UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2004

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 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
|67/8% Quarterly Interest Bond Securities Due 2101                                                                              |  | New York Stock Exchange, Inc.            
|6.25% Notes Due November 1, 2102                                                                                               |  | New York Stock Exchange, Inc.            
|5.60% Notes Due July 15, 2103                                                                                                  |  | 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    ý No    o

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.    o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Act).    Yes    o No    ý

The aggregate market value of common equity, excluding treasury shares, held by non-affiliates of the registrant at June 30, 2004 was
$46,370,344. For purposes of the foregoing, directors are deemed to be affiliates of the registrant and the dollar amount shown is based on the price at which shares of the Company's common stock were
valued under the Company's director share purchase program on June 30, 2004.

At
March 23, 2005, there were outstanding 33,263,259 shares of Common Stock, par value $0.01 per share, of the registrant (excludes 254,736 shares of treasury stock).

Documents Incorporated By Reference

None



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TABLE OF CONTENTS

|         |  |                                                                                                              |  | Page
|-------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|PART I   |  |                                                                                                              |  |     
|Item 1.  |  | Business                                                                                                     |  | 2   
|Item 2.  |  | Properties                                                                                                   |  | 35  
|Item 3.  |  | Legal Proceedings                                                                                            |  | 36  
|Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 36  
|PART II  |  |                                                                                                              |  |     
|Item 5.  |  | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 37  
|Item 6.  |  | Selected Financial Data                                                                                      |  | 38  
|Item 7.  |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                        |  | 39  
|Item 7A. |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 59  
|Item 8.  |  | Financial Statements and Supplementary Data                                                                  |  | 62  
|Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 105 
|Item 9A. |  | Controls and Procedures                                                                                      |  | 105 
|Item 9B. |  | Other Information                                                                                            |  | 105 
|PART III |  |                                                                                                              |  |     
|Item 10. |  | Directors and Executive Officers of the Registrant                                                           |  | 106 
|Item 11. |  | Executive Compensation                                                                                       |  | 113 
|Item 12. |  | Security Ownership of Certain Beneficial Owners and Management                                               |  | 119 
|Item 13. |  | Certain Relationships and Related Transactions                                                               |  | 123 
|Item 14. |  | Principal Accountant Fees and Services                                                                       |  | 123 
|PART IV  |  |                                                                                                              |  |     
|Item 15. |  | Exhibits, Financial Statement Schedules                                                                      |  | 124 

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PART I

Item 1.    Business.

Financial Security Assurance Holdings Ltd., through its insurance company subsidiaries, is primarily engaged in the business of providing financial
guaranty insurance on asset-backed and municipal obligations in domestic and international markets. The financial strength of the Company's insurance company subsidiaries is rated
"Triple-A" by the major securities rating agencies and obligations insured by them are generally awarded "Triple-A" ratings by reason of such insurance. The Company's principal
insurance company subsidiary is Financial Security Assurance Inc. ("FSA"), a wholly owned New York insurance company. FSA was the first insurance company organized to insure
non-municipal obligations and has been a major insurer of asset-backed and other non-municipal obligations since its inception in 1985. FSA expanded the focus of its business
in 1990 to include financial guaranty insurance of municipal obligations and has since become a major insurer of municipal obligations. FSA is licensed to engage in the financial guaranty insurance
business in all 50 states, the District of Columbia, Guam, Puerto Rico and the U.S. Virgin Islands. In addition, the Company offers FSA-insured guaranteed investment contracts and other
investment agreements ("GICs") through other subsidiaries. References to the "Company" are to Financial Security Assurance Holdings Ltd. together with its subsidiaries.

Financial
guaranty insurance written by FSA typically guarantees scheduled payments on financial 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 may, at its option, pay such amounts on an accelerated basis. FSA's underwriting
policy is to insure obligations that would otherwise be investment grade without the benefit of FSA's insurance.

For
the year ended December 31, 2004, the Company had gross premiums written of $832.0 million, of which 37% related to insurance of asset-backed and other
non-municipal obligations and 63% related to insurance of municipal obligations. At December 31, 2004, the Company had net par outstanding of $317.7 billion, of which 39%
represented insurance of asset-backed and other non-municipal obligations and 61% represented insurance of municipal obligations. These amounts exclude intercompany transactions.

The
Company provides FSA-insured GICs to municipalities and other market participants. At December 31, 2004, the Company had $8.0 billion principal amount of outstanding
GICs.

Organization

FSA wholly owns FSA Insurance Company ("FSAIC"), which in turn wholly owns Financial Security Assurance (U.K.) Limited ("FSA-UK") and owns a majority
interest in Financial Security Assurance International Ltd. ("FSA International"). FSAIC is an Oklahoma insurance company that primarily provides reinsurance to FSA. FSA International is a
Bermuda insurance company that provides reinsurance to FSA and financial guaranty insurance for transactions outside United States and European markets. FSA-UK is a United Kingdom
insurance company that primarily provides financial guaranty insurance for transactions in the United Kingdom and other European markets. XL Capital Ltd ("XL") owns a minority
interest in FSA International, as discussed further below.

The
Company conducts its GIC business through its wholly owned subsidiaries FSA Capital Management Services LLC ("FSACM"), FSA Capital Markets Services (Caymans) Ltd. and, prior
to April 2003, FSA Capital Markets Services LLC (collectively, the "GIC Subsidiaries"). FSACM has conducted substantially all of the Company's GIC business since April 2003, following
the receipt of an exemption from the requirements of the Investment Company Act of 1940. The GIC Subsidiaries lend the proceeds from their sales of GICs to FSA Asset Management LLC ("FSAM"), which
invests the funds, generally in obligations that qualify for FSA insurance.

The
Company consolidates the results of certain variable interest entities ("VIEs"), including FSA Global Funding Limited ("FSA Global"), Premier International Funding Co. ("Premier"),
and Canadian

2

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Global
Funding Corporation ("Canadian Global"). The Company refinances certain defaulted transactions by employing refinancing vehicles to raise funds for the refinancings. These refinancing vehicles
are also consolidated.

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

The
Company's management believes that the assets held by FSA Global, Premier and the refinancing vehicles, including those that are eliminated in consolidation, are beyond the reach of
the Company and its creditors, even in bankruptcy or other receivership. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsVariable
Interest Entities."

FSA
Portfolio Management Inc. ("FSA Portfolio Management"), a wholly owned subsidiary of the Company, is engaged in the business of managing a portion of the investment portfolios
of the Company and certain of its subsidiaries. FSA Portfolio Management also owns various strategic and other investments funded from time to time by the FSA group of companies.

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 FSA and
its subsidiaries.

The
Company is a subsidiary of Dexia Holdings, Inc. ("Dexia Holdings"), which, in turn, is owned 90% by Dexia Crédit Local SA ("Dexia Crédit Local")
and 10% by Dexia S.A. ("Dexia"). Dexia is a Belgian corporation whose shares are traded on the Euronext Brussels and Euronext Paris markets as well as on the Luxembourg Stock Exchange. Dexia is
primarily engaged in the business of public finance, banking and investment management in France, Belgium, Luxembourg and other European countries, as well as in the United States. Dexia
Crédit Local is a wholly owned subsidiary of Dexia.

The
Company's Management Committee manages the Company's business. The Chief Executive Officer, President, General Counsel, Chief Risk Management Officer and Chief Financial Officer are
full-time members of the Management Committee, and the heads of the Municipal Finance, Corporate Finance, International Finance and Financial Products groups serve as part-time
members. Bruno Deletre, a director of the Company and a member of the Executive Board of Dexia Crédit Local, is anex officiomember of
the Management Committee.

History

When the Company commenced operations in 1985, it was owned by a number of large insurance companies and other institutional investors. In 1989, the Company was
acquired by U S WEST Capital Corporation, which subsequently changed its name to MediaOne Capital Corporation ("MediaOne"). MediaOne was a subsidiary of MediaOne Group, Inc., with operations
and investments in domestic cable and broadband communications and international broadband and wireless communication. In 1990, the Company established a strategic relationship with The Tokio Marine
and Nichido Fire Insurance Co., Ltd. ("Tokio Marine"), which acquired a minority interest in the Company. Tokio Marine is a major Japanese property and casualty insurance company.

In
1994, the Company completed an initial public offering of common shares, at which time White Mountains Insurance Group, Ltd. ("White Mountains") (formerly known as Fund
American Enterprises Holdings, Inc.) made an investment in the Company, and the chairman of White Mountains became non-executive chairman of the Company. White Mountains is an
insurance holding company.

In
1998, the Company and XL entered into a joint venture, establishing two Bermuda domiciled financial guaranty insurance companiesFSA International and XL Financial
Assurance Ltd ("XLFA").

3

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In
connection with the joint venture, XL acquired a minority interest in the Company. XL owns a minority interest in FSA International and the Company owns a minority interest in XLFA. XL is a major
Bermuda-based insurance holding company.

On
July 5, 2000, the Company completed a merger in which the Company became a direct subsidiary of Dexia Holdings. At the merger date, each outstanding share of the Company's
common stock was converted into the right to receive $76.00 in cash. At December 31, 2004, approximately 99% of the Company's common stock was held by Dexia Holdings. The other holders are an
affiliate of White Mountains and certain directors of the Company who own shares of the Company's common stock or economic interests therein as described under "Item 11. Executive
CompensationDirector Share Purchase Program." Although the Company's common stock is no longer listed on the New York Stock Exchange ("NYSE") as a consequence of the merger, the Company
continues to file periodic reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), because debt securities issued by the Company are listed on the NYSE.

The
principal executive offices of the Company are located at 350 Park Avenue, New York, New York 10022, but are expected to be relocated to 31 West 52nd Street, New York,
New York 10019, in mid-2005. Subsidiaries of the Company maintain offices domestically in San Francisco and Dallas and abroad in London, Madrid, Paris, Singapore, Sydney, Tokyo and
Bermuda.

Business Objectives

The Company's business objective is to remain a leading insurer of asset-backed and municipal obligations while generating premium volume at attractive returns
and minimizing the occurrence and severity of credit losses in its insured portfolio. The Company believes that the demand for financial guaranty insurance will remain strong over the long term as a
result of the anticipated continuation of the following trends:



The
Company also anticipates continued demand over the long term for its GIC business and other financial products programs that employ financial guaranty insurance provided by FSA.

The
Company believes that short term trends for financial guaranty insurance remain uncertain due, among other things, to:



The
Company expects to continue to originate 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 selectively pursues international opportunities primarily in Western
European and Asia Pacific markets.

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Business of the Company

The Company is engaged in the financial guaranty business through its insurance company subsidiaries and in its financial products ("FP") business though its GIC
subsidiaries.

Financial Guaranty Business

FSA's insurance is employed in both the new issue and secondary markets. In the case of new issues, the insured obligations are sold with FSA insurance at the
time the obligations are issued. For both asset-backed and municipal 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") Program provides insurance for asset-backed obligations trading in the secondary market.
Likewise, FSA's Custody Receipt Program provides insurance for municipal obligations trading in the secondary market. Investors and dealers generally obtain secondary-market insurance to upgrade or
stabilize the credit ratings of positions they already hold or plan to acquire or to increase the market liquidity of such positions. FSA's underwriting guidelines require the same underwriting
standards on secondary market issues as on new issues, although FSA's control rights in the event of default are generally more limited.

In
many insured transactions, the issuer of insured securities is party to an interest rate, basis or currency swap that matches the issuer's funding sources to the interest rate or
currency of the insured securities or otherwise hedges the issuer's exposure. In such transactions, FSA typically insures the issuer's obligations under both the insured securities and the derivative
contract.

FSA
insures payment obligations of counterparties and issuers under GICs, GIC equivalents, credit-linked notes and obligations under interest rate, currency and credit default swaps
("CDS"), including guarantees issued in connection with the Company's FP business. FSA also issues surety bonds under its Sure-Bid program, which provides an alternative to traditional
types of good faith deposits for competitive municipal bond transactions.

FSA
insures obligations already carrying insurance from other monoline guarantors, with FSA generally obligated to pay claims on a "second-to-pay" basis,
following a default by both the underlying obligor and the first-to-pay financial guarantor. In recent years, FSA has reinsured a modest amount of business from other financial
guaranty insurers.

The
following table indicates the Company's percentages of par amount (net of reinsurance) outstanding at December 31, 2004 and 2003 with respect to each type of asset-backed and
municipal program:

Net Par Amount and Percentage Outstanding by Program Type

|                 |  | As of December 31, 2004 |        
|---------------- |  | ----------------------- | -------
|
|
|
|New Issue        |  | $                       | 112,808
|Secondary Market |  |                         | 8,496  
|Assumed          |  |                         | 1,046  
|                 |  |                         |        
|Total            |  | $                       | 122,350
|                 |  |                         |        

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|                 |  | As of December 31, 2003 |        
|---------------- |  | ----------------------- | -------
|
|
|
|New Issue        |  | $                       | 110,163
|Secondary Market |  |                         | 6,941  
|Assumed          |  |                         | 1,158  
|                 |  |                         |        
|Total            |  | $                       | 118,262
|                 |  |                         |        

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FSA takes into account the risk it assumes and its projected return in setting insurance premium rates. Critical factors in assessing risk include the credit
quality of the issuer, type of issue, sources of repayment, transaction structure and term to maturity. The premium rate is also a function of market factors and the competitive environment. Market
factors include the value added by the use of insurance, such as the interest rate savings the issuer of an insured obligation obtains. Competition arises from other insurers and uninsured alternative
executions. For insurance on GIC and medium term note transactions, transactions involving "repackaging" of outstanding securities and other transactions, FSA's premium may be arbitrage-based, based
upon the difference between the effective borrowing cost at a Triple-A rate and the interest rate on the underlying securities.



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. Asset-backed obligations insured by FSA also include payment obligations of counterparties and issuers
under synthetic obligations such as CDS and credit- linked notes referencing asset backed securities or pools of securities or other obligations.

Asset-backed
obligations are typically issued in connection with structured financings or securitizations where the securities being issued are secured by or payable with funds from a
specific pool of assets. The assets are typically held by a special purpose entity that also acts as the issuer of the insured obligations. Most asset-backed obligations are secured by or represent
interests in diverse pools of assets, such as residential mortgage loans, auto loans, credit card receivables, other consumer receivables, corporate loans or bonds, government debt and small business
loans. Asset- backed obligations may also be secured by less diverse payment sources, such as multifamily real estate.

Asset-backed
obligations include funded and synthetic transactions. Funded asset-backed obligations are typically 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 funded asset-backed obligations generally have the benefit of one or more forms of credit enhancement, such as overcollateralization or excess cash flow, to cover credit
risks associated with the related assets. Synthetic asset-backed obligations generally take the form of CDS obligations or credit-linked notes that reference either an asset-backed security or pool of
securities or loans, with a defined deductible to cover credit risks associated with the referenced securities or loans.

Asset
securitization often represents an efficient way for commercial banks to comply with capital requirements and for corporations to access the capital markets at more attractive
rates and, frequently, with different accounting treatment. Banks have responded to increased capital requirements by selling

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certain
of their assets, such as credit card receivables and automobile loans, in securitized structures to the financial markets. Some corporations have found securitization of their assets to be a
less costly funding alternative to traditional forms of borrowing or otherwise important in diversifying funding sources. Many finance companies fund consumer finance and home equity lending through
securitization.

Since
the late 1990s, a significant market has developed for funded and synthetic collateralized debt obligations ("CDOs"), which are securitizations of bonds, loans or other securities.
CDOs are used by financial institutions to manage their risk profiles, optimize capital utilization and improve returns on equity. CDOs are also used by dealers or portfolio managers to provide
leveraged investments in bond and loan portfolios tailored to conform to differing risk appetites of investors.

According
to industry sources, the new par volume since 2000 for each type of funded asset-backed security presented, including securities distributed under Rule 144A under the
Exchange Act, were as follows:

|Year |  | New Issues of Funded U.S.
Public Asset-Backed
Securities(1)(2) |       | U.S. Public Issues of
Private-Label
Mortgage-Backed
Securities(1) |   | Non-U.S. Asset-
Backed Securities(1) |  | Worldwide Funded
Collateralized Debt
Obligations(1)
|---- |  | -------------------------------------------------------------- | ----- | ----------------------------------------------------------------- | - | ------------------------------------ |  | ---------------------------------------------------
|
|2000 |  | $                                                              | 272.8 |                                                                   | $ | 65.8                                 |  | $                                                  
|2001 |  |                                                                | 324.6 |                                                                   |   | 143.1                                |  |                                                    
|2002 |  |                                                                | 411.5 |                                                                   |   | 214.0                                |  |                                                    
|2003 |  |                                                                | 505.1 |                                                                   |   | 297.1                                |  |                                                    
|2004 |  |                                                                | 675.5 |                                                                   |   | 328.5                                |  |                                                    

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The
data in the above table excludes synthetic transactions and therefore does not reflect the growth in the use of CDS during the years covered. According to the International Swaps and
Derivatives Association, Inc. ("ISDA"), the notional principal amount of CDS outstanding in world markets were as follows at the dates indicated:

Outstanding
Credit Default Swaps(1)(dollars in billions)December 31, 2001

$
918.9December 31, 2002


2,191.6December 31, 2003


3,779.4June 30, 2004


5,441.9


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According to industry information, the annual totals of funded and synthetic asset-backed par insured of financial guaranty insurance directly originated by monoline guarantors since
2000 were as follows:

U.S. Asset-Backed Obligations
Insured by Monoline Insurance
Companies(1)

Non-U.S. Asset-Backed Obligations
Insured by Monoline Insurance
Companies(dollars in billions)2000

$
116.1

$
55.22001


167.1


51.42002


165.5


63.22003


120.4


45.02004


N/A
(2)

N/A
(2)


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Since
2000, the global securitization market has significantly expanded year-over-year. The relatively mature U.S. asset-backed market is expected by management
to continue to grow over the long term, although not necessarily at the pace of recent years.



FSA insures a range of municipal obligations, including 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 such as utility revenues.
Additional municipal obligations insured by FSA include:



Municipal
obligations include bonds, notes and other evidences of indebtedness issued by public and quasi-public entities, including states and their political subdivisions (such as
counties, cities or towns), utility districts, public universities and hospitals, and public-housing and transportation authorities. An issuer's obligation to pay is supported by the issuer's taxing
power in the case of general obligation bonds, and 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 and
public-private infrastructure financings. Certain municipal obligations, including most project finance obligations, include non-municipal credit risks (to swap counterparties, insurance
companies, construction companies or other non-municipal credits) and operating risks (such as traffic volume or tuition revenues).

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According
to industry sources, the total and insured volume since 2000 of long-term U.S. municipal new issues sold were as follows:

Insured U.S. Municipal Obligations(1)

Year

New Total Volume

New Insured Volume

New Insured Volume as
Percent of New Total Volume(dollars in billions)2000

$
200.7

$
79.4

39.6
%2001


288.2


131.0

45.52002


358.8


177.6

49.52003


383.7


190.7

49.72004


360.2


192.7

53.5


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In
2000, the municipal bond industry saw a decline in both total U.S. municipal bond issuance and the percentage of municipal par issued that benefited from bond insurance, attributable
in part to budget surpluses reducing borrowing needs as well as the need to employ bond insurance. New issue volume increased in 2001, 2002 and 2003, as declining interest rates, diminished tax
revenues and continuing needs for infrastructure investment drove municipalities to borrow on an unprecedented scale. Insurance penetration reached approximately 50% in 2002 and 2003, reaching its
highest historical level in 2004. Insured par volume increased slightly in 2004 despite a decline in total market volume primarily due to generally higher interest rates.

Outside
the United States, guarantors have become increasingly active in public infrastructure finance. These transactions frequently finance public-private partnerships, such as those
authorized by the U.K. Private Finance Initiative.

Since
2000, the annual totals of non-U.S. municipal par insured of financial guaranty insurance directly originated by monoline guarantors, according to industry sources,
were as follows:

Non-U.S. Municipal Obligations Insured by Monoline  Insurance Companies(1)

Year

Amount(dollars in billions)2000

$
4.12001


6.02002


8.12003


13.92004


N/A
(2)


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9

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FSA Global is a Cayman Islands domiciled issuer of FSA-insured notes and other obligations sold in international markets that are generally referred
to as medium term notes ("MTNs"). FSA Global issues securities at the request of interested purchasers in a process known as "reverse inquiry," which generally results in lower interest rates and
borrowing costs than would apply to direct borrowings. FSA Global also issues securities in traditional private placements to institutional investors and to participants in lease financings in which
Company affiliates may play a number of financing roles. At December 31, 2004, the VIEs had $2.4 billion principal amount of outstanding notes, after elimination of intercompany
transactions.

FSA
Global is managed as a "matched funding vehicle," in which the proceeds from the sale of FSA Global notes are invested in obligations chosen to provide cash flows substantially
matched to those of the notes (taking into account, in some cases, dedicated third party liquidity). This matched funding structure is designed to minimize the market risks borne by FSA Global and
FSA. FSA Global raises funds that are invested with a view towards realizing the yield difference between the notes issued and the obligations purchased with the note proceeds. FSA Global generally
raises funds that are U.S. dollar denominated or converted into U.S. dollars at LIBOR-based floating borrowing rates, and invests them in FSA-insured obligations that:



Financial Product Business



The Company's GIC business provides GICs to municipalities and other market participants. FSA insures all GICs issued by the GIC Subsidiaries. The majority of
municipal GICs insured by FSA relate to debt service reserve funds or construction funds that support municipal bond transactions.

Each
GIC entitles its holder to receive the return of the holder's initial principal plus interest at a specified rate, and to withdraw principal from the GIC as permitted. Generally, a
municipal bond trustee or issuer will acquire a municipal GIC in order to invest funds on deposit in a debt service reserve fund or construction fund until it needs to use such funds to service debt
or fund the payment of project expenses in accordance with the underlying bond documents. Non-municipal GICs insured by FSA include GICs acquired by issuers of credit linked notes and GICs
acquired by FSA Global.

The
Company is exposed to risk associated with unexpected withdrawals on its FSA-insured GICs. Debt service reserve fund GICs may be drawn unexpectedly upon a payment default
by the municipal issuer. Construction fund GICs may be drawn more quickly or more slowly than anticipated to pay project expenses. In addition, most FSA-insured GICs allow for withdrawal
of GIC funds in the event of a downgrade of FSA, typically below AA- by Standard & Poor's Ratings Services ("S&P") or Aa3 by Moody's Investors Service, Inc. ("Moody's"),
unless the GIC provider posts collateral or otherwise enhances its credit. The Company manages this risk through the maintenance of liquid collateral and liquidity agreements.

The
GIC Subsidiaries issue GICs and, on the same terms, lend the funds raised to FSAM. The funds are generally raised at (or converted by FSAM into) U.S. dollar LIBOR-based floating rate
obligations. FSAM generally invests the funds in, or converts them into, U.S. dollar LIBOR-based floating rate investments. The investments are generally obligations that would qualify for FSA
insurance from a credit perspective. The GIC Subsidiaries and FSAM generate their gross profits or losses from the difference between the rates at which the GIC Subsidiaries borrow the funds and the
rates yielded by FSAM's

10

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investments.
These investments are owned, and the related risk management function is performed, by FSAM.

Insurance in Force

A summary of the Company's par outstanding by type at December 31, 2004 is as follows:

Par OutstandingDirect

Assumed

Total Gross

Ceded

Net(dollars in millions)Asset-backed(1)

$
158,338

$
1,046

$
159,384

$
37,034

$
122,350Municipal


273,984


1,062


275,046


79,654


195,392Total

$
432,322

$
2,108

$
434,430

$
116,688

$
317,742


---

At
December 31, 2004, the weighted average life of the direct par insured on these policies was approximately three years for asset-backed and 12 years for municipal
obligations.

Asset-Backed and Other Non-Municipal Obligations

FSA's insured portfolio of asset-backed and other non-municipal obligations is divided into five major categories, which are broadly based on the type
of assets backing the insured obligations and include funded and synthetic obligations:



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Municipal Obligations

FSA's insured portfolio of municipal obligations is divided into eight major categories, which include funded and synthetic obligations:



12

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Insured Portfolio

A summary of FSA's insured portfolio at December 31, 2004 is shown below. Exposure amounts are expressed net of reinsurance but do not distinguish between
quota share, first loss or excess of loss reinsurance.

Summary of Insured Portfolio  As of December 31, 2004(1)

|                         |                                              | Number of
Issues In
Force |       | Net Par
Amount
Outstanding |   | Net
Par and
Interest |  | Percent
of Net
Par and
Interest |        
|------------------------ | -------------------------------------------- | ------------------------- | ----- | -------------------------- | - | -------------------- |  | ------------------------------- | -------
|
|Asset-backed obligations |                                              |                           |       |                            |   |                      |  |                                 |        
|                         | Residential mortgages                        |                           | 302   |                            | $ | 27,042               |  | $                               | 29,172 
|                         | Consumer receivables                         |                           | 50    |                            |   | 9,469                |  |                                 | 10,024 
|                         | Pooled corporate obligations                 |                           | 357   |                            |   | 46,390               |  |                                 | 49,207 
|                         | Other domestic asset-backed obligations      |                           | 116   |                            |   | 7,097                |  |                                 | 8,807  
|                         | International obligations                    |                           | 138   |                            |   | 32,352               |  |                                 | 33,584 
|                         |                                              |                           |       |                            |   |                      |  |                                 |        
|                         | Total asset-backed obligations               |                           | 963   |                            | $ | 122,350              |  | $                               | 130,794
|                         |                                              |                           |       |                            |   |                      |  |                                 |        
|Municipal obligations    |                                              |                           |       |                            |   |                      |  |                                 |        
|                         | General obligation bonds                     |                           | 5,596 |                            | $ | 76,081               |  | $                               | 113,733
|                         | Housing revenue bonds                        |                           | 193   |                            |   | 7,628                |  |                                 | 13,941 
|                         | Municipal utility revenue bonds              |                           | 1,025 |                            |   | 33,544               |  |                                 | 54,403 
|                         | Health care revenue bonds                    |                           | 202   |                            |   | 9,261                |  |                                 | 16,959 
|                         | Tax-supported (non-general obligation) bonds |                           | 1,023 |                            |   | 36,631               |  |                                 | 56,496 
|                         | Transportation revenue bonds                 |                           | 121   |                            |   | 12,835               |  |                                 | 23,106 
|                         | Other domestic municipal bonds               |                           | 689   |                            |   | 10,962               |  |                                 | 16,627 
|                         | International obligations                    |                           | 85    |                            |   | 8,450                |  |                                 | 18,453 
|                         |                                              |                           |       |                            |   |                      |  |                                 |        
|                         | Total municipal obligations                  |                           | 8,934 |                            |   | 195,392              |  |                                 | 313,718
|                         |                                              |                           |       |                            |   |                      |  |                                 |        
|                         | Total                                        |                           | 9,897 |                            | $ | 317,742              |  | $                               | 444,512
|                         |                                              |                           |       |                            |   |                      |  |                                 |        

---

13

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Obligation Type

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

Annual New Business Insured by Obligation Type

|                                                 |                                              | Year Ended December 31, |    
|------------------------------------------------ | -------------------------------------------- | ----------------------- | ---
|
|Asset-backed and other non-municipal obligations |                                              |                         |    
|                                                 | Residential mortgages                        |                         | 28 
|                                                 | Consumer receivables                         |                         | 2  
|                                                 | Pooled corporate obligations                 |                         | 13 
|                                                 | Other domestic non-municipal obligations(1)  |                         | 8  
|                                                 | International obligations                    |                         | 8  
|                                                 |                                              |                         |    
|                                                 | Total asset-backed obligations               |                         | 59 
|Municipal obligations                            |                                              |                         |    
|                                                 | General obligations bonds                    |                         | 19 
|                                                 | Housing revenue bonds                        |                         | 6  
|                                                 | Municipal utility revenue bonds              |                         | 5  
|                                                 | Health care revenue bonds                    |                         | 3  
|                                                 | Tax-supported (non-general obligation) bonds |                         | 2  
|                                                 | Transportation revenue bonds                 |                         | 2  
|                                                 | Other domestic municipal bonds               |                         | 2  
|                                                 | International obligations                    |                         | 2  
|                                                 |                                              |                         |    
|                                                 | Total municipal obligations                  |                         | 41 
|                                                 |                                              |                         |    
|                                                 | Total                                        |                         | 100
|                                                 |                                              |                         |    

---

14

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Terms to Maturity

The table below sets forth the contractual terms to maturity of the Company's policies at December 31, 2004 and 2003:

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

|                   |       | As of December 31, 2004 |        | As of December 31, 2003
|------------------ | ----- | ----------------------- | ------ | -----------------------
|
|
|0 to 5 years       |       | $                       | 46,800 |                        
|5 to 10 years      |       |                         | 29,155 |                        
|10 to 15 years     |       |                         | 10,772 |                        
|15 to 20 years     |       |                         | 1,084  |                        
|20 years and above |       |                         | 34,539 |                        
|                   |       |                         |        |                        
|                   | Total |                         | $      | 122,350                
|                   |       |                         |        |                        

---

Issue Size

The tables below set forth the number of policies and net par outstanding as of December 31, 2004, based on the amount of original net par written:

Asset-Backed Policy Count and Net Par Amount Outstanding(1)

|Original Net Par Amount     |       | Number of
Policies |       | Net Par Amount
Outstanding
|--------------------------- | ----- | ------------------ | ----- | --------------------------
|
|Less than $10 million       |       | 712                |       | $                         
|$10 to $50 million          |       | 577                |       |                           
|$50 million to $100 million |       | 426                |       |                           
|$100 million or greater     |       | 942                |       |                           
|                            |       |                    |       |                           
|                            | Total |                    | 2,657 |                           
|                            |       |                    |       |                           

---

15

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MunicipalPolicy Count and Net Par Amount Outstanding

|Original Net Par Amount     |  | Number
of Policies |  | Net Par
Amount
Outstanding
|--------------------------- |  | ------------------ |  | --------------------------
|
|Less than $10 million       |  | 14,158             |  | $                         
|$10 to $50 million          |  | 4,737              |  |                           
|$50 million to $100 million |  | 801                |  |                           
|$100 million or greater     |  | 712                |  |                           
|                            |  |                    |  |                           
|Total                       |  | 20,408             |  | $                         
|                            |  |                    |  |                           

Geographic Concentration

In its asset-backed business, the Company considers geographic concentration as a factor in underwriting insurance for securitizations of pools of assets, such as
residential mortgage loans or
consumer receivables. However, 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 considered a significant credit factor given other more relevant measures of
diversification, such as issuer or industry diversification.

