in accrued income taxes                  8,410       (2,278)       1,240
   Provision (benefit) for deferred income taxes                 (987)         873         (128)
   Net realized gains on investments                           (5,499)      (1,338)         (88)
   Deferred equity compensation                                14,299        5,565        5,735
   Depreciation and accretion of bond discount                 (1,066)        (119)        (171)
   Change in other assets and liabilities                      (7,519)       8,759        9,362
                                                            ---------    ---------    ---------
Cash provided by operating activities                       $   7,188    $  29,631    $  35,110
                                                            =========    =========    =========
</TABLE>

      The Parent Company Condensed Financial Information should be read in
conjunction with the Consolidated Financial Statements and Notes to Consolidated
Financial Statements as incorporated by reference in Item 8 Financial Statements
and Supplementary Data.


                                       35
<PAGE>

                                   SCHEDULE II

           Financial Security Assurance Holdings Ltd. (Parent Company)

                     Notes to Condensed Financial Statements

1.    Condensed Financial Statements

      Certain information and footnote disclosures normally included in
      financial statements prepared in accordance with generally accepted
      accounting principles have been condensed or omitted. These condensed
      financial statements should be read in conjunction with the Company's
      consolidated financial statements and the notes thereto incorporated by
      reference in Item 8 Financial Statements and Supplementary Data.

2.    Significant Accounting Policies

      The Parent Company carries its investments in subsidiaries under the
      equity method.

3.    Preferred Stock

      On September 2, 1994, the Parent Company issued to Fund American 2,000,000
      shares of Series A, non-dividend paying, voting, convertible preferred
      stock having an aggregate liquidation preference of $700,000. The
      preferred stock is convertible, at the option of the holder upon payment
      of the conversion price therefor, into an equal number of shares of common
      stock (subject to anti-dilutive adjustment). The conversion price per
      share (subject to anti-dilutive adjustment) is $29.65. The preferred stock
      will be redeemed (if then outstanding) on May 13, 2004 at a redemption
      price of $0.35 per share. Fund American is entitled to one vote per share
      of preferred stock, voting together as a single class with the holders of
      common stock on all matters upon which holders of common stock are
      entitled to vote. As the holder of the preferred stock, Fund American is
      not entitled to receive dividends or other distributions of any kind
      payable to shareholders of the Parent Company, except that, in the event
      of the liquidation, dissolution or winding up of the Parent Company, it is
      entitled to receive out of the assets of the Parent Company available
      therefor, before any distribution or payment is made to the holders of
      common stock or to any other class of capital stock of the Parent Company
      ranking junior to the Parent Company's preferred stock, liquidation
      payments in the amount of $0.35 per share. Fund American may not transfer
      the preferred stock, except to one of its majority-owned subsidiaries.

4.    Notes Payable

      On September 18, 1997, the Parent Company issued $130,000,000 of 7.375%
      Senior Quarterly Income Debt Securities (Senior QUIDS) due September 30,
      2097 and callable without premium or penalty on or after September 18,
      2002. Interest on these notes is paid quarterly beginning on December 31,
      1997. Debt issuance costs of $4,300,000 are being amortized over the life
      of the debt. The Parent Company used the proceeds to repay the Capital
      Guaranty senior notes described above, to augment capital in the
      Subsidiaries, to repurchase Forward Shares and for general corporate
      purposes.


                                       36