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

Municipal Insured Portfolio by Jurisdiction

|                             |       | As of December 31, 2004 |      
|---------------------------- | ----- | ----------------------- | -----
|
|
|California                   |       | 934                     |      
|New York                     |       | 622                     |      
|Texas                        |       | 701                     |      
|Pennsylvania                 |       | 704                     |      
|Florida                      |       | 274                     |      
|Illinois                     |       | 633                     |      
|New Jersey                   |       | 548                     |      
|Washington                   |       | 297                     |      
|Michigan                     |       | 399                     |      
|Massachusetts                |       | 194                     |      
|Wisconsin                    |       | 425                     |      
|Ohio                         |       | 265                     |      
|Georgia                      |       | 106                     |      
|All other U.S. jurisdictions |       | 2,747                   |      
|International                |       | 85                      |      
|                             |       |                         |      
|                             | Total |                         | 8,934
|                             |       |                         |      

16

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Revenues from external customers attributed to the United States and all foreign countries during each of the Company's last three fiscal years is shown below:

Year Ended December 31,2004

2003

2002(dollars in thousands)U.S.

$
744,149

$
599,410

$
386,808International


52,355


32,926


33,290Total revenues

$
796,504

$
632,336

$
420,098


See
Note 23 to the Consolidated Financial Statements in Item 8 for revenues from external customers, income before income taxes and total assets by segment.

Issuer Concentration

The Company has adopted underwriting and exposure management policies designed to limit the net par insured or net retained credit gap for any one credit. Credit
gap is a concept employed by S&P to estimate the at-risk amount (worst-case risk) on an insured exposure. FSA has also established procedures to ensure compliance with
regulatory single-risk limits applicable to bonds it insured. In many cases, the Company uses reinsurance to limit net exposure to any one credit. At December 31, 2004, the ten
largest net insured asset-backed transactions represented $18.9 billion, or 6.0%, of the total net par amount outstanding, and the ten largest net insured municipal credits represented
$9.6 billion, or 3.1%, of the total net par amount outstanding. For purposes of the foregoing, different issues of asset-backed securities by the same sponsor have not been aggregated. However,
the Company's underwriting policies establish single risk guidelines applicable to asset-backed securities of the same sponsor. In addition, individual corporate names may appear in more than one
FSA-insured CDO transaction, but such exposures are not aggregated for purposes of identifying the largest exposures. Instead, FSA addresses these risks by limiting its exposure to the CDO
sector in the aggregate. In addition to the single risk limits established by its underwriting guidelines, the Company is subject to regulatory limits and rating agency guidelines on exposures to
single credits.

Credit Underwriting Guidelines, Standards and Procedures

Financial guaranty insurance written by FSA generally relies on an assessment of the adequacy of various payment sources to meet debt service 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 are
investment grade without the benefit of FSA's insurance. To this end, each policy FSA writes or reinsures is designed to satisfy 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 that reviews completed transactions,
generally on a quarterly basis, to ensure conformity with underwriting guidelines and standards. In addition, FSA's underwriting policy allows for FSA to insure securities issued to refinance other
securities insured by FSA as to which the issuer is or may be in default.

FSA's
underwriting guidelines for asset-backed obligations are premised on the concept of multiple layers of protection, and vary by obligation type in order to reflect different
structures and types of credit support. 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," reserves or, in the case of CDS, a deductible) or third-party protection (such as bank letters of credit, guarantees, net worth maintenance agreements, indemnity agreements or
reinsurance agreements). This overcollateralization or

17

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third-party
protection need not protect FSA against all risk of loss, but is generally intended to assume the primary risk of financial loss.

Asset-backed
obligations insured by FSA often benefit from self-adjusting mechanisms, such as cash traps or accelerated amortization that take effect upon a failure to
satisfy performance based triggers. Asset-backed obligations insured by FSA may benefit from third party protection. Overcollateralization, excess spread or third-party protection may not 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 securities issued to refinance other securities 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 funded asset-backed obligations rather than providing partial or first-loss coverage sufficient to confer a Triple-A
rating on the insured obligations. In the CDS sector, however, FSA has insured risks on a "compressed" or "mezzanine" basis in which the obligations insured by FSA are subordinate to more senior
uninsured obligations.

FSA's
underwriting guidelines for municipal obligations require that a transaction be rated investment grade by Moody's or S&P or, in the alternative, that the credit quality of the
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 may be required to provide a rate covenant and a pledge of additional security (e.g., mortgages on real property, liens on equipment or revenue pledges) to secure the insured
obligation.

The
rating agencies participate to varying degrees in the underwriting process. Most asset-backed obligations insured by FSA are 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 insured obligation and the risk elements involved. The
independent review of FSA's underwriting practices performed by the rating agencies further strengthens the underwriting process.

The
Company's Risk Management Committee reviews the Company's insured portfolio on a periodic basis. The Risk Management Committee is comprised of FSA's Chief Risk Management Officer,
Chief
Domestic Underwriting Officer, Chief Municipal Underwriting Officer and Chief International Underwriting Officer, with FSA's Chief Executive Officer, President, General Counsel and Chief Financial
Officer asex officiomembers.

The
underwriting process that implements the Company's underwriting guidelines and standards is supported by FSA's 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 is responsible for confirming that each transaction proposed by the Financial Guaranty Department conforms to the
underwriting guidelines and standards. This evaluation 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 (the "MRC") for asset-backed transactions and municipal international transactions and from FSA's Municipal
Underwriting Committee (the "MUNC") for domestic municipal transactions. Subject to applicable limits, a subcommittee of the MRC or MUNC, as applicable, may approve guarantees of transactions in
certain sectors. The MUNC and MRC jointly review certain international transactions with municipal credit elements. Approval is usually based upon both a written and an oral presentation by the
underwriting group to the respective committee. Following approval, the Chair of the applicable underwriting

18

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committee
may approve minor transaction modifications. Major changes require the concurrence of the applicable underwriting committee.

The
MRC is comprised of FSA's Chief Executive Officer, President, Chief Risk Management Officer, Chief Domestic Underwriting Officer, Chief International Underwriting Officer, General
Counsel and Associate General Counsel for Asset-Backed Transactions. The Chief Executive Officer, President and General Counsel are not required to participate in MRC meetings for transactions meeting
certain criteria.

The
MUNC is comprised of FSA's Chief Executive Officer, President, Chief Municipal Underwriting Officer, a Municipal Underwriting Officer, Managing Director of Public Finance and
Associate General Counsel for Municipal Transactions. The MUNC approval process generally requires approval by at least:



Subject
to applicable limits, municipal transactions satisfying credit and return requirements may be approved by a committee (the "Demi-MUNC") comprised of the Chief Municipal
Underwriting Officer, Municipal Underwriting Officer or Managing Director for Municipal Operations, an Associate General Counsel for Municipal Transactions, and any one of certain managing directors
and directors designated by the MUNC. The Demi-MUNC approval process generally requires approval by at least two voting members, with approval by the Chief Municipal Underwriting Officer
or Municipal Underwriting Officer required for transactions exceeding a certain size.

Corporate Research

FSA's Corporate Research Department is comprised of a professional staff under the direction of the Chief Risk Management Officer. The Corporate Research
Department is responsible for evaluating the credit of entities participating or providing recourse on obligations insured by FSA. It also provides analysis of industry segments. Members of the
Corporate 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

FSA's Transaction Oversight Departments and its workout subsidiary TSC 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. TSC, 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 functions report to the Chief Risk Management
Officer. The Underwriting Committee of the Board of Directors receives quarterly reports describing the changes in the overall insured portfolio during the quarter. The Transaction Oversight
Departments review insured transactions to confirm compliance with transaction covenants, monitor credit and other developments affecting transaction participants and collateral, and together with TSC
determine the steps, if any, required to protect the interests of FSA and the holders of FSA-insured obligations. Reviews of 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 transactions to determine the level of ongoing
attention

19

---



required.
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 Departments and TSC work together with the Legal Department and the Corporate Research Department in monitoring these transactions, negotiating
restructurings and pursuing appropriate legal remedies.

The
Company's Transaction Oversight Departments categorize all credits by risk of loss to facilitate appropriate allocation of resources to loss mitigation efforts and to efficiently
communicate the relative credit condition of any risk exposure, as well as the overall health of the insured portfolio. Each risk in the insured portfolio is designated one of five surveillance rating
categories.

Categories
I and II represent fundamentally sound transactions requiring routine monitoring. Category III represents transactions with a material deterioration in asset
performance, financial health of the issuer, or other factors, but for which losses are deemed unlikely. Active monitoring and intervention is employed for Category III transactions.

Category IV
reflects transactions demonstrating sufficient deterioration to indicate that material credit losses are possible even though not yet probable. Category IV is
the equivalent of "watch list" by banking industry standards.

Category V
reflects transactions where losses are probable. This category includes (1) risks where claim payments have been made and where additional payments, net of
recoveries are expected, and (2) risks where claim payments are probable but none have yet been made. Category V and Category IV transactions are subject to intense monitoring and
intervention.

The
table below presents the gross and net par outstanding and the gross and net reserves for risks classified as Category IV and V, as described above, as of December 31,
2004 and 2003.

Par Outstanding

|                                |  | 2004 |         | 2003
|------------------------------- |  | ---- | ------- | ----
|
|
|Category I and II               |  | $    | 426,142 |     
|Category III                    |  |      | 7,213   |     
|Category IV                     |  |      | 283     |     
|Category V no claims            |  |      | 707     |     
|Category V with previous claims |  |      | 85      |     
|                                |  |      |         |     
|Total                           |  | $    | 434,430 |     
|                                |  |      |         |     

Case Basis Loss Reserves

|                                |  | As of December 31,
|------------------------------- |  | ------------------
|
|
|
|Category V no claims            |  | $                 
|Category V with previous claims |  |                   
|                                |  |                   
|Total                           |  | $                 
|                                |  |                   

20

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The decrease in Category V reserves with no claims in 2004 compared to 2003 was due primarily to the payment of a large claim for $34.3 million and a refinancing resulting
in a reclassification of $5.5 million from reserves to an asset valuation account applied to the underlying collateral acquired in connection with the refinancing. These decreases were
partially offset by reassumption of previously ceded business.

The
increase in Category V reserves with previous claim payments in 2004 compared to 2003 was primarily related to the deterioration of a municipal transaction.

Legal

The
Company's Legal Department is comprised of a professional staff of attorneys and legal assistants under the direction of the General Counsel. The Company's Legal Department is
divided into four sectors (asset-backed transactions, municipal transactions, regulatory/reinsurance/corporate and compliance). The Legal Department plays a major role in establishing and implementing
legal requirements and procedures applicable to obligations insured by the Company. Members of the Legal Department serve on the MRC and MUNC, 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 the Company are ordinarily executed with the assistance of outside counsel working closely with
the Legal Department. Municipal obligations insured by the Company are ordinarily executed without employment of outside counsel. The Legal Department works closely with the transaction oversight and
transaction services functions in addressing legal issues, rights and remedies, as well as proposed amendments, waivers and consents, in connection with obligations insured by the Company. The Legal
Department is also responsible for domestic and international regulatory compliance, reinsurance, secondary market transactions, litigation and other matters. The Chief Compliance Officer is a member
of the Legal Department responsible for preparing quarterly compliance activity reports provided to the Audit Committee of the Board of Directors of the Company.

Competition and Industry Concentration

FSA
faces competition from both other providers of and alternatives to third-party credit enhancement. Most securities are sold without third-party credit enhancement. Accordingly, each
transaction FSA proposes to insure must generally compete against an alternative execution that does not employ third-party credit enhancement. FSA faces competition from other Triple-A
rated monoline financial guaranty insurers, primarily Ambac Assurance Corp. ("Ambac"), Financial Guaranty Insurance Company ("FGIC"), MBIA Insurance Corp. ("MBIA"), XL Capital Assurance Inc.
("XLCA") and CDC-IXIS Financial Guaranty ("CIFG"). Although FGIC formerly limited its business primarily to underwriting certain categories of municipal risks, since its change in control
in December 2003 FGIC has competed more broadly in asset-backed and municipal sectors it had not previously serviced. Competition is largely based on premium rates, capacity, underwriting
requirements and trading levels.

New
entrants to the market provide increasing competition to more established market participants such as FSA as they attempt to grow their market share. Assured Guaranty Corp. and
Radian Asset Assurance Inc., two market participants previously engaged primarily in reinsurance, either directly or through affiliates, recently increased their focus on the primary financial
guaranty insurance market. In addition, DEPFA Bank, plc,, an Irish bank, has announced its intention to establish a monoline financial guaranty insurer to compete in the U.S. public finance market.
The Company understands that other parties are considering establishing new financial guaranty insurers that may compete with it.

Traditional
credit enhancers such as bank letter of credit providers and mortgage pool insurers provide competition to FSA as providers of credit enhancement for asset-backed
obligations. Actions by securities rating agencies in recent years have significantly reduced the number of Triple-A rated financial

21

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institutions
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. Nonetheless, bank sponsored commercial paper conduits, 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, CDS, credit-linked notes and other synthetic products provide coverage
directly competitive with financial guaranty insurance, and expand the universe of participants in the financial risk market. Bank affiliates may participate in the U.S. insurance business, including
the financial guaranty insurance business.

Government
sponsored entities, including Fannie Mae and Freddie Mac, compete with the monoline financial guaranty insurers, on a limited basis, in the mortgage-backed and multifamily
sectors. Expansion of the business franchises by government sponsored entities, as well as potential new entrants into the financial guaranty sector such as Federal Home Loan Banks and state pension
funds, present competitive challenges to private sector participants such as FSA.

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:



FSA's
net insurance in force is the outstanding principal, interest and other amounts payable over the remaining life of all obligations insured by FSA, net of ceded reinsurance and
refunded bonds secured by U.S. government securities held in escrow or other qualifying collateral. Qualified statutory capital, determined in accordance with statutory accounting practices, is the
aggregate of policyholders' surplus and contingency reserves calculated in accordance with statutory accounting practices.

In
December 2004, FSA obtained CDS protection on an excess of loss basis (exceeding very large deductibles) providing approximately $17 billion of credit protection on a
number of FSA-insured synthethic CDO transactions shadow rated "super-triple A" at inception.
Given the high credit quality of the risk transferred to the CDS provider, the main effects of this CDS were to improve FSA's statutory capital ratios and increase FSA's margin under regulatory risk
limits on aggregate insured exposures.

Set
forth below are FSA's aggregate gross insurance in force, net insurance in force, qualified statutory capital and capital ratio (represented by the ratio of its net insurance in
force to qualified statutory capital) and the average industry capital ratio at the dates indicated. Net insurance data does not distinguish between quota share reinsurance and first-loss
reinsurance. In light of FSA's use of first-loss reinsurance in the asset-backed and project finance sector, the data below tends to overstate FSA's risk leverage in comparison with its
industry counterparts. Conversely, FSA also insures mezzanine risks and obtains excess-of-loss credit protection in CDS transactions, which reduces FSA's reported risk
leverage. The statutory capital ratio does not reflect the underlying credit quality of the insurance in force, which diminishes the comparative value of the disclosure. Specifically, the credit
quality of FSA's insured portfolio as measured by S&P and Moody's is generally higher than most of FSA's industry peers, although

22

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FSA's
ratio of net debt service to statutory capital is also generally higher than most of FSA's industry peers.

|                                                      |  | As of December 31,
|----------------------------------------------------- |  | ------------------
|
|
|Financial guaranty primary insurers, excluding FSA(1) |  |                   
|Capital ratio                                         |  |                   
|FSA(2)                                                |  |                   
|Gross insurance in force                              |  | $                 
|Net insurance in force                                |  |                   
|Qualified statutory capital                           |  |                   
|Capital ratio                                         |  |                   

---

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 typically but not always receives a ceding commission to cover the 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.

At
December 31, 2004, FSA reinsured approximately 27% of its principal amount outstanding. FSA obtains reinsurance to increase its policy writing capacity, both on an
aggregate-risk and a single-risk basis, to:



FSA's
reinsurance may be on a quota share, first-loss, or excess of loss basis. Quota share reinsurance generally provides protection against a fixed specified percentage of
all losses incurred by FSA. First-loss reinsurance generally provides protection against a fixed specified percentage of losses incurred up to a specified limit. Excess of loss reinsurance
generally provides protection against a fixed percentage of losses incurred to the extent that losses incurred exceed a specified limit. Reinsurance arrangements typically require FSA to retain a
minimum portion of the risks reinsured.

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 that permits FSA to apply reinsurance to transactions it selects subject
to certain limitations. The reinsurer's participation in a treaty

23

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is
either cancelable annually upon 90 days' prior notice by either FSA or the reinsurer or has a one-year term. 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 events, FSA generally has the right to reassume all or a
portion of the business reinsured. Reinsurance agreements may be subject to other termination conditions as required by applicable state law.

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 important
to FSA, and FSA endeavors to place its reinsurance with financially strong reinsurers. FSA's treaty reinsurers at December 31, 2004 were Assured Guaranty Re International Ltd. (formerly
ACE Capital Re International Ltd.), Assured Guaranty Corp. (formerly ACE Guaranty Corp.), Radian Asset Reinsurance Inc. (successor to Radian Reinsurance Inc., formerly Enhance
Reinsurance Company), RAM Reinsurance Co. Ltd., Swiss Reinsurance America Corporation, Tokio Marine and XLFA.

Securities
rating agencies allow FSA "credit" for reinsurance based on the reinsurer's ratings. Generally, 95-100% credit is allowed for Triple-A reinsurance and
65-90% credit is allowed for Double-A reinsurance. In recent years, a number of FSA's reinsurers have been downgraded from Triple-A to Double-A or lower
by one or more rating agencies. While ceding commissions or premium allocation adjustments may compensate in part for such downgrades, the effect of such downgrades, in general, is to decrease the
financial benefits of using reinsurance under rating agency capital adequacy models.

In
2004, the New York Insurance Law was amended to allow financial guaranty insurers such as FSA to treat qualifying CDS from highly rated financial institutions as collateral for
purposes of satisfying risk limits and certain reserve requirements. The effect of these amendments is to make credit defaults swaps an alternative to reinsurance. In December 2004, FSA entered
into its first CDS permitted by the new legislation, obtaining approximately $17 billion of credit protection on an excess of loss basis on certain insured synthetic CDOs.

FSA,
FSAIC and FSA International are party to a quota share reinsurance pooling agreement pursuant to which, after reinsurance cessions to other reinsurers, the FSA companies share in
the net retained risk insured by each of these companies. Under the pooling agreement, FSA, FSAIC and FSA International share the net retained risk in proportion to their policyholders' surplus and
contingency reserves ("Statutory Capital") at the end of the prior calendar quarter. FSA-UK and FSA are party to a quota share and stop loss reinsurance agreement pursuant to which:



Under
this agreement, FSA-UK ceded to FSA approximately 99% of its retention after third party reinsurance of its policies issued in 2004.

Rating Agencies

The
value of FSA's insurance product is generally a function of the "rating" applied to the obligations it insures. The financial strength of FSA and its insurance company subsidiaries
is rated "Aaa" by Moody's and "AAA" by S&P, Fitch Ratings and Rating and Investment Information, Inc. Such ratings reflect only the views of the respective rating agencies, are not
recommendations to buy, sell or hold securities and are subject to revision or withdrawal at any time by such rating agencies.

24

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These
rating agencies periodically review FSA's business and financial condition, focusing on the insurer's underwriting policies and procedures and the quality of the obligations
insured, and publish their ratings and supporting analyses. Each rating agency performs periodic assessments of the credits insured by FSA, as well as the reinsurers and other providers of capital
support to FSA, to confirm that FSA continues to satisfy such rating agency's capital adequacy criteria necessary to maintain FSA's Triple-A rating. 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.

Moody's
and S&P apply their own capital adequacy models in assessing the financial strength of FSA. Financial factors considered by the rating agencies in assessing capital adequacy
include:



Given
the importance of its ratings to its on-going business, FSA's underwriting process generally includes an analysis of the impact on rating agency capital adequacy
determinations in addition to other measures of creditworthiness. Reference is made to the published reports of Moody's, S&P and Fitch Ratings regarding the Company, capital adequacy models, the bond
insurance business in general and FSA's standing relative to its industry peers on the basis of capital adequacy and profitability.

Insurance Regulatory Matters

General

FSA
is licensed to engage in insurance business in all 50 states, the District of Columbia, Guam, Puerto Rico and the U.S. Virgin Islands. FSA is subject to the insurance laws of the
State of New York (the "New York Insurance Law"), and is also subject to the insurance laws of the other states in which it is licensed to transact insurance business. FSAIC is an Oklahoma domiciled
insurance company also licensed in New York and subject to the New York Insurance Law. FSA and its domestic insurance company subsidiary 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 Superintendent of Insurance of the State of New York (the "New York Superintendent") and other state insurance regulatory authorities. The last
completed examination was conducted in 2000 for the three-year period ended December 31, 1999. FSA's accounts are currently under examination for the three-year period
ended December 31, 2002; the examination is complete subject to receipt of the final examination report.

FSA
International is a Bermuda domiciled insurance company subject to applicable requirements of Bermuda law. FSA International maintains its principal executive offices in Hamilton,
Bermuda. FSA International does not intend to transact business or establish a permanent place of business in the United States or Europe. FSA-UK is a United Kingdom domiciled insurance
company subject to applicable requirements of English law. FSA-UK maintains its principal executive offices in London, England. Pursuant to European Union Directives, FSA-UK is
generally authorized to write business out of its London office in other member countries of the European Union subject to the satisfaction of perfunctory registration requirements. FSA has a
Singapore branch authorized to transact insurance business in Singapore and subject to regulation by Singapore authorities.

25

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Domestic Insurance Holding Company Laws

The Company and its domestic insurance company subsidiaries (FSA and FSAIC) are subject to regulation under insurance holding company statutes of their
jurisdiction of domicile (New York and Oklahoma, respectively), as well as other jurisdictions where these insurers 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 company 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, certain dividends and other intercorporate
transfers of assets and 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 and FSAIC, 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 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 of the New York Insurance Law (as amended, "Article 69"), 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:



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. FSA has in the past sought and obtained releases
of excessive contingency reserves from the New York Insurance Department. 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.

26

---



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:



may
not exceed 10% of the sum of the insurer's policyholders' surplus and contingency reserves, 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 reserves. 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 reserves. 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 guaranteed 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 on FSA's financial condition, results of operations, cash requirements, rating agency confirmation of
non-impairment of FSA's ratings and other related factors, and is also subject to restrictions contained in the New York Insurance Law and other states. Under New York Insurance Law, FSA
may pay dividends out of statutory 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:



Based
on FSA's statutory statements for the year ended December 31, 2004, the maximum amount available for payment of dividends by FSA without regulatory approval over the
following 12 months is approximately $84.5 million.

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
Bermuda Ministry of Finance regulates FSA International. The United Kingdom Financial Services Authority regulates FSA-UK. Pursuant to European Union Directives,
FSA-UK has been authorized to provide financial guaranty insurance for transactions in numerous European countries 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 FSA with respect to Australian

27

---



transactions
do not constitute insurance for which a license is required. The Monetary Authority of Singapore regulates activities of FSA's Singapore branch. FSA is in the process of seeking branch
licenses in Canada (and its respective provinces) and Japan.

U.S. Bank Holding Company Act

Dexia indirectly owns approximately 99% of the Company's common stock, as described under "Item 1. BusinessOrganization." Because Dexia has
non-U.S. bank subsidiaries with banking offices in the U.S., Dexia and all of its subsidiaries, including the Company and its subsidiaries, are subject to the U.S. Bank Holding Company Act
(the "BHC Act"). In general, the BHC Act restricts the activities of banking organizations and their affiliates to the ownership and operation of banks and to other activities that are "closely
related to banking" as determined by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). Insurance activities such as those conducted by certain of the Company's subsidiaries
are generally not permissible under this restriction. Under the BHC Act, however, an organization that qualifies as a "financial holding company" is permitted to engage in a broader range of
permissible "financial activities." "Financial activities" include insurance underwriting and agency activities as well as merchant banking. For a non-U.S. organization to qualify as a
"financial holding company," it, if it has a U.S.
banking office, and each of its non-U.S. bank subsidiaries with a U.S. banking office, must be both:



Dexia
holds its investment in, and operates, the Company and its subsidiaries under, the "financial activities" authorization permitted to "financial holding companies."

Investments

In addition to its insurance company assets and other investments (the "Investment Portfolio"), the Company maintains investments from proceeds of
FSA-insured GICs (the "GIC Portfolio") and the portfolio of securities owned by the VIEs (the "VIE Portfolio").

Investment Portfolio

Management's primary objective in managing the Investment Portfolio is generation of an optimal level of after-tax investment income while preserving
capital and maintaining adequate liquidity subject to rating agency capital adequacy criteria that reduce credit for investments based on their ratings to the extent rated less than triple A. The
Investment Portfolio is managed by unaffiliated professional investment managers and the Company's affiliate FSA Portfolio Management, which manages the majority of the municipal portfolio. The
investment management function is overseen by the Investment Committee established by the Company's Board of Directors.

To
accomplish its objectives, the Company has established guidelines for eligible fixed income investments by FSA, requiring that at least 95% of such investments be rated at least
Single-A at acquisition and the overall portfolio be rated Double-A on average. Fixed income investments falling below the minimum quality level are disposed of at such time as
management deems appropriate. For liquidity purposes, the Company's policy is to invest in readily marketable investments with no legal or contractual restrictions on resale. Eligible fixed income
investments include U.S. Treasury and agency obligations, corporate bonds, tax-exempt bonds, asset backed securities and mortgage-backed securities. The 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.

28

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The
Company also has investments in various strategic partners, including:



The
Company and the other owners of SPS have entered into a binding Summary of Terms relating to the potential sale to an unaffiliated third party of their respective interests in SPS
pursuant to an option, exercisable on or before July 31, 2005. The sale is subject to several conditions, including, among other things, execution of definitive agreements. There is no
assurance that the proposed transaction will be consummated.

The
weighted average maturity of the Company's Investment Portfolio at December 31, 2004 was approximately 7.0 years.

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

Investment Portfolio by Rating  As of December 31, 2004(1)(3)

Rating

Percent of
Investment
PortfolioAAA(2)

77.8
%AA

19.7A

2.5Total

100.0
%


---

Summary of Investments

|                       |                             | As of December 31, |        
|---------------------- | --------------------------- | ------------------ | -------
|
|
|
|Long term investments: |                             |                    |        
|                       | Taxable bonds               |                    | $      
|                       | Tax-exempt bonds            |                    |        
|                       |                             |                    |        
|                       | Total long-term investments |                    |        
|Short-term investments |                             |                    | 321,071
|                       |                             |                    |        
|                       | Total investments(2)        |                    | $      
|                       |                             |                    |        

---

29

---





Investment Portfolio by Security Type

|                                      |                      | As of December 31, |          
|------------------------------------- | -------------------- | ------------------ | ---------
|
|
|
|U.S. government and agency securities |                      | $                  | 164,312  
|Mortgage-backed securities            |                      |                    | 220,202  
|Municipal bonds                       |                      |                    | 2,857,642
|Asset-backed securities               |                      |                    | 56,843   
|Corporate securities                  |                      |                    | 237,486  
|Foreign securities                    |                      |                    | 126,099  
|                                      |                      |                    |          
|Total long-term investments           |                      |                    | 3,662,584
|Short-term investments                |                      |                    | 321,071  
|                                      |                      |                    |          
|                                      | Total investments(2) |                    | $        
|                                      |                      |                    |          

---

Distribution of Investments by Contractual Maturity

|                                       |  | As of December 31,
|-------------------------------------- |  | ------------------
|
|
|
|Due in one year or less                |  | $                 
|Due after one year through five years  |  |                   
|Due after five years through ten years |  |                   
|Due after ten years                    |  |                   
|Mortgage-backed securities             |  |                   
|Asset-backed securities                |  |                   
|                                       |  |                   
|Total investments(1)                   |  | $                 
|                                       |  |                   

---

30

---



Mortgage-Backed Securities  Cost and Market Value by Investment Category

|                                               |  | As of December 31, 2004
|---------------------------------------------- |  | -----------------------
|
|
|Pass-through securities U.S. Government agency |  | $                      
|CMOsU.S. Government agency                    |  |                        
|CMOsnon-agency                                |  |                        
|                                               |  |                        
|Total mortgage-backed securities               |  | $                      
|                                               |  |                        

The
Company's investments in mortgage-backed securities consisted of pass-through certificates and collateralized mortgage obligations ("CMOs"), which are backed by mortgage
loans guaranteed or insured by agencies of, or sponsored by, the federal government. These securities are highly liquid with readily determinable market prices. The Company also held, at
December 31, 2004, Triple-A rated CMOs which are not guaranteed by government agencies. Secondary market quotations are available for these securities, although they are not as
liquid as government agency-backed securities.

The
CMOs held at December 31, 2004 have stated maturities ranging from 1 to 40 years and expected average lives ranging from 1 to 14 years based on anticipated
prepayments of principal.

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 mortgage 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 reinvested at then current market rates, which may be below the yield on the prepaid securities.

GIC Portfolio

The following tables set forth certain information concerning the GIC Portfolio:

GIC Portfolio by Rating
As of December 31, 2004(1)(2)

Rating

Percent of Investment
PortfolioAAA

81.5
%AA

9.0A

4.8Other

4.7Total

100.0
%


---

31

---





Summary of GIC Portfolio

|                       |                        | December 31,      |  
|---------------------- | ---------------------- | ----------------- | -
|
|
|Long-term investments: |                        |                   |  
|                       | Taxable bonds          |                   | $
|                       | Short-term investments |                   |  
|                       |                        |                   |  
|                       |                        | Total investments |  
|                       |                        |                   |  

---

Investment Portfolio by Security Type

|                                      |                        | As of December 31, |          
|------------------------------------- | ---------------------- | ------------------ | ---------
|
|
|
|Mortgage-backed securities            |                        | $                  | 2,143,894
|Municipal bonds                       |                        |                    | 451,574  
|U.S. government and agency securities |                        |                    | 282,637  
|Asset-backed and other securities     |                        |                    | 5,033,525
|Corporate securities                  |                        |                    | 8,749    
|                                      |                        |                    |          
|                                      | Total fixed maturities |                    |          
|Short-term investments                |                        |                    | 268,125  
|                                      |                        |                    |          
|                                      | Total investments      |                    | $        
|                                      |                        |                    |          

---

Distribution of Investments by Contractual Maturity

|                                       |                   | As of December 31, 2004
|-------------------------------------- | ----------------- | -----------------------
|
|
|Due in one year or less                |                   | $                      
|Due after one year through five years  |                   |                        
|Due after five years through ten years |                   |                        
|Due after ten years                    |                   |                        
|Mortgage-backed securities             |                   |                        
|Asset-backed and other securities      |                   |                        
|                                       |                   |                        
|                                       | Total investments |                        
|                                       |                   |                        

32

---



VIE Portfolio

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

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

VIE Portfolio by Rating
As of December 31, 2004(1)

Rating

Percent of BondsAAA

2.6
%AA

5.3A

71.6BBB

20.5Total

100.0
%


---

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

As of December 31, 2004

Amortized Cost

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

$
16,007

$
16,007Corporate securities


158,106


157,990Foreign


57,621


57,983Asset-backed securities(1)


1,114,375


1,114,375Short term investments


1,194


1,194Total

$
1,347,303

$
1,347,549


As of December 31, 2003

Amortized Cost

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

$
16,200

$
16,200Corporate securities


181,165


180,380Foreign


61,541


61,207Asset-backed securities(1)


1,164,751


1,164,751Short term investments


11,102


11,102Total

$
1,434,759

$
1,433,640


---

The
amortized cost and fair value of bonds in the VIE Portfolio at December 31, 2004, by contractual maturity, are shown below (in thousands). Actual maturities could differ from
contractual maturities

33

---



because
borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.

Amortized
Cost

Fair ValueDue in one year or less

$
185,970

$
186,182Due after one year through five years


30,951


30,985Due after five years through ten years





Due after ten years


16,007


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


1,114,375


1,114,375Total

$
1,347,303

$
1,347,549


Employees

At December 31, 2004, the Company and its subsidiaries had 345 employees. None of its employees are covered by collective bargaining agreements. The
Company considers its employee relations to be satisfactory.

Available Information

The Company makes available, free of charge on or through its website, http://www.fsa.com, its annual reports on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) and 15(d) of the Exchange Act as
soon as reasonably practicable after the Company electronically files such materials with, or furnishes them to, the Securities and Exchange Commission.

Forward-Looking Statements

The Company relies on 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:



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.

34

---



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:



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 79,000 square feet of office space, are under lease agreements, which generally expire in 2005. In June 2004, FSA entered into a 20-year sublease agreement with
Deutsche Bank AG for new offices at 31 West 52nd Street, New York, New York, 10019, to be used as the Company's new headquarters. The Company anticipates moving to its new space, which consists of
approximately 110,000 square feet of office space, in mid 2005.

FSA
or its subsidiaries also maintain leased office space in San Francisco, Dallas, Hamilton (Bermuda), London (England), Madrid (Spain), Paris (France), Singapore, Sydney (Australia)
and Tokyo (Japan). The Company and its subsidiaries do not own any material real property.

The
Company's telephone number at its principal executive offices is (212) 826-0100.

35

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Item 3.    Legal Proceedings.

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

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

On October 29, 2004, the Company's shareholders executed a Written Consent of Shareholders in Lieu of Annual Meeting, under which they unanimously
approved:



On
November 18, 2004, the Company's shareholders executed a Written Consent of Shareholders under which they unanimously approved the Company's 2004 Equity Participation Plan, in
the form approved by the Board of Directors of the Company.

36

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PART II

Item 5.    Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchaser of Equity Securities.

On
July 5, 2000, the Company completed a merger in which the Company became an indirect wholly owned subsidiary of Dexia, a Belgian corporation whose shares are traded in the
Euronext Brussels and Euronext Paris markets as well as on the Luxembourg Stock Exchange. See "Item 1. BusinessOrganization." As a consequence of these actions, there is no longer an
established public trading market for the Company's common stock, and bid quotations are not reported or otherwise available.

As
of March 2005, the only holders of the Company's common stock were Dexia Holdings, an affiliate of White Mountains (a major shareholder of the Company prior to the merger); and
seven directors of the Company who own shares of the Company's common stock or economic interests therein as described under in "Item 11. Executive CompensationDirector Share Purchase
Program."

The
Company paid a dividend on its common stock of $0.17625 per share for each of the first two quarters of 2002, totaling $11.7 million in aggregate for 2002. During the third
quarter of 2002, the Company determined that it would suspend payment of dividends. The Company resumed payment of dividends in May 2004, paying a dividend on its common stock of $0.2275 per
share for each of the final three quarters of 2004, totaling $22.9 million in aggregate for 2004. Information concerning restrictions on the payment of dividends is set forth in "Item 1.
BusinessInsurance Regulatory MattersDividend Restrictions."

Information
about securities authorized for issuance under the Company's equity compensation plans is set forth in "Item 12. Security Ownership of Certain Beneficial Owners and
ManagementSecurities Available Under Equity Compensation Plans."

37

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Item 6.    Selected Financial Data.

The following Selected Consolidated Financial Data should be read in conjunction with the Consolidated Financial Statements and accompanying notes included
elsewhere herein.

|                                              |  | As of and for the Year Ended December 31, |          
|--------------------------------------------- |  | ----------------------------------------- | ---------
|
|
|SUMMARY OF OPERATIONS(a)                      |  |                                           |          
|Gross premiums written                        |  | $                                         | 832.0    
|Net premiums written                          |  |                                           | 587.8    
|Net premiums earned                           |  |                                           | 395.0    
|Net investment income                         |  |                                           | 172.1    
|Net income                                    |  |                                           | 363.8    
|BALANCE SHEET DATA(a)                         |  |                                           |          
|Total investments(b)                          |  |                                           | 13,836.8 
|Total assets(b)                               |  |                                           | 17,080.8 
|Deferred premium revenue                      |  |                                           | 2,095.4  
|Losses and loss adjustment expense            |  |                                           | 179.9    
|Notes payable                                 |  |                                           | 430.0    
|GIC and VIE debt                              |  |                                           | 10,734.4 
|Common shareholders' equity                   |  |                                           | 2,550.0  
|ADDITIONAL DATA                               |  |                                           |          
|Qualified statutory capital(c)                |  |                                           | 2,280.9  
|Total claims-paying resources(d)              |  |                                           | 5,230.6  
|Net par outstanding                           |  |                                           | 317,742.6
|Net insurance in force (principal + interest) |  |                                           | 444,511.5
|Total dividends                               |  | $                                         | 22.9     

---

38

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

Overview

Management's principal business objective is to grow the intrinsic value of the Company over the long term. To this end, it seeks to accumulate an insured
portfolio of conservatively underwritten municipal and asset-backed obligations and attractively priced guaranteed investment contracts, in order to produce a reliable, predictable earnings stream.
Strategically, the Company seeks to maintain balanced capabilities across domestic and international asset-backed and municipal markets in order to allow the flexibility to pursue the most attractive
opportunities available at any point in the business cycle. References to the "Company" are to Financial Security Assurance Holdings Ltd. together with its subsidiaries.

To
reflect accurately how management evaluates the Company's operations and progress toward long-term goals, this discussion employs both measures promulgated in accordance with
accounting principles generally accepted in the United States of America (GAAP measures) and measures not so promulgated (non-GAAP measures). Although the measures identified as non-GAAP in this
discussion should not be considered substitutes for GAAP measures, management considers them key performance indicators and employs them in determining compensation. Non-GAAP measures therefore
provide investors with important information about the way management analyzes its business and rewards performance.

Comparing
2004 GAAP results with those of 2003, the Company's total revenues increased 26.0% to $796.5 million, and net income increased 25.2% to $363.8 million. Gross premiums written
declined 7.1% to $832.0 million due primarily to a decline in upfront premiums from municipal business. Shareholders' equity increased 17.6% to $2.5 billion.

Results of Operations

Premiums

Net Earned and Written Premiums

|                                                         |  | Year Ended December 31,
|-------------------------------------------------------- |  | -----------------------
|
|
|Premiums written, net of reinsurance                     |  | $                      
|Premiums earned, net of reinsurance                      |  |                        
|Net premiums earned excluding refundings and prepayments |  |                        

Net
premiums earned increased 10.8% in 2004 and 13.2% in 2003. Excluding the effects of refundings and prepayments, net premiums earned increased 7.9% in 2004 and 13.2% in 2003.
Refundings and prepayments result from interest-rate movements and other factors outside the Company's control, and no assurance can be given that refundings and prepayments will continue at the
recent level. The recent slower growth rate in earned premiums is a function of the relatively higher contribution from U.S. municipal originations, which generally have longer maturities and
therefore a slower earnings process.

New Business Production

As explained in detail below, for each accounting period, the Company estimates the present value of originations ("PV originations"). This non-GAAP measure
consists of the total present value of premiums originated ("PV premiums originated") by Financial Security Assurance Inc. ("FSA") and the present value of net interest margin originated ("PV NIM
originated") in the financial products segment. The Company generated PV originations of $927.2 million in 2004, $894.6 million in 2003 and $881.8 million in 2002. Management believes that by
disclosing the components of PV originations in addition to premiums written, the Company provides investors with a more comprehensive description of its new business activity in a given period.

39

---





The GAAP measure "gross premiums written" captures premiums collected in a given period, whether collected for business originated in the period, or in
installments for business originated in prior periods. It is not a precise measure of current-period originations because a significant portion of the Company's premiums are collected in installments.
Therefore, to measure current-period premium production, management calculates the gross present value of premium installments originated in the accounting period and combines it with premiums
received upfront in the accounting period, which produces the non-GAAP measure PV premiums originated.

The
Company's insurance policies and insured credit derivative contracts are generally non-cancelable and remain outstanding for years from date of inception, in some cases as long as 30
years. Accordingly, current-period premium production, as distinct from earned premium, represents premiums to be earned in the future.

Viewed
at a policy level, installment premiums are generally calculated as a fixed premium rate multiplied by the insured debt outstanding as of dates established by the terms of the
policy. Because the actual installment premiums received could vary from the amount estimated at the time of origination based on variances in the actual outstanding debt balances as of the
pre-established dates, the realization of PV premiums originated could be greater or less than the amount reported.

Installment
premiums are not recorded in the financial statements until due, which is a function of the terms of each insurance policy. Future non-cancelable installment premiums are not
captured in premiums earned or premiums written, the most comparable GAAP measures. Management therefore uses PV premiums originated to evaluate current business production.

PV
premiums originated reflects estimated future installment premiums discounted to their present value, as well as upfront premiums, but only for business originated during the period.
To calculate PV premiums originated, management discounts an estimate of all future installment premium receipts at a rate representing the Company's three-year trailing average insurance investment
portfolio return. The estimated installment premium receipts are determined based on each installment policy's projected par balances outstanding multiplied by its premium rate. The Company's
Transaction Oversight Departments estimate the relevant schedule of future par balances outstanding for each insurance policy with installment premiums. At the time of origination, projected debt
schedules are generally based on good faith estimates developed and used by the parties negotiating the transaction. The Company calculates the discount rate for PV premiums originated as the average
pre-tax yield on its investment portfolio for the previous three years. This serves as a proxy for the return that could be achieved if the premiums had been received upfront.

Year-to-year
comparisons of PV premiums originated are affected by the application of a different discount rate each year. The discount rate employed by the Company for this purpose was
5.62% for 2004 originations and 5.91% for 2003 originations. Management intends to revise the discount rate in future years according to the same methodology, in order to reflect specific return
results realized by the Company.

40

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Reconciliation of Gross Premiums Written to Non-GAAP PV Premiums Originated

|                                        |  | Year Ended December 31, |       
|--------------------------------------- |  | ----------------------- | ------
|
|
|Gross premiums written                  |  | $                       | 832.0 
|Gross installment premiums received     |  |                         | (332.4
|                                        |  |                         |       
|Gross upfront premiums originated       |  |                         | 499.6 
|PV estimated future premiums originated |  |                         | 353.9 
|                                        |  |                         |       
|PV premiums originated                  |  | $                       | 853.5 
|                                        |  |                         |       



Unless otherwise noted, percentage changes in this discussion and analysis compare the period named with the comparable period of the prior year.

The
tables below show the PV premiums originated and gross par amount insured by FSA in its three major business sectors.

U.S. Municipal New Originations

|                                           |  | Year Ended December 31,
|------------------------------------------ |  | -----------------------
|
|Gross par insured (in billions)            |  | $                      
|Gross PV premiums originated (in millions) |  |                        

New-issue
volume in the U.S. municipal bond market totaled approximately $360.2 billion, on a sale date basis, a 6.1% decline from the record level of $383.7 billion in
2003 and slightly more than the $358.8 billion in 2002. Insurance penetration was approximately 54%, compared with 50% in both 2003 and 2002. In all three years, low interest rates, strong demand for
refundings and continuing needs for infrastructure investment drove high levels of municipal borrowing. FSA guaranteed approximately 24% of the insured par amount of municipal bonds sold in 2004, and
approximately 27% of the insured par amount of municipal bonds sold in 2003 and 2002.

Including
both primary and secondary U.S. municipal obligations with closing dates in 2004, FSA's U.S. municipal par originated declined 10.7%, and the related PV premiums originated
declined 10.3%. FSA increased its PV premiums originated in the health care revenue and general obligation sectors during the year, but those increases were offset by declines in the non-general
obligation tax-supported sector and various revenue-backed sectors. In 2003, the U.S. municipal par amount insured by FSA increased 6.3%, and PV premiums originated increased 14.8%. Municipal premium
rates were strong throughout 2003 due to wider credit spreads than in prior periods.

U.S. Asset-Backed New Originations

|                                           |  | Year Ended December 31,
|------------------------------------------ |  | -----------------------
|
|Gross par insured (in billions)            |  | $                      
|Gross PV premiums originated (in millions) |  |                        

The
Company's U.S. asset-backed gross par insured rose 211% in 2004. The Company's associated PV premiums originated, which increased 31.9%, did not grow as much as par insured because
most of the growth in par volume came from pooled corporate and residential mortgage transactions of Triple-A underlying credit quality. Such high-quality transactions tend to have relatively low
premium rates but tend to achieve good returns on equity. In 2003, par originated in FSA's U.S. asset-backed business declined

41

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56.2%,
while PV premiums originated declined 9.4%. Compared with 2002 activity, the Company's asset-backed business reflected a shift away from large Super Triple-A CDSs, Triple-A tranches of
residential mortgage-backed securities and auto loan transactions toward higher premium types of transactions, including Triple-A collateralized loan obligations ("CLOs") and certain residential
mortgage and consumer finance issues.

International New Originations

|                                           |  | Year Ended December 31,
|------------------------------------------ |  | -----------------------
|
|Gross par insured (in billions)            |  | $                      
|Gross PV premiums originated (in millions) |  |                        

Full-year
international par insured for 2004 approximated that of the prior year, and international PV premium originations decreased 2.1%. FSA had expected to insure a greater number of
infrastructure transactions during the year, but some significant transactions were postponed. In 2003, the 4.8% decline in international PV premiums originated was less than the 48.0% decline in
gross par insured, largely because of a shift from Super Triple-A pooled corporate CDS to a broader range of transactions, including CLOs, synthetic residential mortgage securitizations and other
structured financings. Infrastructure financings contributed the largest share of international premium production in 2003. PV premiums for international originations are translated into U.S. dollars
using month-end currency exchange rates. Actual premiums received could differ from this amount due to exchange-rate fluctuations.



The financial products segment, in which the Company conducts business through a group of wholly owned subsidiaries (the "GIC Subsidiaries"), produces net
interest margin ("FP NIM") rather than insurance premiums. Like installment premiums, FP NIM is expected to be earned and collected in future periods.

Guaranteed
investment contracts ("GICs") are issued at or converted into LIBOR-based floating rate obligations, with proceeds invested in or converted into LIBOR-based floating-rate
investments intended to result in profits from a higher investment rate than borrowing rate. The difference between the investment revenue and the borrowing cost is the FP NIM.

The
non-GAAP measure PV NIM represents the difference between the estimated interest to be received on the investments and the estimated interest to be paid on liabilities
issued in the form of GICs, net of expected hedge derivative results. PV NIM is calculated after giving effect to swaps and other derivatives that convert substantially all fixed-rate
assets and liabilities to floating rates. At the time of origination, all interest rate hedges are assumed to be completely effective. The Company's future positive interest rate spread can be
reasonably estimated and generally relates to contracts or security instruments that extend for multiple years.

Net
interest income and net interest expense are reflected in the Statements of Operations and Comprehensive Income but are limited to current-year earnings. As GIC contracts extend
beyond the current period, management considers the non-GAAP measure "PV NIM" to be a useful indicator of future FP NIM to be earned and includes it in Adjusted Book Value as another element of
intrinsic value, not found in GAAP book value. PV NIM represents the difference between the estimated interest to be received on the investments and the estimated interest to be paid on liabilities
issued in the form of GICs, net of expected hedge derivative results. PV NIM is calculated after giving effect to swaps and other derivatives that convert substantially all fixed-rate assets and
liabilities to floating rates. At the time of origination, all interest-rate hedges are assumed to be completely effective.

42

---



For
each accounting period, the Company reports the non-GAAP measure PV NIM originated, reflecting its estimate of PV NIM generated by that period's new business in the financial
products segment. The majority of municipal GICs issued by the GIC Subsidiaries relate to debt service reserve funds and construction funds in support of municipal bond transactions. These funds may
be drawn unexpectedly, with the result that the actual timing and amount of repayments may differ from the original estimates, which in turn would affect the realization of the estimate of PV NIM
originated in a given accounting period.

PV
outstanding is the sum of cumulative years' reported PV premiums originated and PV NIM originated, less what has been earned or adjusted due to changes in estimates as described
above. Installment payment contracts, whether in the form of premiums or NIM, are generally non-cancelable and represent a claim to future cash flows. Therefore, management includes these
amounts in its estimate of ABV.

Financial Products PV NIM Originated

|                                                             |  | Year Ended December 31,
|------------------------------------------------------------ |  | -----------------------
|
|
|Gross present value of future net interest margin originated |  | $                      

PV
NIM originated rose 67.1% in 2004. This growth reflects increased activity in both municipal and structured GICs. PV NIM originated for 2003 was 32.9% below PV NIM originated for
2002. The Company constrained its GIC activity during the first four months of 2003 as it approached a regulatory limit of 100 non-qualified holders. This limit was lifted when the Company received an
exemption from the Investment Company Act in April 2003.

Operating Earnings

Management uses two key metrics to measure company performance and to calculate long-term incentive compensation and the annual bonus pool. These two
metricsoperating earnings and adjusted book value ("ABV")are both non-GAAP measures.

The
Company defines "operating earnings" as net income before the effects of fair-value adjustments for FSA-insured credit default swaps ("CDS") that:



CDS
contracts are generally non-cancelable prior to maturity, and the Company views insured CDS risks as comparable to other insured risks. In a typical CDS transaction, the Company, in
exchange for an upfront or periodic premium, indemnifies the insured for economic losses related to specified reference obligations, primarily pools of corporate debt securities or bank loans,
structured such that the risk insured is investment grade without the benefit of the credit protection provided by the Company. In the event a CDS were to migrate below investment grade, the
fair-value impact would be fully reflected in operating earnings.

The
Company discloses operating earnings to inform investors of a key measure used by both management and the Board of Directors to assess the Company's consolidated operating
performance and to calculate its employees' long-term incentive compensation payments. The limitations of the operating earnings metric are the lack of comparability to operating earnings of other
companies that may define it differently and the exclusion of variability related to CDS fair-value adjustments. A significant percentage of the Company's CDS exposures subject to fair-value
adjustments are considered Triple-A or Super Triple-A (defined as credit quality based on loss protection which is greater than 1.3 times the Triple-A

43

---



standard),
and the Company and its subsidiaries do not intend to trade these highly rated, highly structured contracts. Accordingly, management believes it is probable that the financial impact of the
fair-value adjustments for the insured CDS will disappear over the finite terms of the exposures, which are typically five to seven years at inception. For this reason, management believes that the
market volatility of credit-spread pricing, the primary driver of the Company's change in fair-value results, should not influence a measure of the Company's operating performance.

Operating
earnings increased 22.0% in 2004 and 24.2% in 2003.

Reconciliation of Net Income to Non-GAAP Operating Earnings

|                                                         |  | Year Ended December 31, |      
|-------------------------------------------------------- |  | ----------------------- | -----
|
|
|Net income                                               |  | $                       | 363.8
|Less fair-value adjustments of insured CDS, net of taxes |  |                         | 37.7 
|                                                         |  |                         |      
|Operating earnings                                       |  | $                       | 326.1
|                                                         |  |                         |      

Adjusted Book Value

To calculate ABV, the following adjustments, on an after-tax basis, are made to shareholders' equity (GAAP "book value"):



Management
considers ABV a reasonable measure of the Company's intrinsic value, exclusive of franchise value. Like book value, it reflects loss estimates, which are made at the time of
contract origination. Additionally, ABV captures the estimated value of future contractual cash flows related to transactions in force as of the balance sheet date (adjustments 2 and 3 in the
calculation above). An investor attempting to evaluate the Company using GAAP measures alone would not have the benefit of this information. In addition, investors may consider the growth of ABV to be
a performance
measure indicating the degree to which management has succeeded in building a reliable source of future earnings. Certain of the Company's compensation formulas are based in part on the ABV growth
rate. The limitation of the ABV metric is that it relies on an estimate of the amount and timing of the receipt of installment premiums and future net interest margin. Actual installment premium
receipts could vary from the amount estimated based on variances in the actual insured outstanding debt balances as of the dates used to calculate premiums due. Actual net interest margin results
could vary from the amount estimated based on variances in the actual timing and amount of repayment associated with flexible-draw GICs that the Company issues. ABV also excludes the fair-value of
investment-grade insured CDS.

Adjustments
1, 2 and 3 represent the sum of cumulative years' reported PV premiums originated and PV NIM originated, less what has been earned or adjusted due to changes in estimates as
described above.

Adjustments
1 and 2 in the calculation of ABV together constitute "PV premiums outstanding." Because debt schedules related to installment transactions change from time to time,
management uses PV premiums outstanding to indicate its best estimate of the Company's present value of future premium revenues (comprising current- and prior-period originations that have not yet
been earned). Critical

44

---



assumptions
underlying adjustment 2 are discussed above under "New Business ProductionFinancial Guaranty Insurance Originations."

As
discussed above under "New Business ProductionFinancial Products Originations," the Company calculates PV NIM (adjustment 3) because net interest income and net interest
expense reflected in the statement of operations are limited to current-year earnings. The Company's future positive interest rate spread from outstanding GIC business can be reasonably estimated and
generally relates to contracts or security instruments that extend for multiple years. Management therefore includes it in ABV as another element of intrinsic value not found in U.S. GAAP book value.

In
addition, ABV excludes the effect of certain fair-value adjustments that are excluded from operating earnings (adjustment 5 above). As explained in the preceding discussion of
operating earnings, management believes the fair-value adjustments' financial impact will probably disappear over the finite terms of the related exposures.

Shareholders'
equity was $2.5 billion and non-GAAP ABV was $3.7 billion at December 31, 2004. During 2004, ABV grew 16.8% excluding realized and unrealized capital gains
and losses in the investment portfolio and 16.9% including such gains and losses.

Reconciliation of Book Value to Non-GAAP Adjusted Book Value

|                                     |                                                                  | As of December 31,  |        
|------------------------------------ | ---------------------------------------------------------------- | ------------------- | -------
|
|
|Shareholders' equity (book value)(1) |                                                                  | $                   | 2,550.0
|After-tax adjustments:               |                                                                  |                     |        
|                                     | Plus net unearned premium revenues                               |                     |        
|                                     | Plus present value of net future installment premiums and PV NIM |                     |        
|                                     | Less net deferred acquisition costs and goodwill                 |                     |        
|                                     | Less fair value adjustments for insured CDS(2)                   |                     |        
|                                     |                                                                  |                     |        
|                                     |                                                                  | Adjusted book value |        
|                                     |                                                                  |                     |        

---

Net Investment Income and Realized Gains

Net investment income increased 11.7% in 2004, primarily due to higher invested balances arising from new business writings, partially offset by lower
reinvestment rates stemming from the low interest-rate environment during the year. Net investment income increased 10.7% in 2003 from that of the prior year, primarily due to higher invested balances
arising from new business writings. For further discussion, see "Liquidity and Capital Resources," below.

45

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Income from Investments

|                                                                                                                      |  | Year Ended December 31, |      
|--------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | -----
|
|
|Net investment income                                                                                                 |  | $                       | 172.1
|Net realized gains                                                                                                    |  |                         | (0.5 
|Effective tax rate on investment income excluding effects of realized gains and losses and variable interest entities |  |                         | 9.2  

Realized
gains and losses are generally a by-product of the normal investment management process and may vary substantially from period to period.

Losses and Loss Adjustment Expenses

The provision for losses and loss adjustment expenses was $20.6 million in 2004, $34.5 million in 2003 and $65.6 million in 2002. Activity in
the liability for losses and loss adjustment expenses, which consists of case and non-specific reserves, is summarized as follows:

Case Reserve Activity for the
Year Ended December 31,2004

2003

2002(dollars in millions)Gross balance at January 1

$
121.9

$
134.0

$
45.4Less reinsurance recoverable


59.2


76.0


28.9Net balance at January 1


62.7


58.0


16.5Transfer from non-specific reserve


30.7


12.7


45.0Restructured transactions


(13.9
)

(2.2
)

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








Prior year


(34.3
)

(5.8
)

(3.5
)Total paid


(34.3
)

(5.8
)

(3.5
)Net balance at December 31


45.2


62.7


58.0Plus reinsurance recoverable


35.4


59.2


76.0Gross balance at December 31

$
80.6

$
121.9

$
134.0


46

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Non-Specific Reserve Activity for the
Year Ended December 31,2004

2003

2002(dollars in millions)Balance at January 1

$
111.5

$
89.7

$
69.1Provision for lossesCurrent year


20.4


22.4


21.1Prior year


0.2


12.1


44.5Transfers to case reserves


(30.7
)

(12.7
)

(45.0
)Restructured transactions


(2.1
)




Balance at December 31


99.3


111.5


89.7Total case and non-specific reserves

$
179.9

$
233.4

$
223.7


The
gross and net par amounts outstanding on transactions with case reserves were $791.4 million and $752.8 million, respectively, at December 31, 2004. The net case
reserve consisted primarily of six CDO transactions and one municipal transaction, which collectively accounted for approximately 95% of the total net case reserve. The remaining 11 exposures were in
various sectors.

Reserves
for losses and loss adjustment expenses are discounted when established at the then current risk-free rates. The cumulative amount of net discount taken was approximately
$59.5 million at December 31, 2004, $65.9 million at December 31, 2003 and $44.7 million at December 31, 2002.

During
2004, the Company charged $20.6 million to loss expense, consisting of $25.0 million for originations of new business and accretion on in-force business and
$3.2 million related to reassumptions of previously ceded business, offset by reserve releases primarily related to favorable experience in the CDO portfolio. The non-specific reserve decreased
$12.2 million in 2004, primarily due to transfers from the non-specific reserve to case reserves of $30.7 million offset by loss expense of $20.6 million. Case reserves decreased
$17.5 million due to (1) a large, voluntarily accelerated transaction that had a $34.3 million payment and (2) reclassifications from reserves to asset valuation accounts
for refinanced transactions of $13.9 million offset by transfers from the non-specific reserve of $30.7 million. See Note 22 to the Consolidated Financial Statements in
Item 8.

During
2003, the Company charged $34.5 million to loss expense, comprising $9.2 million related to the CDO portfolio discussed below, $22.4 million for origination of new
business and $2.9 million for the accretion of the discount on prior years' reserves. The non-specific reserve increased by $21.8 million in
2003, consisting of the loss expense, a transfer to the non-specific reserve of $1.4 million representing recoveries received on prior-year transactions and a transfer of $14.1 million
from the non-specific reserve to case reserves. In addition, the Company reclassified $2.2 million of case reserves relating to a restructured transaction to securitized loans on the balance
sheet. See Note 22 to the Consolidated Financial Statements in Item 8.

In
the second quarter of 2002, as part of the Company's ongoing credit review process, management identified certain transactions not performing as expected in its portfolio of insured
CDOs. As a result, management undertook a quantitative analysis of all CDO transactions in its insured portfolio that breached senior overcollateralization triggers, which were included in such
transactions as one measure of adverse performance. A present value "deterministic" approach was utilized to estimate the loss inherent in this portfolio. The deterministic model takes the average
cumulative default rate produced by a Monte Carlo simulation and applies those defaults to a cash flow model using (i) a timing sequence dependent on the portfolio's rating and maturity composition,
(ii) an estimate of collateral recovery values for severity and (iii) the LIBOR forward curve as a predictor of interest rates. Management assumed that current default rates on CDO collateral would
improve in a manner consistent with an economic recovery following a period of significant credit deterioration similar to that experienced in 1991/1992 and, as a

47

---



result,
management utilized the Moody's idealized default curve, adjusted by a factor consistent with the relationship between the 1992 cohort experience and the Moody's 30-year average default rate.
The per-period default rate was calculated based on the Moody's weighted-average rating factor for each piece of surviving collateral. Recovery rates were judgmentally established by the Company. In
considering the recovery rates to be utilized, management adjusted Moody's average recovery rates (observed since 1982) downward to reflect more recent adverse observations.

At
June 30, 2002, this analysis produced a present value of expected losses of $51.5 million, net of reinsurance recoveries and net of unearned premiums and future ceding
commissions. Management addressed this net present value of expected loss ($51.5 million) through (i) an increase in the Company's non-specific reserve ($31.0 million) and (ii) amounts
already existing in its non-specific reserve ($20.5 million), including non-specific reserve amounts reallocated to case reserves ($11.3 million). The $31.0 million increase in
the Company's non-specific reserve resulted in a corresponding increase to losses and loss adjustment expenses in the Statements of Operations and Comprehensive Income of $31.0 million. An
additional adjustment of $10.1 million was made in the fourth quarter of 2002 as a result of further deterioration of the CDO portfolio, resulting in an increase to loss expense and a
corresponding increase to the non-specific reserve. Management established a methodology of recording case reserves on CDO transactions based on the extent to which the overcollateralization ratio
(non-defaulted collateral at par value divided by the debt insured) has fallen below 100%, since management believes that claims on such transactions are probable and that the amount of the
undercollateralization is a reasonable estimate of such claims. Such transactions may benefit from excess cash flow attributable in part to higher interest rates on the underlying collateral than on
the insured securities. In addition, such transactions generally require insured payments of principal only at the ultimate maturity of such transactions. As a result, the Company does not expect to
be required to pay claims on these transactions for several years, but may elect to do so at earlier dates at its discretion. In some cases since 2002, the Company has elected to pay claims earlier
than required. Application of this methodology resulted in recording $68.8 million in gross case
reserves and $29.8 million in reinsurance recoverable on unpaid losses, resulting in a $39.0 million increase in net case reserves in 2002. Management, beginning in the second quarter of
2002, has refined the loss factor it applies to its net par underwritten when calculating the non-specific reserve in order to reflect its recent adverse experience. As a result, the non-specific
reserve accrual for the year ended December 31, 2002 was $65.6 million, rather than the approximately $14.9 million that would have been accrued using the prior assumptions.

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

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

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

|                                   |  | As of December 31,
|---------------------------------- |  | ------------------
|
|Case reserve discount rate         |  | 3.13%5.90%       
|Non-specific reserve discount rate |  | 1.20%7.95%       
|Current experience factor          |  | 2.0               

48

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The
primary estimates affecting the statistical calculation are (a) probability of default and (b) severity of loss given default. The Company applies its experience factor to the
statistical calculation to reflect actual loss experience in terms of both frequency and severity. Historically, defaults on guaranteed obligations have been infrequent, but the size of resulting
claims have varied widely due to both the differing sizes of the obligations guaranteed and the significant variability of the severity experienced. Severity represents the magnitude of loss, which is
calculated as par guaranteed minus total recoveries, expressed as a percentage of par guaranteed. Recoveries include salvage value of assets and amounts due from reinsurers. Actual claim frequency and
severity experience may evolve over time, affected by many factors, including changes in the insured portfolio's distribution across sectors and underlying ratings, as well as changes in the economy
and the political environment. The Company's loss reserving methodology is designed to reflect these factors. Changes in the sectors and underlying credit quality of the transactions are captured in
the formula directly, while changes in the economy and political environment are captured in the experience factor.

Given
the broad diversification of FSA's insured portfolio, management believes that a systemic shift in overall portfolio quality is unlikely to occur except in a catastrophic economic
environment. It is therefore necessary to look at particular sectors when examining the sensitivity of the insured portfolio to changes in underlying loss assumptions. Management believes that
different analyses are required for the two broad sectors of the insured portfolio, asset-backed obligations and municipal credits.

Asset-backed
obligations insured by FSA are secured by pools of assets. While the assets in a given transaction are generally of one type (such as automobile loans, residential mortgage
loans, etc.), they are diversified within that asset type. Due to characteristically low default frequency, losses on insured asset-backed transactions have been manageable in management's view,
despite variability.

Management
believes severity is not the primary determinant of possible loss in a portfolio of insured asset-backed obligations. Since introducing a non-specific reserve in 1993, actual
aggregate losses have been reasonably consistent with management's expectation in the majority of asset-backed categories, including insured obligations collateralized by automobile loan or
residential mortgage debt of non-prime borrowers. The one exception involved senior bonds issued in 1998 and 1999 in connection with
structured CDOs. In such a structure, the bonds insured by FSA are in second-loss positions, meaning that there are uninsured, subordinate bondholders or equity investors who must lose all of their
investment outstanding at the time of default or earlier trigger event before the FSA-insured bonds become subject to loss. These transactions were structured to FSA's requirement that the first-loss
position provide FSA an investment-grade level of protection. The underlying assets supporting the insured obligations were pools of corporate bonds individually rated below investment grade. In this
structure, multiple credits must fail before claims are triggered. In 2002, credit quality deteriorated across a broad spectrum of the corporate market, which led to projected claims on these
transactions and charges to FSA's income statement, as well as an increase in the Company's loss experience rate. Yet even under this unprecedented stress scenario, the severity of the largest single
loss was relatively modest.

Accordingly,
management considers default frequency the relevant factor driving adverse loss experience in the asset-backed sector and believes that a reasonably possible adverse change
in default frequencies would not result in a material adverse adjustment to the non-specific loss reserve.

Current
asset-backed case reserves could vary from the current estimate of loss. In particular, the deterministic model used to determine case reserves for CDO transactions utilizes
average cumulative default rates produced by a Monte Carlo simulation and applies those defaults to a cash flow model. While CDO exposures are affected by multiple variables, including default rates,
collateral recovery rates, changes in interest rate movements and the prepayment speeds of the collateral, management believes default frequency is the key determinant of loss. Holding all other
variables constant and assuming only that the CDO's underlying corporate debt instruments were to default at a higher rate than the Monte

49

---



Carlo
average default rate, actual losses would exceed the current estimate. Applying a higher frequency of default, observed at the 90% confidence level, would result in additional present value loss
of $30 million.

To
assess sensitivity to changes in loss assumptions in the municipal insured portfolio, management believes that categories of municipal risk other than the health care sector should
not result in a material adverse change to the estimate of loss under a reasonably possible scenario. Management believes that a material adverse change in loss is reasonably possible to occur in the
health care sector. While the Company has not experienced a loss in this sector, the potential severity of health care losses is comparatively high. Hospital facilities are single-purpose assets and a
failing health care issuer is likely to be liquidated or acquired. If there is collateral associated with a health care credit, it is generally in the form of a hospital facility, the value of which
is primarily driven by the community's need for that facility. The more hospitals competing in a community, the more fragile the value of the hospital collateral is likely to be in a stress scenario.
FSA addresses the severity risk in this sector through internal policies that limit exposure to any single credit.

In
a recently issued S&P scenario analysis, S&P assumed 75% loss severity for health care credits, which means that a loss would equal 75% of par insured. If losses of this severity
occurred in both the lowest rated single-site hospital exposure and the lowest-rated hospital system exposure in FSA's insured portfolio, the loss would be as much as $48 million on a pre-tax basis,
net of reinsurance.

A
material adverse change from management's current estimate of loss for municipal transactions with case reserves is considered unlikely because the only such case reserve is set near
the full policy amount.

FSA
management believes that the liability it carries for losses and loss expenses are adequate to cover the net cost of claims. However, the loss liability is based on assumptions
regarding the Company's probability of default and its severity of loss and there can be no assurance that the liability for losses will not exceed such estimates.

The
sensitivities described above are hypothetical and should be used with caution. The effect of variation in a particular assumption is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities.

The
Company is aware that there are differences regarding the method of measurement of the non-specific reserve among participants in the financial guaranty industry. Other
financial guarantors may not establish a non-specific reserve in the manner described above, may call their non-specific reserve by a different name, such as, but not limited to
"unallocated losses," "active credit reserves" and "portfolio reserves," or may use different statistical techniques than the Company uses to determine loss at a given point in time. Management and
the industry expect accounting literature specific to the financial guaranty industry to evolve; however, management cannot predict or estimate the scope of the guidance or potential impact on the
financial statements at this time. See Note 2 to the Consolidated Financial Statements in Item 8.

At
December 31, 2004, the reinsurance recoverable on unpaid losses from reinsurers and ceded par outstanding, by Standard & Poor's Ratings Services ("S&P") rating levels, are as
follows:

Reinsurer's S&P Rating

Reinsurance
Recoverable

Ceded Par
Outstanding(dollars in millions)AAA

$
11.9

$
34,193.8AA


23.5


65,147.0A





17,552.7Not currently rated





26.9Total

$
35.4

$
116,920.4


50

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Interest Expense

Interest expense was $27.0 million in 2004, $33.0 million in 2003 and $28.1 million in 2002. For further discussion, see "Liquidity and Capital
Resources" below.

Other Operating Expenses

Other operating expenses for 2004 increased 8.5% from that of the previous year. The increase relates primarily to increased personnel costs. The corresponding
14.9% increase in other operating expenses for 2003 is primarily related to higher personnel costs. For additional discussion, see Note 10 to the Consolidated Financial Statements in
Item 8.

Financial Products Net Interest Margin

For the financial products segment, FP NIM was $22.8 million in 2004, $5.1 million in 2003 and $7.6 million in 2002. The increases in
FP NIM are primarily related to an increasing book of GIC business since commencing operations at the end of 2001. FP NIM was adversely affected in 2003 by SFAS 133 adjustments.
Prior-year balances have been reclassified to conform to the current-year presentation.

NIM
shown in accordance with classifications required under GAAP on the Consolidated Statements of Operations and Comprehensive Income ("Total NIM") is calculated as net interest income
on financial products and variable interest entities, plus net realized gains (losses) on financial products, less net interest expense on financial products and variable interest entities. Total NIM
was $16.8 million for 2004, $(3.1) million for 2003 and $6.6 million for 2002. The differences between Total NIM and FP NIM relate primarily to the presentation of intersegment
transactions and the classification of derivatives and variable interest entities ("VIEs").

The
table below reconciles Total NIM with FP NIM, which is used as a key performance measure of the financial products business.

|                                                              |        | Year Ended December 31,
|------------------------------------------------------------- | ------ | -----------------------
|
|
|Total NIM                                                     |        | $                      
|Reclassification of non-hedge derivatives                     |        |                        
|Reclassification of income related to refinanced transactions |        |                        
|Variable interest entities NIM ("VIE NIM")(1)                 |        |                        
|                                                              |        |                        
|                                                              | FP NIM |                        
|                                                              |        |                        

---

Derivative
gains and losses are included in the FP NIM whether or not they are designated hedges. GAAP requires that derivatives designated as hedges be classified in the
Statements of Operations and Comprehensive Income with the underlying item being hedged. Gains and losses on undesignated hedges are shown under the caption net realized and unrealized gains (losses)
on derivative instruments.

Intersegment
transactions relate primarily to intercompany notes held in the FP bond portfolio. In connection with the Company's refinancing transactions, the Company obtains funds from
the FP operations to fund claim payments, as discussed further in Note 22 to the Consolidated Financial Statements in Item 8, creating an interest-bearing intercompany note. This
intercompany note is included in the assets of the financial products segment. The net interest income on intercompany notes is included in FP NIM, but eliminated in the consolidated Total NIM.
The GIC Subsidiaries raise funds through the issuance of FSA-insured GICs in the normal course of FP operations.

Income
related to refinanced transactions included in FP NIM is shown as a separate caption on the Statements of Operations and Comprehensive Income.

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VIE
NIM and FP NIM are combined on the Statements of Operations and Comprehensive Income. VIE NIM pertains to the net interest margin derived from transactions executed by FSA Global
Funding Limited ("FSA Global"), Canadian Global Funding Corporation ("Canadian Global") and Premier International Funding Co. ("Premier"). See Note 25 to the Consolidated Financial
Statements in Item 8.

Net Realized and Unrealized Gains (Losses) on Derivatives

FSA's business includes insurance of CDS referencing diversified pools of obligations. The net par outstanding was $66.0 billion relating to these transactions at
December 31, 2004 and $63.8 billion at December 31, 2003. Many of these transactions require periodic accounting adjustments to reflect an estimate of fair value under SFAS 133. These
transactions have generally been underwritten with Triple-A or higher levels of credit protection provided by significant deductibles that must be exhausted prior to claims under FSA's guaranty.
Adjustments required by SFAS 133 resulted in pre-tax income of $56.4 million for 2004 and $34.8 million for 2003 and losses of $50.2 million for 2002. The benefits during 2004 and 2003 resulted
primarily from tightening credit spreads in the CDS market, while the charge for 2002 resulted primarily from widening credit spreads in that market. Neither of these adjustments indicate any material
improvement or deterioration in the underlying credit quality of FSA's insured CDS portfolio. The gain or loss created by estimated fair-value adjustments will rise or fall each quarter based on
estimated market pricing of highly rated swap guarantees and is not expected to be an indication of potential claims under FSA's guarantee. Fair value is defined as the price at which an asset or a
liability could be bought or sold in a current transaction between willing parties. The fair value is determined based on quoted market prices, if available. If quoted market prices are not available,
as is the case primarily with CDS on pools of assets, then the determination of fair value is based on internally developed estimates. Management applies judgment when developing these estimates and
considers factors such as current prices charged for similar agreements, performance of underlying assets, changes in internal shadow ratings, the level at which the deductible has been set and FSA's
ability to obtain reinsurance for its insured obligations. Due to changes in these factors, the gain or loss from derivative instruments may vary substantially from period to period. Absent any claims
under FSA's guaranty, any "losses" recorded in marking a guaranty to fair value will be reversed by an equivalent "gain" at or prior to the expiration of the guaranty and any "gain" recorded would be
reversed by an equal "loss" over the remaining life of the transaction. The average life of these contracts is 2.9 years. The inception-to-date gain (loss) on the CDS portfolio was $46.6
million at December 31, 2004 and $(9.8) million at December 31, 2003. Given the very high credit quality of FSA's insured CDS portfolio and the Company's intent to hold to maturity, management
believes that "losses" or "gains" attributable to marking these exposures to fair value do not reflect on the profitability of the Company in a meaningful way.

During
the first half of 2002, FSA's insured portfolio contained a portfolio of CDS on 100 corporate names (each rated investment grade at inception of the swap), with $10 million of
exposure per name, for which the Company had first-loss exposure. This "single-name CDS program" was the only transaction of its kind in the insured portfolio. In the third quarter of 2002, the
Company terminated its exposure under this program in exchange for paying termination costs of $43.0 million. The charge was included in net realized and unrealized gains (losses) on derivative
instruments in the Consolidated Statements of Operations and Comprehensive Income during 2002.

Income from Assets Acquired in Refinancing Transactions

Income from assets acquired in refinancing transactions was $14.8 million in 2004, $19.5 million in 2003 and $1.9 million in 2002. The significantly higher
amounts in 2004 and 2003 than in 2002 were due to the refinancings of several insured transactions whereby the Company accelerated claims payment on transactions that had experienced events of default
and acquired the obligations or underlying collateral in order to mitigate future claims. The amounts presented are net of the impact of derivative instruments used to hedge interest-rate risks within
this portfolio of assets.

52

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Equity in Earnings of Unconsolidated Affiliates

Total equity in earnings of unconsolidated affiliates was a loss of $3.3 million in 2004 and gains of $5.5 million in 2003 and $29.3 million in 2002. The Company
has an investment in SPS Holding Corp. ("SPS"), formerly Fairbanks Capital Holding Corp. SPS is owned 64.92% by The PMI Group Inc. and 34.06% by the Company, with the remainder owned by individuals.
At December 31, 2004, the Company's interest in SPS had a book value of $49.6 million. At December 31, 2003, the Company's interest in SPS was $46.4 million, of which $7.6 million represented
goodwill. The Company's equity in earnings from SPS was a loss of $7.1 million in 2004, a loss of $13.5 million in 2003, and income of $13.8 million in 2002.

SPS's
business is subject to regulation, supervision and licensing by various federal, state and local authorities that have increased their focus on lending and servicing practices in
the sub-prime lending industry. In October 2002, the Federal Trade Commission ("FTC") informed SPS that it was investigating whether SPS's loan servicing or other practices violated the Fair Debt
Collection Practices Act, the Fair Credit Reporting Act, Section 5 of the Federal Trade Commission Act or other laws enforced by the FTC. Certain of SPS's shareholders, including the Company, received
civil investigative demands from the FTC relating to their investments in SPS and their knowledge of SPS's servicing operations.

On
November 12, 2003, the FTC announced a settlement with SPS, resolving the FTC's civil allegations against SPS. Pursuant to that settlement, SPS paid $40.0 million to the FTC to
compensate consumers who suffered harm. The settlement enjoins SPS from future law violations and imposes restrictions on SPS's business practices. A related settlement of numerous class action
lawsuits against SPS has been approved by a federal district court in Massachusetts. In the second quarter of 2004, the Company made a $10.3 million additional equity investment in SPS to fund a
portion of the $40.0 million payment that was required to be made to the FTC under the terms of the FTC's settlement agreement with SPS.

In
the third quarter of 2004, the Company determined that its $7.6 million of goodwill associated with its investment in SPS was impaired as a result of challenges encountered by SPS in
acquiring new business, despite servicer ratings of "Average." While management believes book value approximates fair value, the Company will continue to monitor the value of its investment in SPS.
The Company and the other owners of SPS have entered into a binding Summary of Terms relating to the potential sale to an unaffiliated third party of their respective interests in SPS pursuant to an
option, exercisable on or before July 31, 2005. The sale is subject to several conditions, including, among other things, execution of definitive agreements.

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

For
the first three quarters of 2004 and all prior years, equity in earnings of unconsolidated affiliates included the results of XLFA. In accordance with EITF 02-14, "Whether an
Investor Should Apply the Equity Method of Accounting for Investments Other Than Common Stock," the Company no longer accounts for its investment in XLFA under the equity method of accounting.
Effective October 1, 2004, the Company's 15% investment in XLFA is included in equity securities as an available-for-sale security. The fair value of the investment at December 31, 2004 was $54.3
million.

53

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Variable Interest Entities

Asset-backed and, to a lesser extent, municipal transactions insured by FSA may employ VIEs for a variety of purposes. A typical asset-backed transaction, for
example, employs a VIE as the purchaser of the securitized assets and as the issuer of the insured obligations. FSA's participation is typically requested by the sponsor of the VIE or the underwriter,
either via a bid process or on a sole source basis. VIEs are typically owned by transaction sponsors or charitable trusts, although FSA may have an ownership interest in some cases. FSA maintains
certain contractual rights and exercises varying degrees of influence over VIE issuers of FSA-insured obligations. FSA also bears some of the "risks and rewards" associated with the performance of the
VIE's assets. Specifically, as issuer of a financial guaranty insurance policy insuring the VIE's obligations, FSA bears the risk of asset performance (typically, but not always, after a significant
depletion of overcollateralization, excess spread, a deductible or other credit protection). FSA's underwriting policy is to insure only obligations that are otherwise investment grade. In addition,
the VIE typically pays a periodic premium to FSA in consideration of the issuance by FSA of its insurance policy, with the VIE's assets typically serving as the source of such premium, thus providing
some of the "rewards" of the VIE's assets to FSA. VIEs are also employed by FSA in connection with "repackaging" of outstanding securities into new securities insured by FSA and with refinancing
underperforming, non-investment-grade transactions insured by FSA. The degree of influence exercised by FSA over these VIEs varies from transaction to transaction, as does the degree to which "risks
and rewards" associated with asset performance are assumed by FSA. While all transactions insured by FSA are included in the Company's outstanding exposure, and losses under these obligations are
reflected in the Notes to Consolidated Financial
Statements for the year ended December 31, 2004, the assets and liabilities of these VIEs, except for refinanced transactions discussed below and in Note 22 to the Consolidated Financial Statements in
Item 8, have not been consolidated with those of the Company for financial reporting purposes because the Company is not the primary beneficiary.

In
January 2003, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" ("FIN
46"). FIN 46 addresses consolidation of VIEs that have one or both of the following characteristics: (a) the equity investment at risk is not sufficient to permit the entity to finance its activities
without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity; and (b) the equity
investors lack the direct or indirect ability to make decisions about the entity's activities through voting rights or similar rights, the obligation to absorb the expected losses of the entity if
they occur or the right to receive the expected residual returns of the entity if they occur. In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), "Consolidation of
Variable Interest Entities, an interpretation of ARB 51" ("FIN 46R"). FIN 46R replaced FIN 46 and is effective for public companies for periods after December 15, 2003.

The
Company consolidates FSA Global, Canadian Global and Premier. The aggregate increase related to adoption of FIN 46 on July 1, 2003 was a $1.9 billion increase in total assets
and total liabilities. The differences upon consolidation were reflected as a cumulative effect of a change in accounting principle. The cumulative effect of a change in accounting principle for
Canadian Global resulted in additional income of $4.8 million, net of income tax in 2003. During the third quarter of 2004 the majority of the assets of Canadian Global were liquidated and its
liabilities satisfied. There was no income statement effect from consolidating FSA Global and Premier. FSA Global is managed as a "matched funding vehicle," in which the proceeds from the issuance of
FSA-guaranteed notes are invested in obligations having cash flows substantially matched to those of, and maturing prior to, such notes. In certain cases, investments of FSA Global consist of GICs
issued by the GIC Subsidiaries. In each such case, the Company's GIC liability and GIC asset are eliminated in consolidation. At December 31, 2004, $961.9 million was eliminated as a result of such
consolidation. The Company's management believes that the assets held by the VIEs, including those that are eliminated in consolidation, are beyond the reach of the

54

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Company
and its creditors, even in bankruptcy or other receivership. All intercompany insured amounts between FSA and FSA Global or Canadian Global are excluded from the Notes to the Consolidated
Financial Statements for the years ended December 31, 2004 and 2003. In addition, the Company refinances certain defaulted transactions by employing refinancing vehicles to raise funds for the
refinancings. These refinancing vehicles are also consolidated. See Note 22 to the Consolidated Financial Statements in Item 8.

Taxes

The effective tax rates were 21.8% in 2004, 24.1% in 2003 and 16.2% in 2002, which differ from the statutory rate of 35% due primarily to tax-exempt interest
income and income from Financial Security Assurance International Ltd. ("FSA International"), with the White Mountains indemnity payment (see below) being an additional difference in 2004. In
addition, the effective tax rate was affected by the expected repatriation of earnings of Financial Security Assurance International Ltd. ("FSA International") in 2005.

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

In
connection with Dexia's acquisition of the Company in July 2000, the Company became the successor, for tax purposes, to White Mountains Holdings, Inc. ("WMH"). WMH had previously sold
an insurance subsidiary to a third party that was indemnified by White Mountains Insurance Group for certain future adverse loss development up to $50.0 million. In 2004, the Company made an indemnity
payment of $47.0 million to the third party with funds provided for such purpose by White Mountains Insurance Group. While the Company had no legal liability in connection with the indemnity payment,
the payment should be treated for tax purposes as a $47.0 million loss deduction to the Company, as successor to WMH. The Company therefore recorded a deferred tax asset with a corresponding deferred
tax benefit of $16.5 million. There can be no assurance that the deferred tax benefit will not be reversed in the future. In addition, under certain circumstances, which are not probable as of
December 31, 2004, the Company expects to agree to share 50% of the deferred tax benefit with White Mountains Insurance Group.

In
the third quarter of 2002, the Company changed its method of taxing its equity in earnings from SPS, an unconsolidated affiliate of the Company. Prior to 2002, the Company taxed 100%
of its equity in earnings from SPS at the statutory rate of 35%. Following a change in SPS's investors, the Company determined that it would be appropriate to apply the 80% dividend-received deduction
allowed by the Internal Revenue Service when calculating the tax on its equity in earnings from SPS, based on management's expectation that it would realize its gain on such investment through
dividend distributions rather than through sale of its investment. In 2002, the Company recorded a cumulative-to-date benefit of $4.0 million.

Critical Accounting Policies

The Company's critical accounting policies are described in Note 2 to the Consolidated Financial Statements in Item 8.

55

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Liquidity and Capital Resources

Liquidity

The Company's consolidated invested assets at December 31, 2004, net of unsettled security transactions, were $12,227.2 million, compared with the December 31,
2003 balance of $7,942.7 million. These balances include the change in the market value of the Investment Portfolio, which had an unrealized gain position of $262.8 million at December 31, 2004,
compared with an unrealized gain position of $226.7 million at December 31, 2003. These balances exclude the assets in the VIE bond portfolio, which the Company's management believes are beyond the
reach of the Company and its creditors.

At
December 31, 2004, the Company had, at the holding company level, an investment portfolio of $25.9 million available to fund the liquidity needs of its activities outside of its
insurance operations. Because the majority of the Company's operations are conducted through FSA, the long-term ability of the Company to service its debt will largely depend on its receipt of
dividends from, or payment on surplus notes by, FSA.

In
its financial guaranty business, premiums and investment income are the Company's primary sources of funds to pay its operating expenses, insured losses and taxes. In its financial
products business, the Company relies on net interest income to fund its net interest expense and operating expenses. Management believes that the Company's operations provide sufficient liquidity to
pay its obligations. If additional liquidity is needed or cash flow from operations significantly decreases, the Company can liquidate or utilize its investment portfolio as a source of funds in
addition to its alternative liquidity arrangements, as discussed further below. The Company's cash flows from operations are heavily dependent on market conditions, the competitive environment and the
mix of business originated. In addition, payments made in settlement of the Company's obligations in its insured portfolio may, and often do, vary significantly from year to year depending primarily
on the frequency and severity of payment defaults and its decisions regarding whether to exercise its right to accelerate troubled insured transactions in order to mitigate future losses. In each of
the three years reported, the Company has not drawn on any alternative sources of liquidity to meet its obligations, except that the Company has refinanced certain transactions using funds raised
through its financial products segment.

The
following is a summary of the Company's long-term obligations at December 31, 2004:

Long-Term Obligations

|                              |  | Less than 1 Year |         | 13 Years |   | 35 Years |  | Greater than
5 years |         | Total
|----------------------------- |  | ---------------- | ------- | --------- | - | --------- |  | -------------------- | ------- | -----
|
|Loss reserves(1)              |  | $                | 3.3     |           | $ | 4.2       |  | $                    | 3.6     |      
|Long-term debt obligations(2) |  |                  | 2,883.3 |           |   | 2,652.6   |  |                      | 1,400.2 |      
|Operating lease obligations   |  |                  | 5.5     |           |   | 16.6      |  |                      | 16.3    |      
|                              |  |                  |         |           |   |           |  |                      |         |      
|Total                         |  | $                | 2,892.1 |           | $ | 2,673.4   |  | $                    | 1,420.1 |      
|                              |  |                  |         |           |   |           |  |                      |         |      

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At
December 31, 2003, Financial Security Assurance Holdings Inc. (as a separate holding company, "FSA Holdings") held $152.9 million of surplus notes of FSA. During 2004, FSA repaid
$44.0 million of those surplus notes. At December 31, 2004, FSA Holdings held $108.9 million of FSA surplus notes. Payments of principal or interest on such notes may be made only with the approval of
the Superintendent of Insurance of the State of New York (the "New York Superintendent"). FSA Holdings employs surplus

56

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note
purchases in lieu of capital contributions in order to allow it to withdraw funds from FSA through surplus note payments without reducing earned surplus, thereby preserving dividend capacity of
FSA.

FSA
Holdings paid dividends of $22.9 million in 2004 and $11.7 million in 2002. It did not pay dividends in 2003.

On
July 31, 2003, FSA Holdings issued $100.0 million principal amount of 5.60% Notes due July 15, 2103, which are callable without premium or penalty in whole or in part at any time on
or after July 31, 2008. Debt issuance costs of $3.3 million are being amortized over the life of the Notes. In September 2003, FSA Holdings called for redemption, on November 1, 2003, its 6.950%
Senior Quarterly Income Debt Securities ("Senior QUIDS") due November 1, 2098 and delivered to the trustee sufficient collateral to legally defease the 6.950% Senior QUIDS. The unamortized debt
issuance costs of $3.2 million for the 6.950% Senior QUIDS were charged to interest expense in 2003. Subsequently, the trustee used the defeasance collateral to redeem all of the 6.950% Senior QUIDS.

On
November 26, 2002, FSA Holdings issued $230.0 million principal amount of 6.25% Notes due November 1, 2102, which are callable without premium or penalty in whole or in
part at any time on or after November 26, 2007. Debt issuance costs of $7.4 million are being amortized over the life of the debt. FSA Holdings used a portion of the proceeds of this issuance
to redeem in whole FSA Holdings'
$130.0 million principal amount of 7.375% Senior QUIDS due September 30, 2097. Unamortized debt issuance costs of the retired debt of $4.1 million were charged to interest expense in
2002.

On
December 19, 2001, FSA Holdings issued $100.0 million of 67/8% Quarterly Income Bond Securities due December 15, 2101, which are callable without premium
or penalty on or after December 19, 2006. Debt issuance costs of $3.3 million are being amortized over the life of the debt.

FSA's
ability to pay dividends depends on FSA's financial condition, results of operations, cash requirements, determination that FSA's ratings will not be adversely affected 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 the insurance laws of the State of New York, FSA may
pay dividends out of earned surplus, provided that, together with all dividends declared or distributed by FSA during the preceding 12 months, the dividends do not exceed the lesser of (a) 10% of
policyholders' surplus as of its last statement filed with the New York Superintendent or (b) adjusted net investment income during this period. Based on FSA's statutory statements for the year ended
December 31, 2004, and considering dividends that can be paid by its subsidiary, the maximum amount normally available for payment of dividends by FSA without regulatory approval over the following 12
months is approximately $84.5 million. FSA paid dividends of $30.0 million in 2004, and none in 2003 and 2002.

In
2004 and 2003, FSA International paid preferred dividends of $4.9 million and $3.3 million, respectively, to XL Capital Ltd, its minority interest owner.

Additional Capital Resources

FSA's primary uses of funds are to pay operating expenses and to pay dividends to, or pay interest or principal on surplus notes held by, its parent. FSA's funds
are also required to satisfy claims under insurance policies in the event of default by an issuer of an insured obligation and the unavailability or exhaustion of other payment sources in the
transaction, such as the cash flow or collateral underlying the obligations. FSA seeks to structure asset-backed transactions to address liquidity risks by matching insured payments with available
cash flow or other payment sources. The insurance policies issued by FSA provide, in general, that payments of principal, interest and other amounts insured by FSA may not be accelerated by the holder
of the obligation but are paid by FSA in accordance with the obligation's original payment schedule or, at FSA's option, on an accelerated basis. These policy provisions prohibiting acceleration of
certain claims are mandatory under Article 69 of the New York Insurance Law and serve to reduce FSA's liquidity requirements.

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Management
believes that the Company's expected operating liquidity needs, on both a short- and long-term basis, can be funded from its operating cash flow. In addition, the Company has
a number of sources of liquidity that are available to pay claims on a short- and long-term basis: cash flow from premiums written, FSA's investment portfolio and earnings thereon, reinsurance
arrangements with third-party reinsurers, new borrowings through its financial products segment, liquidity lines of credit with banks, and capital market transactions.

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

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

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

FSA-insured
GICs subject the Company to risk associated with unexpected withdrawals of principal allowed by the terms of the GICs. The majority of municipal GICs insured by FSA relate to
debt service reserve funds and construction funds in support of municipal bond transactions. Debt service reserve fund GICs may be drawn unexpectedly upon a payment default by the municipal issuer.
Construction fund GICs may be drawn unexpectedly when construction of the underlying municipal project does not proceed as expected. In addition, most FSA-insured GICs allow for withdrawal of GIC
funds in the event of a downgrade of FSA, typically below Aa3 by Moody's or AA- by S&P, unless the GIC provider posts collateral or otherwise enhances its credit. Some FSA-insured GICs also allow for
withdrawal of GIC funds in the event of a downgrade of FSA below A3 by Moody's or A- by S&P with no right of the GIC provider to avoid such withdrawal by posting collateral or otherwise enhancing its
credit. The Company manages this risk through the maintenance of liquid collateral and bank liquidity facilities.

FSA
Asset Management LLC ("FSAM") has a $100.0 million line of credit with UBS Loan Finance LLC, which expires December 9, 2005, unless extended. This line of credit provides an
additional source of liquidity should there be unexpected draws on GICs issued by the GIC Subsidiaries. There were no borrowings under this arrangement at December 31, 2004.

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Capital Adequacy

S&P, Moody's and Fitch Ratings periodically assess the credits insured by FSA, and the reinsurers and other providers of capital support to FSA, to confirm that
FSA continues to satisfy the rating agencies' capital adequacy criteria necessary to maintain FSA's Triple-A ratings. Capital adequacy assessments by the rating agencies are generally based on FSA's
qualified statutory capital, which is the aggregate of policyholders' surplus and contingency reserves determined in accordance with statutory accounting principles.

In
the case of S&P, assessments of the credits insured by FSA are reflected in defined "capital charges," which are reduced by reinsurance and collateral to the extent "credit" is
allowed for such reinsurance and collateral. Credit provided for reinsurance under the S&P capital adequacy model is generally a function of the S&P rating of the reinsurer providing the reinsurance,
as well as any collateral provided by the reinsurer. Capital charges on outstanding insured transactions and reinsurer ratings are subject to change by S&P at any time. In recent years, a number of
Triple-A-rated reinsurers employed by FSA have been downgraded by S&P. Downgrade of these reinsurers by S&P to the Double-A category resulted in a decline in the credit allowed for reinsurance by S&P
from 100% to 70% or 65% under present criteria. While a downgrade by S&P of all reinsurers to the Double-A category would not impair FSA's Triple-A ratings, it would reduce the "margin of safety" by
which FSA would survive a theoretical catastrophic depression modeled by S&P. A reduction by S&P in credit for reinsurance used by FSA would also be expected ultimately to reduce the Company's return
on equity to the extent that ceding commissions paid to FSA by such reinsurers were not increased to compensate for such reduction. FSA employs considerable reinsurance in its business to manage its
single-risk exposures on insured credits. Any material increase in capital charges by S&P on FSA's insured portfolio would likewise be expected to have an adverse effect on FSA's margin of safety
under the S&P capital adequacy model and, ultimately, the Company's return on equity. The Company may seek to raise additional capital to replenish capital eliminated by any of the rating agencies and
their assessment of FSA's capital adequacy.

Capital
adequacy is one of the financial strength measures under Moody's financial guarantor model. The model includes a penalty for risk concentration and recognizes a benefit for
diversification. The published results reflect four metrics of financial strength relating to the insured portfolio's credit quality, correlation risk, concentration of risk and capital adequacy.
Moody's assesses capital adequacy by comparing FSA's claims-paying resources to a Moody's-derived probability of potential credit losses. Moody's loss distribution reflects FSA's current distribution
of risk by sector (asset-backed and municipal), the credit quality of insured exposures, correlations that exist between transactions, the credit quality of FSA's reinsurers, and the term to maturity
of FSA's insured portfolio. The published results compare levels of theoretical loss in the tail of this distribution to various measures of FSA's claims-paying resources.

Capital Expenditures

The Company plans to incur approximately $30 million, net of lease incentives, in capital expenditures through the second quarter of 2005 for leasehold
improvements, furniture and fixtures related to its new corporate headquarters. The Company expects to fund these capital expenditures out of cash flows from operations. For additional information see
"Item 2Properties."

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk.

Market risk represents the potential for loss due to adverse changes in the fair value of financial instruments caused by interest rate, foreign exchange rate or
equity price movements. The Company has exposure to market risk in (1) its insurance company assets and other investments (the "Investment Portfolio"), (2) the financial products
business, which is driven by interest spreads, and (3) its portfolio of insured CDS.

59

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Investment Portfolio

Over 95% of the Investment Portfolio was invested in fixed-income securities at December 31, 2004. Changes in interest rates affect the value of the Company's
fixed-income portfolio. As interest rates rise, the fair value of fixed-income securities decreases.

Management's
primary objective in managing the Company's Investment Portfolio is to generate an optimal level of after-tax investment income while preserving capital and maintaining
adequate liquidity, subject to rating agency capital adequacy criteria that apply discount factors to investments based on their ratings. The Company bases its investment strategies on many factors,
including the Company's tax position, anticipated changes in interest rates, regulatory and rating agency criteria and other market factors. One internal investment manager and two external investment
managers execute fixed-income investments on behalf of the Company. Management, with the approval of the board of directors, establishes the guidelines for investment decisions.

Sensitivity
to interest-rate movements can be estimated by projecting a hypothetical increase in interest rates of 1.0%. Based on market values and interest rates at year-end 2004, this
hypothetical increase in interest rates of 1.0% across the entire yield curve would result in an estimated after-tax decrease of $134.8 million in the net fair value of the Company's fixed-income
portfolio.

The
Company's Investment Portfolio holdings are primarily U.S. dollar-denominated fixed-income securities, including municipal bonds, U.S. government and agency bonds, and
mortgage-backed, asset-backed, corporate and foreign securities. In calculating the sensitivity to interest rates for the taxable securities, U.S. Treasury rates are changed instantaneously by 1.0%.
Tax-exempt securities are subjected to a change in the municipal Triple-A obligation curve that would be equivalent to a 1.0% taxable interest-rate change based on the average taxable/tax-exempt
ratios for the prior 12 months. The simulation for tax-exempts calculates duration by taking into account the applicable call date if the bond is at a premium or the maturity date if the bond is at a
discount.

Financial Products

FSAM manages the investments in the GIC Portfolio. The primary objectives in managing the GIC Portfolio are to generate a stable net interest margin, to maintain
liquidity and to optimize risk-adjusted returns.

The
assets and liabilities in the financial products segment are hedged using interest rate swaps or futures. A hypothetical increase in interest rates of 1% would result in a pre-tax
loss of $13.6 million (net of interest rate hedges) in the asset portfolio, partially offset by a pre-tax gain of $11.5 million in the liability portfolio (net of interest rate hedges). Since the
Company does not expect to trade these investments prior to maturity absent an unusually large demand for funds, it does not expect to recognize any material adverse impact to income or cash flows
under the above scenario. Under the above scenario, reported income and cash flows would be expected to increase due to higher yields on newly invested funds generated from earnings and run-off of the
outstanding investment portfolio.

The
GIC Portfolio consists primarily of U.S. dollar-denominated asset-backed securities, U.S. agency and government securities and mortgage-backed securities. FSAM generally converts all
fixed-rate
assets and liabilities to floating rates using hedging instruments. As interest rates change, and assuming a highly effective fair-value hedging arrangement, the change in value of the fixed-income
securities will be substantially offset by a similar but opposite change in value of the related hedging instruments.

FSA-insured
GICs subject the Company to risk associated with unexpected timing of withdrawal of principal allowed by the terms of the GICs. The majority of municipal GICs insured by FSA
relate to debt service reserve funds and construction funds in support of municipal bond transactions. Debt service reserve fund GICs may be drawn unexpectedly when the underlying bond issuance
suffers a debt service shortfall. Construction funds may experience withdrawal deviation when the underlying municipal project does not proceed as expected. In addition, most FSA-insured GICs allow
for withdrawal of GIC funds in

60

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the
event of a downgrade of FSA, typically below Aa3 by Moody's or AA- by S&P unless the GIC provider posts collateral or otherwise enhances its credit.

FSAM
also manages the investments in the VIE Portfolio, which are generally held until maturity. The VIE Portfolio is hedged against interest-rate risk.

Credit Default Swaps

Financial instruments that may be affected by changes in credit spreads include structured CDS contracts where the Company acts as a guarantor. Such contracts are
considered derivative instruments subject to fair value accounting under SFAS 133. Because the Company generally provides credit protection under such contracts, widening credit spreads will
have an adverse mark to fair value effect on the Company's Statements of Operations and Comprehensive Income while tightening credit spreads will have a positive effect. These contracts require the
Company to make payments upon the occurrence of certain defined credit events relating to underlying obligations (generally fixed-income obligations), which may be individual obligations or a pool of
obligations, subject to a deductible. These deductibles mitigate the risk of loss. If credit spreads of the underlying obligation(s) change, the fair value of the related structured CDS changes.
Changes in credit spreads are generally caused by changes in the market's perception of the credit quality of the underlying referenced obligations and by supply and demand factors that affect the
level of credit spreads generally.

Because
the portfolio of FSA-insured CDS is not traded, the Company has developed a series of asset credit spread algorithms to estimate fair value. These algorithms derive fair value
from several publicly available indices, depending on the types of assets referenced by the CDS.

To
estimate the income statement sensitivity to changes in CDS market premium rates, the Company has analyzed the historical credit spread data for each of the principal indices used to
determine fair value of the CDS portfolio (applicable to most but not all net CDS par outstanding) and, through statistical techniques, measured the historical volatility as a means to estimate future
performance.

Measuring
potential losses in fair value can be performed through the application of various statistical techniques. One such technique is Value at Risk ("VaR"), which is a summary
statistical measure that, in the Company's application, uses historical credit spread information by asset type to estimate the volatility and correlation of credit spread movements in order to
calculate a maximum loss that could occur over a defined period of time (three months) given a certain probability (95%).

Statistical
models alone do not provide a reliable method of monitoring and controlling market risk. Furthermore, the Company does not analyze the market sensitivity of its insured CDS
portfolio for purposes other than to quantify the potential exposure to quarterly accounting fair-value gain or loss. Management believes that each of the transactions for which it has provided CDS
protection contain significant protections against loss, and quarterly changes in credit spreads generally do not imply any fundamental change in future loss potential. The quantitative fair-value
risk information generated by a VaR model is limited by the methods, assumptions and parameters established in creating the model. In particular, the history of the relevant asset credit spread
information is relatively short and the insight gained by using such information to forecast potential future fair-value changes may therefore be limited.

The
application of the VaR model as of year-end 2004 resulted in a three-month maximum change in fair value of $57 million at a 95% confidence level. Management does not believe that
this represents potential claim payments as the related CDS contracts are presumed to maintain their current high credit ratings. To the extent credit spreads widened at the same time underlying CDS
asset pools measurably deteriorated, the mark to fair value could be significantly more adverse than estimated.

The
net par outstanding that was not part of the above statistical analysis has a weighted average market premium rate of 10.4 basis points and an average life of 3.7 years. A
one-basis-point widening in credit spreads to an average of 11.4 basis points would produce a mark-to-market loss of $3.2 million. Historically, the quarterly change in credit spreads of this part of
the portfolio has not been greater than one basis point.

61

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Item 8.    Financial Statements and Supplementary Data.

Financial Security Assurance Holdings Ltd. and Subsidiaries  Index to Consolidated Financial Statements and Schedule

|                                                                                                                                                                          |  | Page
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----
|Report of Independent Registered Public Accounting Firm                                                                                                                   |  | 63  
|Consolidated Balance Sheets as of December 31, 2004 and 2003                                                                                                              |  | 64  
|Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2004, 2003 and 2002                                                       |  | 65  
|Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2004, 2003 and 2002                                                           |  | 66  
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2004, 2003 and 2002                                                                                |  | 67  
|Notes to Consolidated Financial Statements                                                                                                                                |  | 69  
|Schedule:                                                                                                                                                                 |  |     
|II Condensed Financial Statements of Financial Security Assurance Holdings Ltd. as of December 31, 2004 and 2003 and for the Years Ended December 31, 2004, 2003 and 2002 |  | 130 

62

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Report of Independent Registered Public Accounting Firm

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

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

As
discussed in Note 25 to the consolidated financial statements, the Company changed its method of accounting for its interest in certain variable interest entities.

/s/
PricewaterhouseCoopers LLP

---

PricewaterhouseCoopers LLP
New York, New York
March 23, 2005

63

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

|                                                                                                             |                                                                  | December 31,
2004                                 |            | December 31,
2003 |        
|------------------------------------------------------------------------------------------------------------ | ---------------------------------------------------------------- | ------------------------------------------------- | ---------- | ----------------- | -------
|ASSETS                                                                                                       |                                                                  |                                                   |            |                   |        
|Bonds at fair value (amortized cost of $3,662,584 and $3,275,310)                                            |                                                                  | $                                                 | 3,914,763  |                   | $      
|Equity securities at fair value (cost of $54,300)                                                            |                                                                  |                                                   | 54,300     |                   |        
|Short-term investments                                                                                       |                                                                  |                                                   | 321,071    |                   |        
|Variable interest entities' bonds at fair value (amortized cost of $1,346,109 and $1,423,657)                |                                                                  |                                                   | 1,346,355  |                   |        
|Variable interest entities' short-term investment portfolio                                                  |                                                                  |                                                   | 1,194      |                   |        
|Financial products bond portfolio at fair value (amortized cost of $7,914,471 and $4,033,979)                |                                                                  |                                                   | 7,925,072  |                   |        
|Financial products bond portfolio pledged as collateral at fair value (amortized cost of $5,908 and $70,358) |                                                                  |                                                   | 5,913      |                   |        
|Financial products short-term investment portfolio                                                           |                                                                  |                                                   | 268,125    |                   |        
|                                                                                                             |                                                                  |                                                   |            |                   |        
|                                                                                                             | Total investment portfolio                                       |                                                   |            | 13,836,793        |        
|Assets acquired in refinancing transactions:                                                                 |                                                                  |                                                   |            |                   |        
|                                                                                                             | Bonds at fair value (amortized cost of $151,895)                 |                                                   |            | 157,036           |        
|                                                                                                             | Securitized loans                                                |                                                   |            | 371,092           |        
|                                                                                                             | Other                                                            |                                                   |            | 224,908           |        
|                                                                                                             |                                                                  |                                                   |            |                   |        
|                                                                                                             |                                                                  | Total assets acquired in refinancing transactions |            |                   | 753,036
|Cash                                                                                                         |                                                                  |                                                   | 14,353     |                   |        
|Deferred acquisition costs                                                                                   |                                                                  |                                                   | 308,015    |                   |        
|Prepaid reinsurance premiums                                                                                 |                                                                  |                                                   | 759,191    |                   |        
|Investment in unconsolidated affiliates                                                                      |                                                                  |                                                   | 49,645     |                   |        
|Reinsurance recoverable on unpaid losses                                                                     |                                                                  |                                                   | 35,419     |                   |        
|Other assets                                                                                                 |                                                                  |                                                   | 1,324,355  |                   |        
|                                                                                                             |                                                                  |                                                   |            |                   |        
|                                                                                                             | TOTAL ASSETS                                                     |                                                   | $          | 17,080,807        |        
|                                                                                                             |                                                                  |                                                   |            |                   |        
|LIABILITIES AND MINORITY INTEREST AND
SHAREHOLDERS' EQUITY                                                   |                                                                  |                                                   |            |                   |        
|Deferred premium revenue                                                                                     |                                                                  | $                                                 | 2,095,423  |                   | $      
|Losses and loss adjustment expenses                                                                          |                                                                  |                                                   | 179,941    |                   |        
|Guaranteed investment contracts and variable interest entities' debt                                         |                                                                  |                                                   | 10,734,357 |                   |        
|Deferred federal income taxes                                                                                |                                                                  |                                                   | 216,619    |                   |        
|Notes payable                                                                                                |                                                                  |                                                   | 430,000    |                   |        
|Accrued expenses, minority interest and other liabilities                                                    |                                                                  |                                                   | 874,510    |                   |        
|                                                                                                             |                                                                  |                                                   |            |                   |        
|                                                                                                             | TOTAL LIABILITIES AND MINORITY INTEREST                          |                                                   |            | 14,530,850        |        
|                                                                                                             |                                                                  |                                                   |            |                   |        
|COMMITMENTS AND CONTINGENCIES                                                                                |                                                                  |                                                   |            |                   |        
|Common stock (200,000,000 shares authorized; 33,517,995 issued; par value of $.01 per share)                 |                                                                  |                                                   | 335        |                   |        
|Additional paid-in capitalcommon                                                                            |                                                                  |                                                   | 900,215    |                   |        
|Accumulated other comprehensive income (net of deferred income taxes of $91,926 and $76,041)                 |                                                                  |                                                   | 177,796    |                   |        
|Accumulated earnings                                                                                         |                                                                  |                                                   | 1,471,611  |                   |        
|Deferred equity compensation                                                                                 |                                                                  |                                                   | 23,528     |                   |        
|Less treasury stock at cost (297,276 and 297,658 shares held)                                                |                                                                  |                                                   | (23,528    | )                 |        
|                                                                                                             |                                                                  |                                                   |            |                   |        
|                                                                                                             | TOTAL SHAREHOLDERS' EQUITY                                       |                                                   |            | 2,549,957         |        
|                                                                                                             |                                                                  |                                                   |            |                   |        
|                                                                                                             | TOTAL LIABILITIES AND MINORITY INTEREST AND SHAREHOLDERS' EQUITY |                                                   | $          | 17,080,807        |        
|                                                                                                             |                                                                  |                                                   |            |                   |        

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

64

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

|                                                                      |                                                                                                                                      | Year Ended December 31, |        
|--------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------ | ----------------------- | -------
|
|REVENUES:                                                             |                                                                                                                                      |                         |        
|                                                                      | Net premiums written                                                                                                                 |                         | $      
|                                                                      |                                                                                                                                      |                         |        
|                                                                      | Net premiums earned                                                                                                                  |                         | $      
|                                                                      | Net investment income                                                                                                                |                         |        
|                                                                      | Net realized gains (losses)                                                                                                          |                         |        
|                                                                      | Net interest income from financial products and variable interest entities                                                           |                         |        
|                                                                      | Financial products net realized gains (losses)                                                                                       |                         |        
|                                                                      | Net realized and unrealized gains (losses) on derivative instruments                                                                 |                         |        
|                                                                      | Income from assets acquired in refinancing transactions                                                                              |                         |        
|                                                                      | Other income                                                                                                                         |                         |        
|                                                                      |                                                                                                                                      |                         |        
|TOTAL REVENUES                                                        |                                                                                                                                      |                         | 796,504
|EXPENSES:                                                             |                                                                                                                                      |                         |        
|                                                                      | Losses and loss adjustment expenses                                                                                                  |                         |        
|                                                                      | Interest expense                                                                                                                     |                         |        
|                                                                      | Policy acquisition costs                                                                                                             |                         |        
|                                                                      | Net interest expense from financial products and variable interest entities                                                          |                         |        
|                                                                      | Other operating expenses                                                                                                             |                         |        
|                                                                      |                                                                                                                                      |                         |        
|TOTAL EXPENSES                                                        |                                                                                                                                      |                         | 320,513
|                                                                      |                                                                                                                                      |                         |        
|Minority interest                                                     |                                                                                                                                      |                         | (7,210 
|Equity in earnings (losses) of unconsolidated affiliates              |                                                                                                                                      |                         | (3,339 
|                                                                      |                                                                                                                                      |                         |        
|INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE |                                                                                                                                      |                         | 465,442
|Provision (benefit) for income taxes:                                 |                                                                                                                                      |                         |        
|                                                                      | Current                                                                                                                              |                         |        
|                                                                      | Deferred                                                                                                                             |                         |        
|                                                                      |                                                                                                                                      |                         |        
|                                                                      | Total provision                                                                                                                      |                         |        
|                                                                      |                                                                                                                                      |                         |        
|INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE                  |                                                                                                                                      |                         | 363,784
|Cumulative effect of accounting change, net of income taxes of $2,598 |                                                                                                                                      |                         |       
|                                                                      |                                                                                                                                      |                         |        
|NET INCOME                                                            |                                                                                                                                      |                         | 363,784
|OTHER COMPREHENSIVE INCOME, NET OF TAX:                               |                                                                                                                                      |                         |        
|                                                                      | Unrealized gains arising during period (net of deferred income tax provision of $16,122, $11,049 and $44,750)                        |                         |        
|                                                                      | Less: reclassification adjustment for gains included in net income (net of deferred income tax provision of $237, $1,278 and $7,874) |                         |        
|                                                                      |                                                                                                                                      |                         |        
|                                                                      | Other comprehensive income                                                                                                           |                         |        
|                                                                      |                                                                                                                                      |                         |        
|COMPREHENSIVE INCOME                                                  |                                                                                                                                      | $                       | 394,147
|                                                                      |                                                                                                                                      |                         |        

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

65

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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES    CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY    (in thousands)

|                                                                                                     |  | Common
Stock |     | Additional
Paid-In
Capital-
Common |   | Unrealized
Gain
on
Investments |   | Accumulated
Earnings |         | Deferred
Equity
Compensation |   | Treasury
Stock |   | Total |       
|---------------------------------------------------------------------------------------------------- |  | ------------ | --- | ---------------------------------- | - | ------------------------------ | - | -------------------- | ------- | ---------------------------- | - | -------------- | - | ----- | ------
|BALANCE, December 31, 2001                                                                           |  | $            | 335 |                                    | $ | 903,494                        |   | $                    | 62,966  |                              | $ | 669,163        |   | $     | 23,716
|Net income for the year                                                                              |  |              |     |                                    |   |                                |   |                      |         |                              |   | 181,075        |   |       |       
|Net change in accumulated other comprehensive income (net of deferred income tax expense of $36,876) |  |              |     |                                    |   |                                |   |                      | 71,717  |                              |   |                |   |       |       
|Dividends paid on common stock                                                                       |  |              |     |                                    |   |                                |   |                      |         |                              |   | (20,380        | ) |       |       
|Deferred equity payout                                                                               |  |              |     |                                    |   |                                |   |                      |         |                              |   |                |   |       | (271  
|                                                                                                     |  |              |     |                                    |   |                                |   |                      |         |                              |   |                |   |       |       
|BALANCE, December 31, 2002                                                                           |  |              | 335 |                                    |   | 903,494                        |   |                      | 134,683 |                              |   | 829,858        |   |       | 23,445
|Net income for the year                                                                              |  |              |     |                                    |   |                                |   |                      |         |                              |   | 290,586        |   |       |       
|Net change in accumulated other comprehensive income (net of deferred income tax expense of $9,771)  |  |              |     |                                    |   |                                |   |                      | 12,750  |                              |   |                |   |       |       
|Capital issuance costs                                                                               |  |              |     |                                    |   | (3,605                         | ) |                      |         |                              |   |                |   |       |       
|Capital contribution                                                                                 |  |              |     |                                    |   | 335                            |   |                      |         |                              |   |                |   |       |       
|                                                                                                     |  |              |     |                                    |   |                                |   |                      |         |                              |   |                |   |       |       
|BALANCE, December 31, 2003                                                                           |  |              | 335 |                                    |   | 900,224                        |   |                      | 147,433 |                              |   | 1,120,444      |   |       | 23,445
|Net income for the year                                                                              |  |              |     |                                    |   |                                |   |                      |         |                              |   | 363,784        |   |       |       
|Net change in accumulated other comprehensive income (net of deferred income tax expense of $15,885) |  |              |     |                                    |   |                                |   |                      | 30,363  |                              |   |                |   |       |       
|Capital issuance costs                                                                               |  |              |     |                                    |   | (1,260                         | ) |                      |         |                              |   |                |   |       |       
|Capital contribution                                                                                 |  |              |     |                                    |   | 1,251                          |   |                      |         |                              |   |                |   |       |       
|Dividends paid on common stock                                                                       |  |              |     |                                    |   |                                |   |                      |         |                              |   | (22,876        | ) |       |       
|Deferred equity payout                                                                               |  |              |     |                                    |   |                                |   |                      |         |                              |   |                |   |       | 83    
|Other                                                                                                |  |              |     |                                    |   |                                |   |                      |         |                              |   | 10,259         |   |       |       
|                                                                                                     |  |              |     |                                    |   |                                |   |                      |         |                              |   |                |   |       |       
|BALANCE, December 31, 2004                                                                           |  | $            | 335 |                                    | $ | 900,215                        |   | $                    | 177,796 |                              | $ | 1,471,611      |   | $     | 23,528
|                                                                                                     |  |              |     |                                    |   |                                |   |                      |         |                              |   |                |   |       |       

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

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

|                                       |                                                                                  | Years Ended December 31, |           
|-------------------------------------- | -------------------------------------------------------------------------------- | ------------------------ | ----------
|
|Cash flows from operating activities:  |                                                                                  |                          |           
|                                       | Premiums received, net                                                           |                          | $         
|                                       | Policy acquisition and other operating expenses paid, net                        |                          |           
|                                       | Termination fee on derivatives                                                   |                          |           
|                                       | Recoverable advances recovered (paid)                                            |                          |           
|                                       | Losses and loss adjustment expenses paid, net                                    |                          |           
|                                       | Net investment income received                                                   |                          |           
|                                       | Federal income taxes paid                                                        |                          |           
|                                       | Interest paid on notes                                                           |                          |           
|                                       | Interest paid on guaranteed investment contracts                                 |                          |           
|                                       | Interest received on guaranteed investment contracts portfolio                   |                          |           
|                                       | Variable interest entities' interest paid                                        |                          |           
|                                       | Variable interest entities' net interest income received                         |                          |           
|                                       | Income received from refinanced assets                                           |                          |           
|                                       | Other                                                                            |                          |           
|                                       |                                                                                  |                          |           
|                                       | Net cash provided by operating activities                                        |                          |           
|                                       |                                                                                  |                          |           
|Cash flows from investing activities:  |                                                                                  |                          |           
|                                       | Proceeds from sales and maturities of bonds                                      |                          |           
|                                       | Purchases of bonds                                                               |                          |           
|                                       | Net (increase) decrease in short-term investments                                |                          |           
|                                       | Proceeds from sales and maturities of guaranteed investment contract bonds       |                          |           
|                                       | Purchases of guaranteed investment contract bonds                                |                          |           
|                                       | Securities purchased under agreements to resell                                  |                          |           
|                                       | Net (increase) decrease in guaranteed investment contract short-term investments |                          |           
|                                       | Purchases of variable interest entities' bonds                                   |                          |           
|                                       | Maturities of variable interest entities' bonds                                  |                          |           
|                                       | Net decrease in variable interest entities' short-term investments               |                          |           
|                                       | Purchases of property, plant and equipment                                       |                          |           
|                                       | Assets acquired through refinancing transactions                                 |                          |           
|                                       | Other investments                                                                |                          |           
|                                       |                                                                                  |                          |           
|Net cash used for investing activities |                                                                                  |                          | (4,117,159
|                                       |                                                                                  |                          |           
|Cash flows from financing activities:  |                                                                                  |                          |           
|                                       | Issuance of notes payable                                                        |                          |           
|                                       | Repayment of notes payable                                                       |                          |           
|                                       | Distribution to minority shareholder                                             |                          |           
|                                       | Dividends paid                                                                   |                          |           
|                                       | Securities sold under repurchase agreements                                      |                          |           
|                                       | Proceeds from issuance of guaranteed investment contracts                        |                          |           
|                                       | Repayment of guaranteed investment contracts                                     |                          |           
|                                       | Proceeds from issuance of variable interest entities' debt                       |                          |           
|                                       | Repayment of variable interest entities' debt                                    |                          |           
|                                       | Capital issuance costs                                                           |                          |           
|                                       | Repayment of variable interest entities' preferred stock                         |                          |           
|                                       |                                                                                  |                          |           
|                                       | Net cash provided by financing activities                                        |                          |           
|                                       |                                                                                  |                          |           
|Net (decrease) increase in cash        |                                                                                  |                          | (5,107    
|Cash at beginning of year              |                                                                                  |                          | 19,460    
|                                       |                                                                                  |                          |           
|Cash at end of year                    |                                                                                  | $                        | 14,353    
|                                       |                                                                                  |                          |           

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

67

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

|                                                                                                  |  | Year Ended December 31, |        
|------------------------------------------------------------------------------------------------- |  | ----------------------- | -------
|
|Reconciliation of net income to net cash flows from operating activities:                         |  |                         |        
|Net income                                                                                        |  | $                       | 363,784
|Increase in accrued investment income                                                             |  |                         | (15,976
|Increase in deferred premium revenue and related foreign exchange adjustment                      |  |                         | 169,670
|Increase in deferred acquisition costs                                                            |  |                         | (34,369
|Increase (decrease) in current federal income taxes payable                                       |  |                         | 7,528  
|Increase (decrease) in unpaid losses and loss adjustment expenses, net of reinsurance recoverable |  |                         | (29,651
|Increase (decrease) in amounts withheld for others                                                |  |                         |       
|Provision (benefit) for deferred income taxes                                                     |  |                         | 48,087 
|Net realized losses (gains) on investments                                                        |  |                         | (844   
|Depreciation and accretion of discount                                                            |  |                         | 29,639 
|Minority interest and equity in earnings of unconsolidated affiliates                             |  |                         | 10,549 
|Change in other assets and liabilities                                                            |  |                         | 4,397  
|                                                                                                  |  |                         |        
|Cash provided by operating activities                                                             |  | $                       | 552,814
|                                                                                                  |  |                         |        

On
July 1, 2003, the Company consolidated $1.9 billion in assets and $1.9 billion in liabilities relating to variable interest entities with no corresponding cash movement. The Company
received tax benefits of $1.2 million in 2004 and $0.3 million in 2003 from its parent company, which were recorded as capital contributions. See Note 10 for disclosure of non-cash
transactions relating to restricted treasury stock transactions.

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

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FINANCIAL SECURITY ASSURANCE HOLDINGS LTD. AND SUBSIDIARIES    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS    FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002

1.    ORGANIZATION AND OWNERSHIP

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

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

The
Company issues guaranteed investment contracts ("GICs") through wholly owned subsidiaries FSA Capital Management Services LLC ("FSACM"), FSA Capital Markets Services (Caymans) Ltd.
and, prior to April 2003, FSA Capital Markets Services LLC (collectively, the "GIC Subsidiaries"). FSACM has conducted substantially all of the Company's GIC business since April 2003, following the
receipt of an exemption from the requirements of the Investment Company Act of 1940. The GIC Subsidiaries lend the proceeds from their sales of GICs to FSA Asset Management LLC ("FSAM"), which invests
the funds, generally in obligations that qualify for FSA insurance. The GIC Subsidiaries and FSAM are collectively referred to as the "financial products segment."

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

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

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

On
July 5, 2000, the Company completed a merger in which Financial Security Assurance Holdings Ltd. ("FSA Holdings") became a direct subsidiary of Dexia Holdings, Inc., which, in turn,
is owned 90% by Dexia Crédit Local and 10% by Dexia S.A. ("Dexia"), a Belgian corporation whose shares are traded on the Euronext Brussels and Euronext Paris markets, as well as on the
Luxembourg Stock Exchange. Dexia Crédit Local is a wholly owned subsidiary of Dexia. At the merger date, each
outstanding share of the Company's common stock was converted into the right to receive $76.00 in cash. At December 31, 2004, Dexia Holdings, Inc. owned approximately 99% of the Company's outstanding
shares; the only other holders of the Company's common stock were an affiliate of White Mountains Insurance Group, Ltd. and certain current and former directors of the Company who owned shares of the
Company's common stock or economic interests therein under the Director Share Purchase Program (see Note 10).

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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



The consolidated financial statements include the accounts of FSA Holdings and its direct and indirect subsidiaries, principally including FSA, FSA Insurance
Company, Financial Security Assurance International Ltd. ("FSA International"), Financial Security Assurance (U.K.) Limited, the GIC Subsidiaries, FSAM, FSA Portfolio Management Inc., Transaction
Services Corporation, FSA Services (Australia) Pty Limited and FSA Services (Japan) Inc. (collectively, the "Subsidiaries"). The consolidated financial statements also include the accounts of certain
VIEs as described in Note 1. All intercompany accounts and transactions have been eliminated. Certain prior-year balances have been reclassified to conform to the 2004 presentation.



Investments in debt and equity securities designated as available for sale are carried at fair value. The unrealized gain or loss on the investments that are not
hedged is reflected as a separate component of

70

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shareholders'
equity, net of applicable deferred income taxes. The unrealized gain or loss on the investments that qualify as fair-value hedges is recorded in income currently.

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

Investments
in unconsolidated affiliates are based on the equity method of accounting (see Note 18). The Company records its share of unrealized gains or losses, net of applicable
deferred taxes, in other comprehensive income.



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

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

In
addition to insuring CDS agreements, the Company may, from time to time, enter into derivative instruments that have not been designated as hedges for accounting purposes. The Company
records these instruments at fair value with a corresponding adjustment to net realized and unrealized gains (losses) on derivative instruments in the Statements of Operations and Comprehensive
Income.

71

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Securities purchased under agreements to resell and securities sold under agreements to repurchase are accounted for as collateralized transactions and are
recorded at contract value plus accrued interest, subject to the provisions of Statement of Financial Accounting Standards No. 140, "Accounting for Transfer and Servicing of Financial Assets and
Extinguishment of Liabilities." It is the Company's policy to take possession of securities borrowed under agreements to resell.



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



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

Financial
guaranty as an industry has emerged over the past thirty years. Management believes that existing insurance accounting under Statement of Financial Accounting Standards No. 60,
"Accounting and Reporting by Insurance Enterprises" ("SFAS 60"), does not specifically address financial guaranty insurance. Accordingly, the accounting for loss and loss adjustment expenses within
the financial guaranty insurance industry has developed based on analogy to the most directly comparable elements of existing literature including sections of SFAS 60, Statement of Financial
Accounting Standards No. 5, "Accounting for Contingencies" ("SFAS 5") and Emerging Issues Task Force Issue 85-20, "Recognition of fees for guaranteeing a loan ("EITF 85-20").



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

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

Case
reserves for financial guaranty insurance companies differ from those of traditional property and casualty insurance companies. The primary difference is that traditional property
and casualty case reserves include only claims that have been incurred and reported to the insurance company. In a

72

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

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

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

The
Company establishes non-specific reserves on its entire portfolio of credits because management believes that a portfolio of insured obligations will deteriorate over its life and
that the existence of inherent loss can be proven statistically by data such as rating agency publications. The establishment of these reserves is a systematic process that considers this
quantitative, statistical information obtained primarily from Moody's Investors Service, Inc. ("Moody's") and Standard & Poor's Ratings Services ("S&P"), together with qualitative factors such as
overall credit quality trends resulting from economic and political conditions, recent loss experience in particular segments of the portfolio and changes in underwriting policies and procedures. The
factors used to establish reserves are evaluated periodically by comparing the statistically computed loss amount to the incurred losses as represented by case reserve activity to develop an
experience factor, which is updated and applied to future originations. The process results in management's best estimate of inherent losses associated with providing credit protection at each balance
sheet date.

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

73

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corporate
transactions, commercial real estate, and all other asset-backed transactions. The severity factors are derived from capital charge assessments provided by S&P. S&P capital charges project
loss levels by asset class and are incorporated into their capital adequacy stress scenario analysis.

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

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

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

Since
the non-specific reserve contains the inherent losses of the portfolio, when a case reserve adjustment is deemed appropriate, whether the result of adverse or positive credit
developments, accretion or the addition of a new case reserve, a full transfer is made between the non-specific reserve and the case reserve balances with no effect to income. The adequacy of the
non-specific reserve balance is reviewed periodically and at least annually based on a review of the Company's inception-to-date cumulative case based losses divided by the total
inception-to-date cumulative net par underwritten. This inception-to-date result is compared with the product of the non specific reserves divided by the net par outstanding as of the balance sheet
date. In the event that such ratios are not in line, then further analysis is performed to quantify appropriate adjustments that may be either income statement charges or benefits, as occurred in
2002, 2003 and 2004 as described in Note 16.

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

As of December 31,2004

2003Case reserve discount rate

3.13%5.90%

4.94%6.10%Non-specific reserve discount rate

1.20%7.95%

1.2%7.95%Current experience factor

2.0

2.4


74

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

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

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

In
January and February of 2005, the Securities and Exchange Commission ("SEC") staff discussed with financial guaranty industry participants, differences in loss recognition practices
among those participants. Based on discussions with the SEC staff, the Company understands that the Financial Accounting Standards Board ("FASB") staff is considering whether additional guidance
regarding financial guaranty insurance should be provided. When and if the FASB or SEC reach a conclusion on this issue, the Company and the rest of the financial guaranty industry may be required to
change some aspects of their loss reserving policies, and the potential changes could extend to premium and expense recognition. The Company cannot predict how the FASB or SEC will resolve this issue
and the resulting impact on its financial statements.

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



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

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The
Company does not defer acquisition costs relating to GICs issued by the GIC Subsidiaries, except for GIC commissions paid to third parties, which are included in other assets. The
amortization of these commissions is recorded in net interest expense from financial products and VIEs.



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



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



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

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

3.    INVESTMENTS

In addition to its insurance company and certain non-insurance subsidiaries' investments (the "Investment Portfolio"), the Company maintains investments from
proceeds of FSA-insured GICs (the "GIC Portfolio") and the portfolio of securities owned by the VIEs (the "VIE Portfolio"), and assets acquired in refinancing transactions (see Note 22).



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

Consolidated
net investment income attributable to the investment portfolio consisted of the following (in thousands):

Year Ended December 31,2004

2003

2002Bonds

$
171,736

$
153,544

$
138,095Equity investments








336Short-term investments


2,815


3,185


3,092Investment expenses


(2,500
)

(2,681
)

(2,403
)Net investment income

$
172,051

$
154,048

$
139,120


76

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The credit quality of bonds in the Investment Portfolio at December 31, 2004 was as follows:

|Rating(1) |  | Percent of Bonds |  
|--------- |  | ---------------- | -
|AAA       |  | 77.8             | %
|AA        |  | 19.7             |  
|A         |  | 2.5              |  
|          |  |                  |  
|          |  | 100.0            | %
|          |  |                  |  

---

Of
the bonds included in the Investment Portfolio, 12.9% were AAA by virtue of insurance provided by FSA. Without giving effect to the FSA guaranty, the weighted-average rating of the
FSA-insured investments was in the A+ range, and all of these investments were investment grade.

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

|                                                                                      |       | As of December 31, 2004
|------------------------------------------------------------------------------------- | ----- | -----------------------
|
|U.S. Treasury securities and obligations of U.S. government corporations and agencies |       | $                      
|Obligations of states and political subdivisions                                      |       |                        
|Mortgage-backed securities                                                            |       |                        
|Corporate securities                                                                  |       |                        
|Foreign securities                                                                    |       |                        
|Asset-backed securities                                                               |       |                        
|Short-term investments                                                                |       |                        
|                                                                                      |       |                        
|                                                                                      | Total |                        
|                                                                                      |       |                        

|                                                                                      |       | As of December 31, 2003
|------------------------------------------------------------------------------------- | ----- | -----------------------
|
|U.S. Treasury securities and obligations of U.S. government corporations and agencies |       | $                      
|Obligations of states and political subdivisions                                      |       |                        
|Mortgage-backed securities                                                            |       |                        
|Corporate securities                                                                  |       |                        
|Foreign                                                                               |       |                        
|Asset-backed securities                                                               |       |                        
|Short-term investments                                                                |       |                        
|                                                                                      |       |                        
|                                                                                      | Total |                        
|                                                                                      |       |                        

77

---



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

|                                                                                      |       | Less than 12 Months |         | 12 Months or More |   | Total  |       
|------------------------------------------------------------------------------------- | ----- | ------------------- | ------- | ----------------- | - | ------ | ------
|
|U.S. Treasury securities and obligations of U.S. government corporations and agencies |       | $                   | 60,259  |                   | $ | (192   | )     
|Obligations of states and political subdivisions                                      |       |                     | 214,194 |                   |   | (1,266 | )     
|Mortgage-backed securities                                                            |       |                     | 32,701  |                   |   | (304   | )     
|Corporate securities                                                                  |       |                     | 29,146  |                   |   | (162   | )     
|Foreign securities                                                                    |       |                     | 1,722   |                   |   | (39    | )     
|Asset-backed securities                                                               |       |                     | 16,279  |                   |   | (71    | )     
|                                                                                      |       |                     |         |                   |   |        |       
|                                                                                      | Total |                     | $       | 354,301           |   | $      | (2,034
|                                                                                      |       |                     |         |                   |   |        |       

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

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

|                                                                |       | Amortized
Cost |           | Fair Value
|--------------------------------------------------------------- | ----- | -------------- | --------- | ----------
|Due in one year or less                                         |       | $              | 376,156   |           
|Due after one year through five years                           |       |                | 542,572   |           
|Due after five years through ten years                          |       |                | 517,956   |           
|Due after ten years                                             |       |                | 2,269,926 |           
|Mortgage-backed securities (stated maturities of 1 to 40 years) |       |                | 220,202   |           
|Asset-backed securities (stated maturities of 1 to 35 years)    |       |                | 56,843    |           
|                                                                |       |                |           |           
|                                                                | Total |                | $         | 3,983,655 
|                                                                |       |                |           |           

Proceeds
from sales of bonds for the investment portfolio during 2004, 2003 and 2002 were $770.5 million, $948.3 million and $772.0 million, respectively. Gross gains of $5.2
million, $12.6 million and $30.5 million and gross losses of $5.7 million, $7.5 million and $1.3 million were realized on sales in 2004, 2003 and 2002, respectively.

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

78

---





Net investment income for the GIC Portfolio consisted of the following (in thousands):

Year Ended December 31,2004

2003

2002Interest from hedges

$
(29,679
)
$
(17,029
)
$
(13,182
)Bonds


137,548


59,271


39,517Short-term investments


3,499


4,430


1,494Net SFAS 133 adjustment


(5,861
)

(11,660
)

(568
)Net interest income

$
105,507

$
35,012

$
27,261


The
credit quality of bonds held in the GIC Portfolio at December 31, 2004 was as follows:

Rating(1)

Percent of BondsAAA

81.5
%AA

9.0A

4.8Other

4.7Total

100.0
%


---

Of
the bonds included in the GIC Portfolio, 9.1% were AAA by virtue of insurance provided by FSA. Without giving effect to the FSA guaranty, the weighted-average rating of the
FSA-insured investments was in the Double-A range, and all of these investments were investment grade.

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

|December 31, 2004                                     |       | Amortized
Cost |           | Gross
Unrealized
Gains |   | Gross
Unrealized
Losses |        | Fair Value
|----------------------------------------------------- | ----- | -------------- | --------- | ---------------------- | - | ----------------------- | ------ | ----------
|Obligations of U.S. states and political subdivisions |       | $              | 734,211   |                        | $ | 8,755                   |        | $         
|Mortgage-backed securities                            |       |                | 2,143,894 |                        |   | 6,666                   |        |           
|Corporate securities                                  |       |                | 8,749     |                        |   | 5                       |        |           
|Asset-backed and other securities                     |       |                | 5,033,525 |                        |   | 2,594                   |        |           
|Short-term investments                                |       |                | 268,125   |                        |   |                        |        |           
|                                                      |       |                |           |                        |   |                         |        |           
|                                                      | Total |                | $         | 8,188,504              |   | $                       | 18,020 |           
|                                                      |       |                |           |                        |   |                         |        |           

|December 31, 2003                                     |       | Amortized
Cost |           | Gross
Unrealized
Gains |   | Gross
Unrealized
Losses |       | Fair Value
|----------------------------------------------------- | ----- | -------------- | --------- | ---------------------- | - | ----------------------- | ----- | ----------
|Obligations of U.S. states and political subdivisions |       | $              | 344,552   |                        | $ | 190                     |       | $         
|Mortgage-backed securities                            |       |                | 209,284   |                        |   | 829                     |       |           
|Corporate securities                                  |       |                | 18,829    |                        |   | 110                     |       |           
|Asset-backed securities                               |       |                | 3,531,672 |                        |   | 4,257                   |       |           
|Short-term investments                                |       |                | 228,812   |                        |   |                        |       |           
|                                                      |       |                |           |                        |   |                         |       |           
|                                                      | Total |                | $         | 4,333,149              |   | $                       | 5,386 |           
|                                                      |       |                |           |                        |   |                         |       |           

79

---



The following table shows the gross unrealized losses and fair value for the GIC Portfolio, aggregated by investment category and length of time that individual securities have been in a
continuous unrealized loss position, at December 31, 2004 (in thousands):

|                                                      |       | Less than 12 Months |         | 12 Months or More |   | Total  |       
|----------------------------------------------------- | ----- | ------------------- | ------- | ----------------- | - | ------ | ------
|
|Obligations of U.S. states and political subdivisions |       | $                   | 154,349 |                   | $ | (2,823 | )     
|Mortgage-backed securities                            |       |                     | 578,852 |                   |   | (1,037 | )     
|Asset-backed securities                               |       |                     | 967,384 |                   |   | (1,704 | )     
|                                                      |       |                     |         |                   |   |        |       
|                                                      | Total |                     | $       | 1,700,585         |   | $      | (5,564
|                                                      |       |                     |         |                   |   |        |       

The
Company periodically monitors the GIC Portfolio for individual investments in an unrealized loss position in order to assess whether that investment is considered
other-than-temporarily impaired. In each case, the Company determines the nature and cause of the decline and whether the Company maintains the ability and intent to hold the security until the
unrealized loss may reverse or until maturity. At December 31, 2004, there were 14 securities that were in an unrealized loss position for a continuous 12-month period or longer. None of the 14
securities had an unrealized loss that exceeded book value by 14% at December 31, 2004. At December 31, 2004, the Company determined that no investments were considered other-than-temporarily
impaired.

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

|                                                                       |       | Amortized
Cost |           | Fair Value
|---------------------------------------------------------------------- | ----- | -------------- | --------- | ----------
|Due in one year or less                                                |       | $              | 276,874   |           
|Due after one year through five years                                  |       |                |          |           
|Due after five years through ten years                                 |       |                | 77,525    |           
|Due after ten years                                                    |       |                | 656,686   |           
|Mortgage-backed securities (stated maturities of 1 to 30 years)        |       |                | 2,143,894 |           
|Asset-backed and other securities (stated maturities of 3 to 40 years) |       |                | 5,033,525 |           
|                                                                       |       |                |           |           
|                                                                       | Total |                | $         | 8,188,504 
|                                                                       |       |                |           |           

Proceeds
from sales of bonds held in the GIC Portfolio during 2004, 2003 and 2002 were $91.7 million, $190.7 million and $274.1 million, respectively. Gross gains of $2.6 million were
realized on sales in 2004, offset by $0.4 million of unrealized losses on derivatives used to hedge the securities that were sold. Gross gains of $10.5 million were realized on sales in 2003,
offset by $11.5 million of unrealized losses on derivatives used to hedge the securities that were sold. Gross losses of $0.2 million were realized on sales in 2002.

80

---



4.     DEFERRED ACQUISITION COSTS

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

Year Ended December 31,2004

2003

2002Balance, beginning of period

$
273,646

$
253,777

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


(65,838
)

(73,943
)

(68,464
)Premium taxes


16,551


16,773


13,401Compensation and other acquisition costs


145,857


135,430


122,441Total


96,570


78,260


67,378Costs amortized during the period


(62,201
)

(58,391
)

(54,093
)Balance, end of period

$
308,015

$
273,646

$
253,777


5.     STATUTORY ACCOUNTING PRACTICES

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



81

---





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

Year Ended December 31,Net Income:2004

2003

2002GAAP BASIS

$
363,784

$
290,586

$
181,075Non-insurance companies net loss


10,043


30,354


1,704Premium revenue recognition


(80,169
)

(27,867
)

(19,624
)Losses and loss adjustment expenses incurred


3,889


21,813


20,585Deferred acquisition costs


(34,370
)

(19,868
)

(13,285
)Deferred income tax provision (benefit)


63,465


17,303


(23,888
)Current income tax


(18,706
)

(18,049
)

(8,162
)Change in fair value of derivatives


(56,927
)

(34,796
)

48,788VIE consolidation


(5,735
)

(5,120
)

Other


(3,193
)

8,588


7,895STATUTORY BASIS

$
242,081

$
262,944

$
195,088


As of December 31,Shareholders' Equity:2004

2003GAAP BASIS

$
2,549,957

$
2,168,436Non-insurance companies liabilities, net


149,829


139,209Premium revenue recognition


(290,204
)

(189,823
)Loss and loss adjustment expense reserves


96,380


109,237Deferred acquisition costs


(308,015
)

(273,646
)Contingency reserve


(1,099,462
)

(936,761
)Unrealized gain on investments


(258,677
)

(232,877
)Deferred income taxes


277,828


199,346Surplus notes


74,756


154,761Other


(10,971
)

29,615STATUTORY BASIS SURPLUS

$
1,181,421

$
1,167,497SURPLUS PLUS CONTINGENCY RESERVE

$
2,280,883

$
2,104,258


6.     FEDERAL INCOME TAXES

Dexia Holdings, Inc. ("Dexia Holdings") and the Company and its Subsidiaries, except FSA International, file a consolidated federal income tax return.

The
tax-sharing agreement provides that each member's tax benefit or expense is calculated on a separate return basis and that any credit or losses available to the Company be allocated
among the members based on each member's taxable income. At December 31, 2004 and 2003, the Company and its Subsidiaries received benefits from utilizing Dexia Holding's credits and losses of
$1.3 million and $0.3 million, respectively. These amounts have been recorded as capital contributions and reductions in amounts payable to Dexia Holdings in the financial statements.

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

82

---



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

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

In
connection with Dexia's acquisition of the Company in July 2000, the Company became the successor, for tax purposes, to White Mountains Holdings, Inc. ("WMH"). WMH had previously sold
an insurance subsidiary to a third party that was indemnified by White Mountains Insurance Group for certain future adverse loss development up to $50.0 million. In 2004, the Company made an indemnity
payment of $47.0 million to the third party with funds provided for such purpose by White Mountains Insurance Group. While the Company had no legal liability in connection with the indemnity payment,
the payment should be treated for tax purposes as a $47.0 million loss deduction to the Company, as successor to WMH. The Company therefore recorded a deferred tax asset with a corresponding deferred
tax benefit of $16.5 million. There can be no assurance that the deferred tax benefit will not be reversed in the future. In addition, under certain circumstances, which are not probable, the Company
expects to agree to share 50% of the deferred tax benefit with White Mountains Insurance Group.

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

As of December 31,2004

2003Deferred acquisition costs

$
95,736

$
85,441Deferred premium revenue adjustments


37,826


16,520Unrealized capital gains


92,771


76,886Contingency reserves


113,507


96,481Undistributed earnings


9,274


4,513Derivative fair-value adjustments


14,133


Other





2,008Total deferred federal income tax liabilities


363,247


281,849Loss and loss adjustment expense reserves


(35,540
)

(34,304
)Deferred compensation


(93,083
)

(89,182
)White Mountains indemnity payment


(16,450
)

Derivative fair-value adjustments





(5,717
)Other


(1,555
)

Total deferred federal income tax assets


(146,628
)

(129,203
)Net deferred federal income taxes liability

$
216,619

$
152,646


83

---



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

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

Year Ended December 31,2004

2003

2002Tax at statutory rate

35.0
%
35.0
%
35.0
%Tax-exempt investments

(8.9
)
(8.4
)
(16.4
)Income of foreign subsidiary

(1.4
)
(2.8
)
(2.5
)White Mountain indemnity payment

(3.5
)


Other

0.6

0.3

0.1Provision for income taxes

21.8
%
24.1
%
16.2
%


In
2002, the Company changed its method of accounting for taxes in respect of its equity in earnings of SPS Capital Holding Corp. ("SPS"), an unconsolidated affiliate of the Company (see
Note 18). Prior to 2002, the Company accounted for its equity earnings from SPS net of income tax at the statutory rate of 35%. Following a change in SPS's investors, the Company determined that it
would be appropriate to apply the 80% dividend-received deduction allowed by the Internal Revenue Service when accounting for the tax on its equity earnings from SPS, based on management's expectation
that it would realize its gain on such investment through dividend distributions rather than through sale of its investment. In 2002, the Company recorded a cumulative-to-date benefit of $4.0 million,
included in tax-exempt investments in the above reconciliation, relating to this change.

7.     DIVIDENDS AND CAPITAL REQUIREMENTS

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

8.     CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES

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

FSA
has a standby line of credit commitment in the amount of $325.0 million with a group of international banks to provide loans to FSA after it has incurred, during the term of the
facility, cumulative municipal losses (net of any recoveries) in excess of the greater of $325.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%, which amounted
to $1,067.0 million at December 31, 2004. The obligation to repay loans made under this agreement is a limited recourse obligation payable solely from, and collateralized by, a pledge of recoveries
realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This

84

---



commitment
has a term expiring on April 30, 2011 and contains an annual renewal provision subject to approval by the banks. No amounts have been utilized under this commitment as of December
31, 2004.

FSAM
has a $100.0 million line of credit with UBS Loan Finance LLC, which expires December 9, 2005, unless extended. This line of credit provides an additional source of liquidity should
there be unexpected draws on GICs issued by the GIC Subsidiaries. There were no borrowings under this agreement at December 31, 2004.

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

9.     LONG-TERM DEBT

On July 31, 2003, the Company issued $100.0 million principal amount of 5.60% Notes due July 15, 2103, which are callable without premium or penalty
in whole or in part at any time on or after July 31, 2008. Debt issuance costs of $3.3 million are being amortized over the life of the Notes. In September 2003, the Company called for
redemption, on November 1, 2003, $100.0 million of its 6.950% Senior Quarterly Income Debt Securities ("Senior QUIDS") due November 1, 2098 and delivered to the trustee sufficient collateral to
legally defease the 6.950% Senior QUIDS. Unamortized debt issuance costs of $3.2 million for the 6.950% Senior QUIDS were charged to interest expense in 2003. Subsequently, the trustee used the
defeasance collateral to redeem all of the 6.950% Senior QUIDS.

On
November 26, 2002, the Company issued $230.0 million principal amount of 6.25% Notes due November 1, 2102, which are callable without premium or penalty in whole or in
part at any time on or after November 26, 2007. Debt issuance costs of $7.4 million are being amortized over the life of the debt. The Company used a portion of the proceeds of this issuance to
redeem in whole the Company's $130.0 million principal amount of 7.375% Senior QUIDS due September 30, 2097. Unamortized debt issuance costs of the retired debt of $4.1 million were
charged to interest expense in 2002.

On
December 19, 2001, the Company issued $100.0 million of 67/8% Quarterly Income Bond Securities due December 15, 2101, which are callable without premium
or penalty on or after December 19, 2006. Debt issuance costs of $3.3 million are being amortized over the life of the debt.

10.   EMPLOYEE BENEFIT PLANS

The Company maintains both qualified and non-qualified non-contributory defined contribution pension plans for the benefit of eligible employees. Contributions
are based on a fixed percentage of employee compensation. Pension expense, which is funded annually, amounted to $5.8 million, $4.9 million and $5.1 million for the years ended
December 31, 2004, 2003 and 2002, respectively.

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

85

---



Performance shares are awarded under the 1993 Equity Participation Plan. The 1993 Equity Participation Plan authorizes the discretionary grant of performance shares by the Human
Resources Committee to key employees. The amount earned for each performance share depends on the attainment of certain growth rates of adjusted book value (or, in the case of performance shares
issued after January 1, 2001, growth rates of adjusted book value and book value) per outstanding share over a three-year period. At the election of the participant at the time of award, growth
rates may be determined including or excluding realized and unrealized gains and losses on the Investment Portfolio. No payout occurs if the compound annual growth rate of adjusted book value (or in
the case of performance shares issued after January 1, 2001, growth rates of adjusted book value and book value) per outstanding share is less than 7%, and a 200% payout occurs if the compound
annual growth rate is 19% or greater. Payout percentages are interpolated for compound annual growth rates between 7% and 19%.

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

Outstanding
at
Beginning of
Year

Granted
During
the Year

Earned
During
the Year

Forfeited
During the
Year

Outstanding
at
End of Year

Price per
Share
at Grant
Date2002

1,437,231

372,775

380,279

13,901

1,415,826

$
85.632003

1,415,826

342,845

464,778

13,261

1,280,632


92.722004

1,280,632

349,506

398,292

20,038

1,211,808


109.71


The
Company applies APB Opinion 25 and related Interpretations in accounting for its performance shares. The estimated final cost of these performance shares is accrued over the
performance period. The expense for the performance shares was $73.3 million, $63.1 million and $58.9 million for the years ended December 31, 2004, 2003 and 2002,
respectively.

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

In
the fourth quarter of 2000, the Company purchased 304,757 shares of its common stock from Dexia Holdings, Inc. for $24.0 million. In 2004, an additional 1,890 shares
were purchased for $0.3 million. This purchase was intended to fund obligations relating to the Company's Director Share Purchase Program ("DSPP"), which enables its participants to make deemed
investments in the Company's common stock under the DCP and SERP. Under the DSPP, the deemed investments in the Company's stock are irrevocable, settlement of the deemed investments must be in stock
and, after receipt, the participants must generally hold the stock for at least six months. In 2004 and 2002, $0.2 million and $0.3 million, respectively, of restricted treasury stock
was distributed to a director as a DSPP payout. No distribution was made in 2003.

11.   COMMITMENTS AND CONTINGENCIES

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

86

---



cancelable
operating leases, which expire at various dates through 2013. Future minimum rental payments are as follows (in thousands):

Year Ended December 31,2005

$
5,462.32006


7,579.72007


8,913.42008


8,156.12009


8,171.1Thereafter


114,367.5Total

$
152,650.1


Rent
expense was $7.8 million in 2004, $7.3 million in 2003 and $6.2 million in 2002.

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

12.   REINSURANCE

The Company obtains reinsurance to increase its policy-writing capacity on both an aggregate-risk and a single-risk basis; to meet rating agency, internal and
state insurance regulatory limits; to diversify risk; to reduce the need for additional capital; and to strengthen financial ratios. The Company reinsures portions of its risks with affiliated (see
Note 14) and unaffiliated reinsurers under quota share, first-loss and excess-of-loss treaties and on a facultative basis.

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

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

Year Ended December 31,2004

2003

2002Written premiums ceded

$
244,211

$
281,542

$
270,954Written premiums assumed


11,567


3,294


2,443Earned premiums ceded


161,733


159,350


134,093Earned premiums assumed


6,608


3,832


4,079Losses and loss adjustment expense payments ceded


52,372


16,993


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


16








As of December 31,2004

2003Principal outstanding ceded

$
116,687,760

$
96,571,216Principal outstanding assumed


2,134,427


1,935,306Deferred premium revenue ceded


759,191


695,398Deferred premium revenue assumed


17,823


13,060Losses and loss adjustment expense reserves ceded


35,419


59,235Losses and loss adjustment expense reserves assumed


553


592


87

---



13.   OUTSTANDING EXPOSURE AND COLLATERAL

The Company's policies insure the scheduled payments of principal and interest on asset-backed (including FSA-insured CDS) and municipal obligations. The gross
amount of financial guarantees in force (principal and interest) was $622.6 billion at December 31, 2004 and $558.2 billion at December 31, 2003. The net amount of financial guarantees
in force was $444.5 billion at December 31, 2004 and $403.1 billion at December 31, 2003.

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

|                   |       | As of December 31, 2004 |        | As of December 31, 2003
|------------------ | ----- | ----------------------- | ------ | -----------------------
|
|
|0 to 5 years       |       | $                       | 46,800 |                        
|5 to 10 years      |       |                         | 29,155 |                        
|10 to 15 years     |       |                         | 10,772 |                        
|15 to 20 years     |       |                         | 1,084  |                        
|20 years and above |       |                         | 34,539 |                        
|                   |       |                         |        |                        
|                   | Total |                         | $      | 122,350                
|                   |       |                         |        |                        

---

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

|                   |       | As of December 31, 2004 |        | As of December 31, 2003
|------------------ | ----- | ----------------------- | ------ | -----------------------
|
|
|0 to 5 years       |       | $                       | 21,662 |                        
|5 to 10 years      |       |                         | 6,909  |                        
|10 to 15 years     |       |                         | 2,228  |                        
|15 to 20 years     |       |                         | 1,373  |                        
|20 years and above |       |                         | 4,862  |                        
|                   |       |                         |        |                        
|                   | Total |                         | $      | 37,034                 
|                   |       |                         |        |                        

The
Company limits its exposure to losses from writing financial guarantees by underwriting investment-grade obligations, diversifying its portfolio and maintaining rigorous collateral
requirements on

88

---



asset-backed
obligations, as well as through reinsurance. The net par outstanding of insured obligations in the asset-backed insured portfolio includes the following amounts by type of collateral (in
millions):

|                               |                                | Net of Amounts
Ceded(1) as of
December 31, |        | Amounts
Ceded as of
December 31,
|------------------------------ | ------------------------------ | ------------------------------------------ | ------ | --------------------------------
|
|
|Residential mortgages          |                                | $                                          | 35,641 |                                 
|Consumer receivables           |                                |                                            | 9,540  |                                 
|Pooled corporate obligations   |                                |                                            | 68,340 |                                 
|Other asset-backed obligations |                                |                                            | 8,829  |                                 
|                               |                                |                                            |        |                                 
|                               | Total asset-backed obligations |                                            | $      | 122,350                         
|                               |                                |                                            |        |                                 

---

The
net par outstanding of insured obligations in the municipal insured portfolio includes the following amounts by type of issue (in millions):

|                                           |                             | Net Par Outstanding
as of December 31, |        | Ceded as of
December 31,
|------------------------------------------ | --------------------------- | -------------------------------------- | ------ | ------------------------
|
|
|General obligation bonds                   |                             | $                                      | 77,865 |                         
|Housing revenue bonds                      |                             |                                        | 7,628  |                         
|Municipal utility revenue bonds            |                             |                                        | 33,544 |                         
|Health care revenue bonds                  |                             |                                        | 9,261  |                         
|Tax-supported non-general obligation bonds |                             |                                        | 36,631 |                         
|Transportation revenue bonds               |                             |                                        | 12,834 |                         
|Other municipal bonds                      |                             |                                        | 17,629 |                         
|                                           |                             |                                        |        |                         
|                                           | Total municipal obligations |                                        | $      | 195,392                 
|                                           |                             |                                        |        |                         

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

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

89

---



municipalities
located therein issued an aggregate of 2% or more of the Company's net par amount outstanding (in millions) of insured municipal securities as of December 31, 2004:

State

Number of
Issues

Net Par Amount
Outstanding

Percent of Total
Municipal Net
Par Amount
Outstanding

Ceded Par
Amount
OutstandingCalifornia

934

$
26,501

13.6
%
$
8,897New York

622


17,917

9.2


9,362Texas

701


13,297

6.8


4,815Pennsylvania

704


12,276

6.3


3,418Florida

274


10,881

5.6


3,820Illinois

633


9,337

4.8


3,699New Jersey

548


9,053

4.6


4,176Washington

297


7,272

3.7


2,867Michigan

399


5,896

3.0


2,096Massachusetts

194


4,933

2.5


2,639Wisconsin

425


4,713

2.4


1,299Ohio

265


4,412

2.3


2,199Georgia

106


4,288

2.2


1,417All other U.S. jurisdictions

2,747


56,283

28.7


21,740International

85


8,333

4.3


7,210Total

8,934

$
195,392

100.0
%
$
79,654


14.   RELATED PARTY TRANSACTIONS

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

The
Subsidiaries earned premiums of $2.5 million and $5.0 million in the first half of 2003 and full year 2002, respectively, relating to the guarantees of debt issued or
assets purchased by FSA Global and Canadian Global. Inter-company premiums earned relating to VIEs have been eliminated in consolidation for periods subsequent to July 1, 2003.

The
Subsidiaries earned premiums of $28.0 million, $20.5 million and $17.3 million for the years ended December 31, 2004, 2003 and 2002, respectively, relating to business
with affiliates of Dexia. Deferred premium revenue relating to those transactions was $17.0 million and $6.9 million at December 31, 2004 and 2003, respectively. Gross par outstanding
relating to those transactions was $24.0 billion and $16.8 billion at December 31, 2004 and 2003, respectively. The Company also paid Dexia a fee of $0.7 million in 2003 and $3.3 million
in 2002 relating to business in which both Dexia and the Company were involved. For the years ended December 31, 2004, 2003 and 2002 the Company recorded pre-tax income (loss) of $97.6 million,
$52.9 million and $(3.7) million, respectively, relating to swaps where Dexia was the counterparty. At December 31, 2004 and 2003, the Company recorded other assets of $373.1 million and
other liabilities of $17.2 million, primarily relating to swaps where Dexia was the counterparty. In addition, at December 31, 2004 and 2003, the Company had $163.0 million and
$154.3 million in VIE debt, respectively, relating to debt issued by the Company and purchased by Dexia. During 2004 and 2003, the Company recorded $8.8 million and $3.3 million,
respectively, in VIE net interest expense relating to such debt.

90

---



15.   DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

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

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

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

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

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

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

For
notes payable, the carrying amount of notes payable represents the principal amount due at maturity. The fair value is based on the quoted market price.

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

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

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

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

91

---



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

|                               |                                                                                      | As of December 31, 2004 |   | As of December 31, 2003
|------------------------------ | ------------------------------------------------------------------------------------ | ----------------------- | - | -----------------------
|
|Assets:                        |                                                                                      |                         |   |                        
|                               | Bonds                                                                                |                         | $ | 3,914,763              
|                               | Equity securities                                                                    |                         |   | 54,300                 
|                               | Short-term investments                                                               |                         |   | 321,071                
|                               | FP bond portfolio                                                                    |                         |   | 7,925,072              
|                               | FP short-term investment portfolio                                                   |                         |   | 268,125                
|                               | FP bond portfolio pledged as collateral                                              |                         |   | 5,913                  
|                               | VIE bonds                                                                            |                         |   | 1,346,355              
|                               | VIE short-term investments                                                           |                         |   | 1,194                  
|                               | Cash                                                                                 |                         |   | 14,353                 
|                               | Assets acquired in refinancing transactions                                          |                         |   | 753,036                
|                               | Fair-value adjustments on derivatives                                                |                         |   | 638,016                
|                               | Receivable for investments sold                                                      |                         |   | 161                    
|Liabilities:                   |                                                                                      |                         |   |                        
|                               | Deferred premium revenue, net of prepaid reinsurance premiums                        |                         |   | 1,336,232              
|                               | Losses and loss adjustment expenses, net of reinsurance recoverable on unpaid losses |                         |   | 144,522                
|                               | GIC and VIE debt                                                                     |                         |   | 10,734,357             
|                               | Notes payable                                                                        |                         |   | 430,000                
|                               | Fair-value adjustments on derivatives                                                |                         |   | 6,224                  
|                               | Payable for investments purchased                                                    |                         |   | 262,033                
|Off-balance-sheet instruments: |                                                                                      |                         |   |                        
|                               | Installment premiums                                                                 |                         |   |                       

92

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16.   LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

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

Case Reserve Activity for the Year Ended2004

2003

2002(dollars in millions)Gross balance at January 1

$
121.9

$
134.0

$
45.4Less reinsurance recoverable


59.2


76.0


28.9Net balance at January 1


62.7


58.0


16.5Transfer from non-specific reserve


30.7


12.7


45.0Restructured transactions


(13.9
)

(2.2
)

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








Prior year


(34.3
)

(5.8
)

(3.5
)Total paid


(34.3
)

(5.8
)

(3.5
)Net balance at December 31


45.2


62.7


58.0Plus reinsurance recoverable


35.4


59.2


76.0Gross balance at December 31

$
80.6

$
121.9

$
134.0


Non-Specific Reserve Activity for the Year Ended2004

2003

2002(dollars in millions)Balance at January 1

$
111.5

$
89.7

$
69.1Provision for lossesCurrent year


20.4


22.4


21.1Prior year


0.2


12.1


44.5Transfers to case reserves


(30.7
)

(12.7
)

(45.0
)Restructured transactions


(2.1
)




Balance at December 31


99.3


111.5


89.7Total case and non-specific reserves

$
179.9

$
233.4

$
223.7


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

During
2004, the Company charged $20.6 million to loss expense, consisting of $25.0 million for originations of new business and $3.2 million related to
reassumptions of previously ceded business, offset by reserve releases primarily related to a large refinancing transaction in 2004. The non-specific reserves decreased $12.2 million in 2004,
primarily due to transfers from the non-specific reserve to the case reserves of $30.7 million offset by loss expense of $20.6 million. Case reserves decreased $17.5 million due
to (1) a large, voluntarily accelerated transaction that had a $34.3 million payment and (2) reclassifications from reserves to asset valuation accounts for refinanced
transactions of $13.9 million offset by transfers from the non-specific reserve of $30.7 million. (See Note 22.)

93

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In
September 2004, FSA exercised its rights to have the collateral of a defaulted collateralized bond obligation liquidated at a public sale, in which the Company offered the highest
bid. The Company acquired the collateral to gain control of the portfolio in order to mitigate future losses. The previously established case reserve was drawn down to reflect the excess of the
purchase amount over the fair value of the collateral. The remaining $9.5 million balance in the case reserve related to this transaction
was returned to the non-specific reserve. After reevaluating its requirements for the CDO portion of the non-specific reserve, the Company then reduced the non-specific reserve by $9.5 million,
which was partially offset by normal reserve additions. The net amount transferred from the case reserves to the non-specific reserve was $1.4 million, which also included a transfer from the
non-specific to the case reserves for a municipal utility transaction. The CDO portfolio continues to perform within the expectations reflected in previously recorded provisions for CDOs.

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

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

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

94

---



payments
of principal only at the ultimate maturity of such transactions. Application of this methodology resulted in recording $68.8 million in gross case reserves and $29.8 million in
reinsurance recoverable on unpaid losses, resulting in a $39.0 million increase in net case reserves in 2002. Management, beginning in the second quarter of 2002, has refined the loss factor it
applies to its net par underwritten when calculating the non-specific reserve in order to reflect its recent adverse experience. As a result, the non-specific reserve accrual for the year ended
December 31, 2002 was $65.6 million, rather than approximately $14.9 million that would have been accrued using the prior assumptions.

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

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

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

17.   QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

|     |                                                                       | First |   | Second  |   | Third |         | Fourth |   | Full Year
|---- | --------------------------------------------------------------------- | ----- | - | ------- | - | ----- | ------- | ------ | - | ---------
|
|2004 |                                                                       |       |   |         |   |       |         |        |   |          
|     | Gross premiums written                                                |       | $ | 189,521 |   | $     | 236,100 |        | $ | 198,171  
|     | Net premiums written                                                  |       |   | 116,494 |   |       | 166,581 |        |   | 148,831  
|     | Net premiums earned                                                   |       |   | 92,210  |   |       | 101,719 |        |   | 100,585  
|     | Net investment income                                                 |       |   | 41,077  |   |       | 41,555  |        |   | 43,684   
|     | Losses and loss adjustment expenses                                   |       |   | 7,700   |   |       | 7,665   |        |   | (4,263   
|     | Net realized and unrealized gains on derivative instruments           |       |   | 13,039  |   |       | 9,490   |        |   | 17,853   
|     | Income before income taxes                                            |       |   | 110,100 |   |       | 108,138 |        |   | 126,400  
|     | Net income                                                            |       | $ | 84,047  |   | $     | 83,205  |        | $ | 91,835   
|2003 |                                                                       |       |   |         |   |       |         |        |   |          
|     | Gross premiums written                                                |       | $ | 129,554 |   | $     | 294,832 |        | $ | 262,127  
|     | Net premiums written                                                  |       |   | 92,185  |   |       | 187,884 |        |   | 182,946  
|     | Net premiums earned                                                   |       |   | 80,090  |   |       | 88,158  |        |   | 95,460   
|     | Net investment income                                                 |       |   | 36,533  |   |       | 37,776  |        |   | 38,991   
|     | Losses and loss adjustment expenses                                   |       |   | 6,300   |   |       | 6,595   |        |   | 14,638   
|     | Net realized and unrealized gains (losses) on derivative instruments  |       |   | (225    | ) |       | 2,365   |        |   | 8,259    
|     | Income before income taxes and cumulative effect of accounting change |       |   | 83,760  |   |       | 88,763  |        |   | 81,851   
|     | Cumulative effect of accounting change, net of taxes                  |       |   |        |   |       |        |        |   | 4,800    
|     | Net income                                                            |       | $ | 65,825  |   | $     | 68,089  |        | $ | 66,081   

Certain
prior-quarter balances have been reclassified to conform to the year-end presentation.

95

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18.   EQUITY INVESTMENTS

The Company made equity investments in SPS Holding Corp. ("SPS") (formerly, Fairbanks Capital Holding Corp.) of $10.3 million and $13.4 million in 2004 and 2002,
respectively, and did not make any equity investments in 2003. At December 31, 2004, the Company had a 34.1% interest in SPS. The Company's investment in SPS is accounted for using the equity method
of accounting. Amounts recorded by the Company in connection with SPS at December 31, 2004, 2003 and 2002 were as follows (in thousands):

2004

2003

2002Investment in SPS

$
49,645

$
46,423

$
59,971Equity in earnings (losses) from SPS


(7,100
)

(13,548
)

13,795


At
December 31, 2004 and 2003, the Company's retained earnings included $4.0 million and $3.5 million, respectively, of accumulated undistributed earnings of SPS.

SPS's
business is subject to regulation, supervision and licensing by various federal, state and local authorities that have increased their focus on lending and servicing practices in
the sub-prime lending industry. In October 2002, the Federal Trade Commission (the "FTC") informed SPS that it was
investigating whether SPS's loan servicing or other practices violated the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, Section 5 of the Federal Trade Commission Act or other
laws enforced by the FTC. Certain of SPS's shareholders, including the Company, received civil investigative demands from the FTC relating to their investments in SPS and their knowledge of SPS's
servicing operations.

On
November 12, 2003, the FTC announced a settlement with SPS, resolving the FTC's civil allegations against SPS. Pursuant to that settlement, SPS paid $40.0 million to the FTC to
compensate consumers who suffered harm. The settlement enjoins SPS from future law violations and imposes new restrictions on SPS's business practices. A related settlement of numerous class action
lawsuits against SPS has been approved by a federal district court in Massachusetts. The $10.3 million additional equity investment in SPS funded a portion of the $40.0 million payment that was
required to be made to the FTC under the terms of the FTC's settlement agreement with SPS.

In
the third quarter of 2004, the Company determined that its $7.6 million of goodwill associated with its investment in SPS was impaired, and it charged that amount to income, as a
result of challenges encountered by SPS in acquiring new business, despite servicer ratings of "Average." While management believes book value approximates fair value, the Company will continue to
monitor the value of its investment in SPS. The Company and the other owners of SPS have entered into a binding Summary of Terms relating to the potential sale to an unaffiliated third party of their
respective interests in SPS pursuant to an option, exercisable on or before July 31, 2005. The sale is subject to several conditions, including, among other things, execution of definitive
agreements.

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

Until
the fourth quarter of 2004 this investment was accounted for using the equity method of accounting because the Company has significant influence over XLFA's operations. In the
second quarter

96

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

2004

2003

2002Equity securities

$
54,300



Investment in XLFA




64,440

52,206Equity in earnings from XLFA


3,761

19,077

9,145Dividends received from XLFA


12,003

6,640

6,665


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

19.   MINORITY INTEREST IN SUBSIDIARY

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

20.   GIC AND VIE DEBT

The obligations under GICs issued by the GIC Subsidiaries may be called at various times prior to maturity based on certain agreed-upon events. As of December 31,
2004, the interest rates on outstanding GICs were between 0.85% and 5.95% per annum and between 1.12% and 7.75% per annum on VIE debt. Payments due under GICs are based on expected withdrawal dates
and exclude hedge accounting adjustments and prepaid interest of $12.7 million and include accretion of $743.5 million. VIE debt includes $1,331.0 million of future interest accretion on zero coupon
obligations and excludes $272.2 million of hedge accounting adjustments. The following table presents (in millions) the combined principal amounts due under GICs and VIE debt for 2005 and each of the
next four years ending December 31, and thereafter:

Principal
Amount2005

$
2,883.32006


1,499.02007


1,153.62008


460.12009


940.1Thereafter


5,587.9Total

$
12,524.0


97

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21.   DERIVATIVE INSTRUMENTS



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

Changes
in the fair value of CDS, which were gains of $56.4 million and $34.8 million for the years ended December 31, 2004 and 2003, respectively, and losses of $50.2 million in 2002,
were recorded in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income. The Company included net par outstanding of
$66.0 billion and $63.8 billion relating to these CDS transactions at December 31, 2004 and December 31, 2003, respectively, in the asset-backed balances in Note 13. The gains or losses recognized by
recording these contracts at fair value are determined each quarter based on quoted market prices, if available. If quoted market prices are not available then the determination of fair value is based
on internally developed estimates. Management applies judgment when developing these estimates and considers factors such as current prices charged for similar agreements, performance of underlying
assets, changes in internal shadow ratings, the level at which the deductible has been set and the Company's ability to obtain reinsurance for its insured obligations. The Company does not believe
that the fair value adjustments are an indication of potential claims under FSA's guarantees. The average life of these contracts is 2.9 years. The inception to date gain (loss) on the CDS
portfolio was $46.6 million at December 31, 2004 and $(9.8) million at December 31, 2003.

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



The Company enters into derivative contracts designated as fair-value hedges, to manage interest-rate and foreign currency exposure in its GIC bond portfolio,
GICs, VIE debt and VIE Portfolio. The derivative contracts are recorded at fair value. These derivatives generally include interest-rate futures and interest-rate and currency swap agreements, which
are primarily utilized to convert fixed-rate debt and investments into U.S. dollar floating-rate debt and investments. The gains and losses relating to these fair-value hedges are included in net
interest income from financial products and VIEs and in net interest expense from financial products and VIEs, as appropriate, along with the offsetting change in fair value of the hedged item
attributable to the risk being hedged. The inception-to-date net unrealized loss on derivatives used to hedge the GIC liabilities and the financial products bond portfolio of $6.2 million and $14.2
million at December 31, 2004 and December 31, 2003, respectively, was recorded in accrued expenses and other liabilities. The inception-to-date net unrealized gain on the outstanding derivatives used
to hedge the VIE debt and VIE bond portfolio of $590.8 million and $407.7 million at December 31, 2004 and December 31, 2003, respectively, was recorded in other assets.

In
order for a derivative to qualify for hedge accounting, it must be highly effective at reducing the risks associated with the exposure being hedged. An effective hedge is defined as a
hedge that falls within an 80% to 125% correlation range. The difference between a perfect hedge (i.e., one that correlates exactly 100%) and the actual correlation within the 80% to 125% range is the
ineffective portion of the

98

---



hedge.
A failed hedge is one whose correlation falls outside of the 80% to 125% range. The table below presents the net gain (loss) related to the ineffective portion of the Company's fair value
hedges and net gain (loss) related to failed hedges (in millions).

2004

2003

2002Ineffective portion of fair value hedges

$
(2.1
)
$
0.6

$
(0.2
)Failed hedges


(3.4
)

5.0


4.3




The Company enters into various other derivative contracts that do not qualify for hedge accounting treatment under SFAS 133. These derivatives include swaptions,
caps and other derivatives and are used principally as economic hedges against interest-rate movements. Gains and losses on these derivatives are reflected in net realized and unrealized gains
(losses) on derivative instruments in the Statement of Operations and Comprehensive Income.

22.   REFINANCED TRANSACTIONS

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

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

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

As of December 31,2004

2003Assets acquired in refinancing transactionsSecuritized loans

$
371,092

$
440,611Bonds


157,036


Asset-backed senior notes


88,840


71,099Equity securities


15,659


Mortgage loans


77,462


Short-term investments


27,749


Other assets


15,198


(507
)Total

$
753,036

$
511,203


Securitized
loans are carried at cost, net of losses at the date of purchase. Income is recorded based on the effective yield method. The cash flows on the securitized loans, net of
reinsurance, are monitored and the effective yield modified to reflect any change in the cash flow estimate on a prospective basis (see Note 26). Since the notes represent 100% of the debt
capitalization of the trusts and since FSA maintains all the risk of further asset decline (except as provided by reinsurance) and maintains control
over key decisions regarding the trusts (such as removal of the servicer, sale of the assets and liquidation of the entity), the trusts were consolidated with FSA for accounting purposes. FSA also
consolidated the refinancing vehicles.

99

---



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

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

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

23.   SEGMENT REPORTING

The Company operates in two business segments: financial guaranty and financial products. The financial guaranty segment is primarily in the business of providing
financial guaranty insurance on asset-backed and municipal obligations. It also includes the results of the VIEs that were consolidated for the first time in the third quarter of 2003. The financial
products segment includes the GIC operations of the Company, which issues GICs to municipalities and other market participants. The GICs provide for the return of principal and the payment of interest
at a pre-specified rate. The following tables summarize the financial information (in thousands) by segment as of December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003 and
2002:

For the Year Ended December 31, 2004Financial
Guaranty

Financial
Products

Intersegment
Eliminations

TotalRevenues:External

$
701,374

$
95,130





796,504Intersegment


21,892


30,620


(52,512
)

Expenses:External


222,398


98,115





320,513Intersegment


30,620


21,892


(52,512
)

Income before income taxes


459,699


5,743





465,442Segment assets

$
9,838,979

$
9,361,392

$
(2,119,564
)
$
17,080,807


For the Year Ended December 31, 2003Financial
Guaranty

Financial
Products

Intersegment
Eliminations

TotalRevenues:External

$
610,509

$
21,827




$
632,336Intersegment


7,436


25,875


(33,311
)

Expenses:External


199,764


52,116





251,880Intersegment


25,875


7,436


(33,311
)

Income before income taxes


388,223


(11,850
)




376,373Segment assets

$
8,856,917

$
5,415,160

$
(1,862,317
)
$
12,409,760


100

---



For the Year Ended December 31, 2002Financial Guaranty

Financial Products

Intersegment Eliminations

TotalRevenues:External

$
397,647

$
22,451



$
420,098Intersegment





5,619

(5,619
)

Expenses:External


194,044


32,506




226,550Intersegment


5,619




(5,619
)

Income before income taxes


220,615


(4,436
)



216,179


The
intersegment assets consist of (1) intercompany notes issued by FSA and held within the GIC Portfolio and (2) GICs issued by the GIC Subsidiaries and held within the
VIE Portfolio. The intersegment revenues and expenses relate to interest income and interest expense on intercompany notes and GICs.

24.   OTHER ASSETS AND LIABILITIES

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

2004

2003Other Assets:Fair value of VIE swaps

$
590,792

$
407,742VIE other invested assets


156,540


150,410Securities purchased under agreements to resell





175,000Deferred compensation trust


112,941


97,514Tax and loss bonds


102,193


85,512Accrued interest on VIE swaps


99,794


76,295Accrued interest income


63,614


56,076Fair-value adjustments on derivatives


47,224


Other assets


151,257


198,190Total Other Assets

$
1,324,355

$
1,246,739


2004

2003Accrued Expenses and Other Liabilities:Payable for securities purchased

$
262,033

$
116,878Deferred compensation trust


112,941


97,262Equity participation plan


123,382


114,165Minority interest


50,245


60,910Securities sold under agreements to repurchase


5,656


63,965Fair-value adjustments on derivatives


6,224


23,986Other liabilities


314,029


276,373Total Accrued Expenses and Other Liabilities

$
874,510

$
753,539


25.   VARIABLE INTEREST ENTITIES

In January 2003, the FASB issued FIN 46, which addresses consolidation of VIEs that have one or both of the following characteristics: (a) the equity investment
at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will
absorb some or all of the expected losses of the entity; and (b) the equity investors lack the direct or indirect ability to make decisions about the entity's activities through voting rights or
similar rights, the obligation to absorb the expected losses of the entity if they occur or the

101

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right
to receive the expected residual returns of the entity if they occur. In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003), "Consolidation of Variable Interest
Entities, an interpretation of ARB 51" ("FIN 46R"). FIN 46R replaced FIN 46 and is effective for public companies for periods after December 15, 2003.

FSA
Global is managed as a "matched funding vehicle," in which the proceeds from the issuance of FSA-guaranteed notes are invested in obligations having cash flows substantially matched
to those of, and maturing prior to, such notes. In certain cases, investments of FSA Global consist of GICs issued by the GIC Subsidiaries. Similarly, Premier has GICs issued by the GIC Subsidiaries
in their investment portfolios. In each such case, the Company's GIC liability and asset are eliminated in consolidation. At December 31, 2004, $961.9 million was eliminated as a result of such
consolidation. All intercompany insured amounts between FSA and FSA Global and Canadian Global previously included in the Company's outstanding exposure are excluded from the Notes to the Consolidated
Financial Statements for December 31, 2004 and 2003.

FIN
46R requires that, upon consolidation, the Company initially measure the VIE's assets, liabilities and minority interest at their carrying amounts under existing GAAP as if the
entity had been consolidated from the time the Company was considered its primary beneficiary (or parent). The increase in total assets and total liabilities, at July 1, 2003, related to the
consolidation of these entities was $1.9 billion. The difference upon consolidation was reflected as a cumulative effect of a change in accounting principle at July 1, 2003. The cumulative effect of a
change in accounting principle for Canadian Global resulted in additional income of $4.8 million, net of income tax. There were no cumulative income statement effects from consolidating FSA Global and
Premier. The following table presents the impact of consolidation of the VIEs.

|                                                                                    |                | Twelve Months Ended
December 31, 2004 |        | Six Months Ended
December 31, 2003 |  
|----------------------------------------------------------------------------------- | -------------- | ------------------------------------- | ------ | ---------------------------------- | -
|Net interest income from financial products segment and variable interest entities  |                | $                                     | 47,134 |                                    | $
|Net premiums written                                                                |                |                                       | (5,351 | )                                  |  
|                                                                                    |                |                                       |        |                                    |  
|                                                                                    | Total revenues |                                       | $      | 41,783                             |  
|                                                                                    |                |                                       |        |                                    |  
|Net interest expense from financial products segment and variable interest entities |                | $                                     | 42,342 |                                    | $
|Other operating expenses                                                            |                |                                       | (1,054 | )                                  |  
|                                                                                    |                |                                       |        |                                    |  
|                                                                                    | Total expenses |                                       | $      | 41,288                             |  
|                                                                                    |                |                                       |        |                                    |  



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

Rating(1)

Percent of BondsAAA

2.6
%AA

5.3A

71.6BBB

20.5100.0
%


---

102

---



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

December 31, 2004

Amortized Cost

Fair ValueObligations of states and political subdivisions

$
16,007

$
16,007Corporate securities


158,106


157,990Foreign securities


57,621


57,983Asset-backed securities(1)


1,114,375


1,114,375Short-term investments


1,194


1,194Total

$
1,347,303

$
1,347,549


December 31, 2003

Amortized Cost

Fair ValueObligations of states and political subdivisions

$
16,200

$
16,200Corporate securities


181,165


180,380Foreign securities


61,541


61,207Asset-backed securities(1)


1,164,751


1,164,751Short-term investments


11,102


11,102Total

$
1,434,759

$
1,433,640


---

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

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

Amortized
Cost

Fair ValueDue in one year or less

$
185,970

$
186,182Due after one year through five years


30,951


30,985Due after five years through ten years





Due after ten years


16,007


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


1,114,375


1,114,375Total

$
1,347,303

$
1,347,549


26.   RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 03-3:
"Accounting for Certain Loans or Debt Securities Acquired in a Transfer" ("SOP 03-3"). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be
collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to

103

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credit
quality. SOP 03-3 supersedes Practice Bulletin 6 for transactions entered into after the initial application of SOP 03-3. For loans acquired in fiscal years prior to the effective date of SOP
03-3 and within the scope of Practice Bulletin 6 (such as certain assets acquired via refinancing transactions, see Note 22), SOP 03-3 amends the application of Practice Bulletin 6 with regard to
accounting for decreases in cash flows expected to be collected.

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

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

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

104

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

None.

Item 9A.    Controls and Procedures.

The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the
Company's disclosure controls and procedures as of December 31, 2004. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility
of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving
their control objectives. Based upon and as of the date of the evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure
controls and procedures were effective to provide reasonable assurance that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded,
processed, summarized and reported as and when required. Such evaluation did not identify any change in the Company's internal control over financial reporting that occurred during the period ended
December 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

Item 9B.    Other Information.

None.

105

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PART III

Item 10.    Directors and Executive Officers of the Registrant.

Directors

On October 29, 2004, the Company's shareholders appointed twelve directors to serve until the later of the Company's next annual meeting of shareholders or until
their successors have been duly elected and qualified. Information about the directors is set forth below and in "Item 12. Security Ownership of Certain Beneficial Owners and
Management"Directors and Executive Officers."

|Dirk Bruneel
Age 54      |  | Director of the Company since November 2001. Mr. Bruneel has been a member of the Management Board of Dexia S.A. since July 2001, and Chairman of the Management Board of Dexia Bank Nederland N.V. since November 2002. He
is currently the Chairman of the Board of Directors of Dexia Securities France S.A., a member of the Supervisory Board of Dexia Municipal Agency S.A. and Chairman of the Board of Directors of Artesia Mortgage Capital Corporation. Mr. Bruneel served
as Chairman of the Management Committee of Artesia Banking Corporation (a Belgian-based bank acquired by Dexia S.A. in July 2001) from November 1998 until August 2001 and of BACOB Bank s.c. from January 1995 until August 2001, and was a member of the
Management Committee of Dexia Bank from July 2001 through January 2002. He currently serves as a member of the Board of Directors of Dexia Insurance and DVV Verzekeringen NV, Ehsal and VEV, and Treasurer ofVlaams Omroeporkest
en Kamerkoor.
|------------------------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Robert P. Cochran
Age 55 |  | Chairman of the Board of Directors of the Company since November 1997, and Chief Executive Officer and a Director of the Company since August 1990. Mr. Cochran served as President of the Company and FSA from August 1990 until November 1997. He has
been Chief Executive Officer of FSA since August 1990, Chairman of FSA since July 1994, and a director of FSA since July 1988. Prior to joining the Company in 1985, Mr. Cochran was Managing Partner of the Washington, D.C. office of the Kutak Rock law
firm. Mr. Cochran is a Director of XL Financial Assurance Ltd and White Mountains Insurance Group, Ltd.                                                                                                                                                                                                                                                                                                                                                                     
|                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

106

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|Bruno Deletre
Age 43    |  | Director of the Company since September 2001. Mr. Deletre has been a member of the Executive Board and Managing Director of Dexia Crédit Local since May 2001. Prior to that time, he held various positions in the French Ministry of
FinanceTreasury, and served as Advisor to the French Minister of Economy and Finance from 1995 to 1997. He is chairman of the board of Dexia Global Structured Finance.                                                                                                                                                                                                                                                                                                             
|----------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Robert N. Downey
Age 69 |  | Director of the Company since August 1994. Mr. Downey has been a Senior Director of Goldman Sachs & Co. since 1999, a Limited Partner from 1991 to 1999, and a General Partner from 1976 until 1991. At Goldman, Sachs & Co., Mr. Downey served as
head of the Municipal Bond Department and Vice Chairman of the Fixed Income Division. Mr. Downey was a Director of the Securities Industry Association from 1987 through 1991 and served as its Chairman in 1990 and Vice Chairman in 1988 and 1989. He
was also formerly Chairman of the Municipal Securities Division of the Public Securities Association (known today as the Bond Market Association) and Vice Chairman of the Municipal Securities Rulemaking Board.
|Jacques Guerber
Age 55  |  | Director of the Company since September 2002. Mr. Guerber has been Chairman of the Executive Board of Dexia Crédit Local, a subsidiary of Dexia S.A. formerly known as Crédit Local de France, since January 2000 and a member of the
Executive Committee of Dexia S.A. since December 1999. He was previously Senior Executive Vice President of Crédit Local de France since 1996 and a member of that company's Management Board since 1988. Earlier, he held management positions in
the Local Development Division of Caisse des Dépôts et Consignations.                                                                                                                                                              
|David O. Maxwell
Age 74 |  | Director of the Company since August 1994. Mr. Maxwell was Chairman and Chief Executive Officer of Fannie Mae from 1981 until his retirement in 1991. Mr. Maxwell is a member of the advisory boards of Centre Partners II, L.P. and Centre Partners III,
L.P.                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

107

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|Séan W. McCarthy
Age 46 |  | Director of the Company since February 1999. Mr. McCarthy has been President and Chief Operating Officer of the Company since January 2002, and prior to that time served as Executive Vice President of the Company since November 1997. He has been
President of FSA since November 2000, and served as Chief Operating Officer of FSA from November 1997 until November 2000. Mr. McCarthy was named a Managing Director of FSA in March 1989, head of its Financial Guaranty Department in April 1993 and
Executive Vice President of FSA in October 1999. He has been a director of FSA since September 1993. Prior to joining FSA in 1988, Mr. McCarthy was a Vice President of PaineWebber Incorporated.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|James H. Ozanne
Age 61  |  | Director of the Company since September 2004. Mr. Ozanne previously served on the Board of Directors of the Company from January 1990 through May 2003, when he became Chief Executive Officer of SPS Holding Corp., a mortgage servicing holding company
in which the Company owns a minority interest, a position he held until September 2004. He served as Vice Chairman of the Board of Directors of the Company from May 1998 until July 2000. Prior to May 2003, Mr. Ozanne was Chairman of Greenrange
Partners. He was Chairman of Source One Mortgage Services Corporation, which was a subsidiary of White Mountains ("Source One"), from March 1997 to May 1999, Vice Chairman of Source One from August 1996 until March 1997, and a director of Source One
from August 1996 to May 1999. He was Chairman and Director of Nations Financial Holdings Corporation from January 1994 to January 1996. He was President and Chief Executive Officer of U S WEST Capital Corporation ("USWCC") from September 1989 until
December 1993. Prior to joining USWCC, Mr. Ozanne was Executive Vice President of General Electric Capital Corporation. Mr. Ozanne is currently non-executive chairman of SPS and a director of Distributed Energy Services Corp. He has been Chairman of
PECO Pallet, a privately-owned grocery pallet rental company, since 2000.
|                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

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|Pierre Richard
Age 64  |  | Director and Vice Chairman of the Company since July 2000. Mr. Richard was appointed Group Chief Executive and Chairman of the Executive Committee of Dexia S.A. in December 1999 after its reorganization. He had been co-Chairman of Dexia Group since
its creation through the alliance between Crédit Local de France and Crédit Communal de Belgique in December 1996. In October 1987, when Crédit Local de France was incorporated, he became its Chief Executive Officer and then, in
December 1993, after the firm's privatization, he was named Chairman and Chief Executive Officer. He previously served as Deputy General Manager of Caisse des Dépôts et Consignations and, before that, as head of the Local Authorities
Department at the French Ministry of Interior, where he was closely involved in drafting the new legislation for decentralization. He serves on the boards of the European Investment Bank, Compagnie Nationale Air France, Le Monde SA, Credit du Nord
and Generali France Holding. He has been decorated as anOfficier of the Légion d'Honneurand theOrdre National du Mériteand as aCommandeur of the Ordre of Leopold II.
|---------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Roger K. Taylor
Age 53 |  | Director of the Company since February 1995. Effective January 2002, Mr. Taylor became a part- time employee of the Company and Vice Chairman of FSA. He formally retired in July 2004. Mr. Taylor served as Chief Operating Officer of the Company from
May 1993 through December 2001 and President of the Company from November 1997 through December 2001. Mr. Taylor joined FSA in January 1990, and served FSA as its President from November 1997 until November 2000, a director since January 1992 and a
Managing Director since January 1991. Prior to joining FSA, Mr. Taylor was Executive Vice President of Financial Guaranty Insurance Company, a financial guaranty insurer. Mr. Taylor is a director of SPS Capital Holding Corp.                                                                                                                                                                                                                                                                                                                                                                                                                   
|                       |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

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|Rembert von Lowis
Age 51 |  | Director of the Company since July 2000. Mr. von Lowis is a member of the Executive Committee and Chief Financial Officer of Dexia S.A. He became Senior Executive Vice President of Crédit Local de France in 1993. Mr. von Lowis joined
Crédit Local de France as Chief Financial Officer and member of its Executive Board in 1988. Earlier, he held management positions in the Local Development Division in Caisse des Dépôts et Consignations and the Local Authorities
Department of the French Ministry of Interior. Mr. Von Lowis is a director of Dexia CLF Finance Company.                                                                                                                                                                                                                                                                      
|------------------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|George U. Wyper
Age 49   |  | Director of the Company since September 2004. Mr. Wyper is the founder and managing member of Wyper Capital Management, L.P., which he founded in 1998. He was Senior Managing Director and a member of the Operating Committee of Warburg Pincus
Counsellors, Inc from 1994 to 1998. He served as Chief Investment Officer of White River Corporation from 1991 to 1994 and as President and Chief Executive Officer of Hanover Advisors from 1992 to 1994. Prior to 1991 he was Chief Investment Officer
of Fund American Enterprises from 1988 to 1990 and Director of Fixed Income Investments for Fireman's Fund Insurance Company from 1987 to 1988. Mr. Wyper is currently President of the Darien Library and serves on the boards of the Yale School of
Management, the American Numismatic Society and the Museum of Rhode Island School of Design.

Executive Officers of the Company

In addition to Messrs. Cochran and McCarthy (who are described above under the caption "Directors"), the Company's other executive officers are described below.
The Company's executive officers consist of the full-time members of the Management Committee.

|Name                 |  | Age |  | Position                                                                                   
|-------------------- |  | --- |  | -------------------------------------------------------------------------------------------
|Russell B. Brewer II |  | 48  |  | Managing Director of the Company and FSA; Chief Risk Management Officer and Director of FSA
|Joseph W. Simon      |  | 46  |  | Managing Director and Chief Financial Officer of the Company and FSA; Director of FSA      
|Bruce E. Stern       |  | 51  |  | Managing Director, General Counsel and Secretary of the Company and FSA; Director of FSA   

110

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The
present principal occupation and five-year employment history of each of the above-named executive officers of the Company, as well as other directorships of corporations currently
held by each such person, are set forth below:

Mr.
Brewer has been a Managing Director of FSA since March 1989 and the Chief Risk Management Officer of FSA since September 2003. Mr. Brewer was the Chief Underwriting Officer of FSA
from September 1990 until September 2003. He has been a Managing Director of the Company since May 1999 and a director of FSA since September 1993. From March 1989 to August 1990, Mr. Brewer was
Managing Director, Asset Finance Group, of FSA. Prior to joining FSA in 1986, Mr. Brewer was an Associate Director of Moody's Investors Service, Inc.

Mr.
Simon was elected a Managing Director and the Chief Financial Officer of the Company and FSA in September 2002, having served in such capacity since April 2002. Prior to joining the
Company, Mr. Simon was Chief Financial Officer of Intralinks, a technology company serving the financial markets. Earlier, he worked for TENTV.com, a provider of business-to-business video portals.
From 1993 to 1999, he was a senior financial officer, last serving as the Chief Financial Officer, of Cantor Fitzgerald. Mr. Simon, a certified public accountant, began his professional career at
Price Waterhouse in 1983.

Mr.
Stern has been a Managing Director, the Secretary and the General Counsel of the Company since April 1993. Since April 1993, he has been the Secretary of FSA, and since March 1989,
he has been a Managing Director of FSA. He has been a director of FSA since August 1990. Prior to joining FSA as General Counsel in 1987, Mr. Stern was an attorney with Cravath, Swaine & Moore.

Audit Committee

The Company has a separately designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. From January to September
2004 the Audit Committee consisted of Messrs. von Lowis (who served as Chairman), Deletre and Maxwell. On September 9, 2004, Messrs. von Lowis and Deletre stepped down from the Committee, and Messrs.
Ozanne and Wyper joined the Committee.

Mr.
Ozanne serves as Chairman of the Audit Committee. All members of the Audit Committee are independent within the meaning of Rule 10A-3 of the Exchange Act. Because the Company has
only debt securities listed on the New York Stock Exchange, the additional independence standards for audit committee members imposed by the NYSE are not applicable to the Company.

Audit Committee Financial Expert

The Board of Directors of the Company has determined that Audit Committee members David O. Maxwell and James H. Ozanne are audit committee financial experts as
defined by Item 401(h) of Regulation S-K of the Exchange Act.

Code of Ethics

The Company has adopted a code of ethics for directors, officers (including the Company's principal executive officer, principal financial officer, principal
accounting officer and controller) and employees, known as the Code of Conduct. The Company will provide to any person without charge, upon request, a copy of the Code of Conduct. Any such request
should be made to the Company in writing or by telephone, to:



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The
Company intends to satisfy the disclosure requirement under Item 10 of Form 8-K regarding an amendment to, or a waiver from, a provision of its code of ethics that applies to its
principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, and that relates to any element of the code of ethics
definition enumerated in paragraph (b) of Item 406 of Regulation S-K of the Exchange Act, by posting such information on its website,www.fsa.com.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16 of the Exchange Act requires periodic reporting by beneficial owners of more than 10% of any equity security registered under Section 12 of the
Exchange Act and directors and executive officers of issuers of such equity securities. Upon the Merger in July 2000, the Company's common stock ceased to be registered under Section 12 of the
Exchange Act or listed on the NYSE. Consequently, the Company no longer has equity securities registered under Section 12 of the Exchange Act, and the reporting obligations of Section 16 of the
Exchange Act no longer apply.

112

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Item 11.    Executive Compensation.

Summary Compensation Table

The table below sets forth a summary of all compensation paid to the chief executive officer of the Company and the other four most highly compensated executive
officers of the Company and its subsidiaries, in each case for services rendered in all capacities to the Company and its subsidiaries for the years ended December 31, 2004, 2003 and 2002.

|                                                                      |  |                |  |   |                         |  |   | Long-Term
Compensation(1)     |  |  
|--------------------------------------------------------------------- |  | -------------- |  | - | ----------------------- |  | - | ----------------------------- |  | -
|
|
|
|Robert P. Cochran
Chairman of the Board and
Chief Executive Officer   |  | 2004
2003
2002 |  | $ | 500,000
500,000
490,000 |  | $ | 3,400,000
3,200,000
2,600,000 |  | $
|Séan W. McCarthy
President and
Chief Operating Officer                |  | 2004
2003
2002 |  |   | 310,000
310,000
300,000 |  |   | 3,000,000
2,800,000
2,400,000 |  |  
|Bruce E. Stern
Managing Director, General
Counsel and Secretary       |  | 2004
2003
2002 |  |   | 240,000
240,000
230,000 |  |   | 900,000
800,000
650,000       |  |  
|Russell B. Brewer II
Managing Director and
Chief Underwriting Officer |  | 2004
2003
2002 |  |   | 240,000
240,000
230,000 |  |   | 900,000
800,000
600,000       |  |  
|Joseph W. Simon(4)
Managing Director and
Chief Financial Officer      |  | 2004
2003
2002 |  |   | 240,000
240,000
172,500 |  |   | 750,000
500,000
400,000       |  |  

---

|                     |  | 2004 |        | 2003 |   | 2002  
|-------------------- |  | ---- | ------ | ---- | - | ------
|
|Robert P. Cochran    |  | $    | 18,450 |      | $ | 71,550
|Séan W. McCarthy     |  |      | 18,450 |      |   | 71,550
|Bruce E. Stern       |  |      | 18,450 |      |   | 71,550
|Russell B. Brewer II |  |      | 18,450 |      |   | 71,550
|Joseph W. Simon      |  |      | 18,450 |      |   | 48,150

113

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Employment Agreements and Arrangements; Change in Control Provisions

Each of Messrs. Cochran and McCarthy entered into employment agreements with the Company, effective July 5, 2004. The employment agreements generally guarantee
continuation of compensation and benefits through December 31, 2007, and provide for renewals and extensions of this initial term for two-year terms, subject to notice of termination from either party
at least six months prior to the end of the extended term. At any point after the initial term has expired, Mr. Cochran may elect to become Non-Executive Chairman of the Company for the remainder of
the term and any extensions.

Under
the agreements, compensation consists of:



The
2004 bonus pool guidelines contemplate a bonus pool equal to 11.25% of the after-tax growth in adjusted book value for the year, excluding unrealized gains/losses on investments and
SFAS 133 mark-to-market adjustments, but including a return on equity modifier. An additional reserve bonus pool made up of previously earned but undistributed bonus pool allocations from prior
years, equal to approximately $25 million after giving effect to 2004 bonuses (paid in the first quarter of 2005), may also be distributable. Messrs. Cochran and McCarthy are entitled to receive an
annual cash bonus equal to at least 5.0% and 4.0%, respectively, of the bonus pool. The employment agreements provide that an additional 2.0% of the bonus pool will be allocated among those two
executive officers as determined by the Human Resources Committee.

The
employment agreements provide that Messrs. Cochran and McCarthy may elect to retire at age 60, but that retirement is mandatory at age 65. Upon retirement, each of Mr. Cochran and
Mr. McCarthy will be entitled to his pro-rata annual base salary and annual bonus through the date of retirement and the vesting of his outstanding performance shares over time as if he remained
employed. Messrs. Cochran and McCarthy are not entitled to any on-going retirement compensation except as provided by the Company's defined contribution Pension Plan and SERP.

The
employment agreements provide for continued participation in the Company's benefit plans and severance benefits in lieu of the Company's existing severance policy. Specifically, if
the Company

114

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terminates
Mr. Cochran or Mr. McCarthy without cause or either of such executive officers terminates his employment for "good reason," he will be entitled to:



"Good
reason" includes, for Mr. McCarthy, not being named Mr. Cochran's successor as Chief Executive Officer of the Company.

Both
employment agreements provide that, if the employee is terminated for cause or terminates his employment without "good reason" during the term, he will be entitled only to be paid
his pro rata annual base salary through the date of termination. If such termination occurs after the term of the agreement, he will also be entitled to his pro-rata annual bonus through the date of
termination and his performance shares will vest pro rata in proportion to the percentage of the applicable performance cycle during which he was employed by the Company. Each employment agreement
contains a non-compete provision extending through the greater of two years and the term of the agreement.

If
Mr. Cochran becomes Non-Executive Chairman of the Company, he will be entitled to his then-current salary and an annual performance share unit award with an estimated economic value
at least equal to 50% of normal prior awards. If Mr. McCarthy becomes the Chief Executive Officer of the
Company, he will be entitled to compensation equal to 90% or more of Mr. Cochran's latest compensation, including salary, bonus and performance share units.

The
Company's severance policy for senior management entitles Messrs. Brewer, Simon and Stern to 12 months of compensation, in each case if terminated without cause and based on current
compensation (or, in certain events, prior compensation if higher). The severance policy was amended in connection with the Merger to provide reimbursement (on a grossed-up basis) for any "golden
parachute" excise taxes payable by employees upon their termination of employment following the Merger, and to restrict adverse amendments to the policy through December 31, 2004.

The
Equity Plans provide for accelerated vesting and payment of performance shares and Dexia Restricted Stock awarded thereunder, if any, upon the occurrence of certain change in control
transactions involving the Company. These provisions are generally applicable to all participants in the Equity Plans. Each of the named executive officers holds performance shares and Dexia
Restricted Stock awarded under the Equity Plans.

The
Equity Plans provide that the Company's Board of Directors may elect to continue the plan if a change in control occurs. Following a "plan continuation," performance shares and Dexia
Restricted Stock are not accelerated, but vest and are payable as if no change in control had occurred, except in the case of any employee who is terminated without cause or leaves for "good reason"
following the change in control. The Board elected a plan continuation in connection with the Merger.

Compensation of Directors

Each director of the Company who is not an officer of the Company or Dexia received a fee of $40,000 per annum for service as a director (increased to $50,000 per
annum effective May 2004), and an additional annual fee of $5,000 if chairperson of a Committee of the Board of Directors (increased to $20,000 in the case of the Underwriting Committee and Audit
Committee effective May 2004). Such directors also received $2,000 for each Board meeting and regular Committee meeting attended and reimbursement for expenses for each such meeting attended. Each
director is entitled to defer fees under

115

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the
Company's Deferred Compensation Plan (the "DCP") and to participate in the director share purchase program. Under a cost-sharing agreement, the Company reimburses Dexia Crédit Local
for the portion of director Bruno Deletre's Dexia Crédit Local compensation that relates to his work as liaison with the Company on behalf of Dexia.

Director Share Purchase Program

In the fourth quarter of 2000, the Company entered into an agreement with Dexia Holdings and Dexia Public Finance Bank, now Dexia Crédit Local, to
establish the Director Share Purchase Program, pursuant to which Company directors could invest in shares of the Company's common stock. The Director Share Purchase Program entitles each director of
the Company to purchase from Dexia (or an affiliate thereof) up to 126,958 restricted shares of the Company's common stock (which represented a $10 million investment at the purchase price at
inception of the program) at a price determined in accordance with the formula described below, provided that:



Directors
may purchase such shares either directly or through deemed investments under the DCP or SERP. Each deemed investment election with respect to these shares is irrevocable.

The
Director Share Purchase Program enables the Company to purchase from Dexia Holdings, at the same price, the same number of shares of common stock purchased by directors through
phantom investments under the DCP or SERP. Upon expiration of any applicable deferral period, the Company is obligated to pay out the phantom investments in shares of common stock, which must be held
by the participant as if acquired directly from Dexia Holdings for generally a minimum of six months.

The
purchase price for each restricted share acquired by a director or put to Dexia Crédit Local is equal to the product of 1.4676 and adjusted book value per share ("ABV
per share"), with ABV per share determined in accordance with the methodology employed for valuing performance share award payouts under the Equity Plans. The purchase price per share, determined
pursuant to such formula, was $162.78 at December 31, 2004. ABV per share is measured at the close of the calendar quarter in which a director submits a repurchase notice, provided that ABV per share
freezes on the first
anniversary of the later of the termination of directorship or, in the case of deferred shares, receipt of shares upon expiration of the deferral period.

Sales
under the program are not registered under the Securities Act of 1933 in reliance upon an exemption from registration under Section 4(2) of that Act. None of the directors made any
additional direct or phantom investments under the Director Share Purchase Program during 2003, or any direct investments after 2002, the year of inception of the Program. During 2004, one director
invested in 1,890 phantom shares and during the first quarter of 2005, one director purchased 6,199 shares outright. For more information regarding the directors' share ownership, see "Item 12.
Security Ownership of Certain Beneficial Owners and ManagementDirectors and Executive Officers."

116

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Equity Plans

In November 2004 the Company adopted the 2004 Equity Plan, to be used for future equity compensation awards to Company executives and employees in lieu of the
1993 Equity Plan. The 2004 Equity Plan provides for awards of:



The
following table sets forth a summary of the performance share units ("PSU") awarded to each of the named executive officers for the year ended December 31, 2004 (which awards were
made in February 2005), as well as the number of performance shares ("PS") and Dexia restricted shares the awards were comprised of.

|Name                 |  | Number of
Performance
Share Units |  |               |  | Number of Performance Shares ("PS")
and Dexia Restricted Shares
|-------------------- |  | --------------------------------- |  | ------------- |  | ---------------------------------------------------------------
|Robert P. Cochran    |  | 34,000                            |  | Comprised of: |  | 30,600 PS and 19,671 Dexia shares                              
|Séan W. McCarthy     |  | 25,000                            |  | Comprised of: |  | 22,500 PS and 14,464 Dexia shares                              
|Bruce E. Stern       |  | 9,000                             |  | Comprised of: |  | 8,100 PS and 5,207 Dexia shares                                
|Russell B. Brewer II |  | 9,000                             |  | Comprised of: |  | 8,100 PS and 5,207 Dexia shares                                
|Joseph W. Simon      |  | 8,000                             |  | Comprised of: |  | 7,200 PS and 4,629 Dexia shares                                

Unlike
the 1993 Equity Plan, the 2004 Equity Plan does not provide for stock options, Company restricted stock or equity bonus awards.

Performance Shares

Each performance share represents the economic value of up to two shares of common stock of the Company, and not just appreciation, as is the case with a stock
option. The number of shares of common stock actually earned for each performance share depends upon the attainment by the Company and its subsidiaries (on a consolidated basis) of "performance
objectives" during the time period specified by the Committee at the time an award of performance shares is made.

Both
Equity Plans authorize the discretionary grant of performance shares by the committee administering the Equity Plan (the Human Resources Committee) to key employees of the Company
and its subsidiaries. So long as the Company's common stock is not registered under the Exchange Act, the Company expects to pay its performance shares in cash rather than stock.

Since
its inception, up to 3,300,000 shares of common stock have been available for distribution under the 2004 Equity Plan in respect of performance shares. Such shares may be newly
issued shares, treasury shares or shares purchased in the open market. If performance shares awarded under the 2004 Equity Plan are forfeited, the shares allocated to such awards are again available
for distribution in connection with future awards under the Plan.

The
following table sets forth (a) a summary of performance shares awarded to each of the named executive officers for the year ended December 31, 2004 (which awards were made in
February 2005), (b) the applicable performance period until payout and (c) the related estimated future payouts at the stated assumed annual rates of adjusted book value per share and book value per
share growth.

117

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Long-Term Incentive Plans Awards in 2004(1)

|                     |  |        |  |     |  | Estimated Future Payouts(3)
|-------------------- |  | ------ |  | --- |  | ---------------------------
|
|Robert P. Cochran    |  | 30,600 |  | (2) |  | 0                          
|Séan W. McCarthy     |  | 22,500 |  | (2) |  | 0                          
|Bruce E. Stern       |  | 8,100  |  | (2) |  | 0                          
|Russell B. Brewer II |  | 8,100  |  | (2) |  | 0                          
|Joseph W. Simon      |  | 7,200  |  | (2) |  | 0                          

---

Dexia Restricted Stock

The 2004 Equity Plan authorizes the discretionary grant of Dexia restricted stock by the Human Resources Committee, the committee administering the Equity Plan,
to the employees of the Company and its subsidiaries. Dexia restricted stock awarded under the 2004 Equity Plan represents ordinary shares of Dexia subject to certain vesting requirements and
restrictions on transfer. Holders of Dexia restricted stock are entitled to receive all dividends paid on such stock from the date of grant.

118

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The
following table sets forth a summary of Dexia restricted stock awarded to each of the named executive officers for the year ended December 31, 2004 (which awards were made in
February 2005) as a component of Performance Share Units.

Dexia Restricted Stock Awarded In 2004(1)

|Name                 |  | Dexia Shares
Awarded |  | Performance
Period Until
Payout
|-------------------- |  | -------------------- |  | -------------------------------
|Robert P. Cochran    |  | 19,671               |  | (2)                            
|Séan W. McCarthy     |  | 14,464               |  | (2)                            
|Bruce E. Stern       |  | 5,207                |  | (2)                            
|Russell B. Brewer II |  | 5,207                |  | (2)                            
|Joseph W. Simon      |  | 4,629                |  | (2)                            

---

Compensation Committee Interlocks and Insider Participation

The Human Resources Committee consisted of Messrs. Maxwell (Chairperson), Cochran, Deletre, Downey and Richard during 2004. Mr. Taylor joined the Committee in
September 2004. Except for Messrs. Cochran and Taylor, none of such persons is currently or has ever been an officer or employee of the Company or any subsidiary of the Company. Mr. Richard is the
Group Chief Executive and Chairman of the Executive Committee of Dexia and Mr. Deletre is a member of the Executive Board of Dexia Crédit Local.

As
described in "Director Share Purchase Program," above, members of the Human Resources Committee are entitled to participate in a share purchase program available to all directors of
the Company, either directly or through deemed investments under the Company's DCP or SERP.

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

5% Shareholders

The following table sets forth certain information regarding beneficial ownership of the Company's equity at March 15, 2005 as to each person known by the Company
to beneficially own, within the meaning of the the Exchange Act, 5% or more of the outstanding shares of the common stock, par value $.01 per share, of the Company.

|Title of class                         |  | Name and address of
beneficial owner                                          |  | Amount and nature of
beneficial ownership |        | Percent of
class |    
|-------------------------------------- |  | ----------------------------------------------------------------------------- |  | ----------------------------------------- | ------ | ---------------- | ---
|Common stock, par value $.01 per share |  | Dexia S.A.(1)
7 à 11 quai André Citröen BP-1002
75 901 Paris Cedex 15, France |  | 32,871,757 shares                         | (1)(2) | 98.8%            | (2)
|                                       |  |                                                                               |  |                                           |        |                  |    
|                                       |  | Boulevard Pachéco 44
B-1000 Brussels, Belgium                                 |  |                                           |        |                  |    

---

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Directors and Executive Officers

The following table sets forth certain information regarding beneficial and economic ownership of the Company's Common Stock at March 15, 2005 for (a) each
director of the Company, (b) each executive officer named under "Executive Compensation Summary Compensation Table" and (c) all executive officers and directors of the Company as a group. Beneficial
ownership is less than 1% for each executive officer and director listed, individually and as a group.

Directors and Executive Officers

Amount and Nature
of Beneficial
Ownership(1)

Economic
Ownership(1)Dirk Bruneel(2)



Robert P. Cochran

41,744

258,891Bruno Deletre(2)



Robert N. Downey

20,159

29,259Jacques Guerber(2)



Séan W. McCarthy



119,219David O. Maxwell

6,009

19,299James H. Ozanne



24,591Pierre Richard(2)



Roger K. Taylor



96,489George U. Wyper

6,199

6,199Rembert von Lowis(2)



Bruce E. Stern



34,767Russell B. Brewer II



34,767Joseph W. Simon



22,533All executive officers and directors as a group (15 persons)

74,111

646,014


---

Officer

Performance SharesRobert P. Cochran

131,933Séan W. McCarthy

93,167Bruce E. Stern

34,767Russell B. Brewer II

34,767Joseph W. Simon

22,533


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The
Company is not aware of any arrangements that may result in a change in control of the Company.

The
following table sets forth beneficial ownership of common shares of the Company's parent, Dexia, at March 15, 2005, for (a) each director of the Company, (b) each executive officer
and (c) all executive officers and directors of the Company as a group. Beneficial ownership is less than 1% for each executive officer and director listed, individually and as a group.

Directors and Executive Officers(1)(2)

Amount and Nature of
Beneficial OwnershipDirk Bruneel

38,102Robert P. Cochran

546,341Bruno Deletre

1,155Robert N. Downey

Jacques Guerber

8,427Séan W. McCarthy

457,304David O. Maxwell

James H. Ozanne

Pierre Richard

30,210Roger K. Taylor

249,250George U. Wyper

Rembert von Lowis

24,802Bruce E. Stern

173,916Russell B. Brewer II

172,706Joseph W. Simon

26,189All executive officers and directors as a group (15 persons)

1,728,402


---



121

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Officer

Leveraged SharesRobert P. Cochran

525,170Séan W. McCarthy

441,340Bruce E. Stern

160,280Russell B. Brewer II

163,030Joseph W. Simon

21,560


Securities Available Under Equity Compensation Plans

The following table sets forth information as of December 31, 2004 with respect to each compensation plan of the Company under which equity securities of the
Company are authorized for issuance.

|Plan Category                                                 |  | Number of securities
to be issued upon
exercise of
outstanding options,
warrants and
rights(a) |  | Weighted average
exercise price of
outstanding options,
warrants and rights(b) |  | Number of securities
remaining available
for future issuance under
equity compensation plans
(excluding securities
reflected in column (a))(c)
|------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|Equity compensation plans approved by security holders(1)     |  | 0                                                                                              |  | Not applicable                                                                 |  | 2004 Equity Plan(3): 2,964,400                                                                                                                
|                                                              |  |                                                                                                |  |                                                                                |  | Director Share Purchase Program(4):
1,196,528                                                                                                 
|Equity compensation plans not approved by security holders(2) |  |                                                                                               |  |                                                                               |  |                                                                                                                                              
|Total                                                         |  | 0                                                                                              |  | Not applicable                                                                 |  | 4,160,928                                                                                                                                     

---

122

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Item 13.    Certain Relationships and Related Transactions.

Financial Guaranty Transactions

Since the Merger in July 2000, various affiliates of Dexia S.A., including certain wholly owned bank subsidiaries and/or their U.S. branches, have participated in
transactions in which subsidiaries of the Company have provided financial guaranty insurance. For example, Dexia affiliates have provided liquidity facilities and letters of credit in FSA-insured
transactions, and been the beneficiary of financial guaranty insurance policies issued by insurance company subsidiaries of the Company. In the opinion of management of the Company, the terms of these
arrangements are no less favorable to the Company than the terms that could be obtained from unaffiliated parties.

Director Share Purchase Program

Directors are entitled to purchase up to 126,958 of actual or phantom shares of the Company's Common Stock, as described in "Item 11. Executive
CompensationDirector Share Purchase Program."

Other Relationships

Additional information relating to certain relationships and related transactions is set forth in "Item 11. Executive CompensationCompensation
Committee Interlocks and Insider Participation."

Item 14.    Principal Accountant Fees and Services.

Aggregate fees (in thousands) for professional services by PricewaterhouseCoopers LLP invoiced in 2004 and 2003, were:

2004

2003Audit

$
1,084.5

$
1,088.9Audit related


367.7


276.8Tax


536.1


446.4Total

$
1,988.3

$
1,812.1


Audit
fees for the years ended December 31, 2004 and 2003 were for professional services rendered for the audits of the consolidated financial statements of the Company and statutory and
subsidiary audits (including value added tax), issuance of comfort letters and consents. Included in this amount is $0.2 million and $0.2 million in fees relating to consents that are reimbursed to
the Company by the issuer of FSA-insured deals for the years ended December 31, 2004 and 2003, respectively.

Audit
related fees for the years ended December 31, 2004 and 2003 were for assurance and related services related to the Company's retirement plans and consultations concerning financial
accounting and reporting standards.

Tax
fees for the years ended December 31, 2004 and 2003 were for services related to tax compliance, including the preparation of tax returns for expatriates, assistance with tax audits
and appeals, and tax services for employee benefit plans.

Audit Committee Pre-Approval Policies and Procedures

The Audit Committee pre-approves all non-audit related fees and approves all audit fees paid to the Company's auditors.

123

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Part IV

Item 15.    Exhibits, Financial Statement Schedules.

Item 8 sets forth the following financial statements of Financial Security Assurance Holdings Ltd. and Subsidiaries:



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

Schedule

TitleII

Condensed Financial Statements of Independent Registrant for the Years Ended December 31, 2004, 2003 and 2002.The report of the Independent Registered Public Accounting Firm with respect to the above listed financial statement schedule is set forth on page 63 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.


The following are annexed as exhibits to this Report:

|Exhibit No. |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                         
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|2.1         |  | Agreement and Plan of Merger dated as of March 14, 2000 by and among Dexia S.A., Dexia Crédit Local de France S.A., PAJY Inc. and the Company. (Previously filed as Exhibit 2.1 to Current
Report on Form 8-K (Commission File No. 1-12644) dated March 14, 2000, and incorporated herein by reference.)                                                                                        
|3.1         |  | Restated Certificate of Incorporation of the Company. (Previously filed as Exhibit 3.1 to the Company's Registration Statement on Form S-3 (Reg. No. 333-74165) (the "Form S-3"), and incorporated herein by reference.)                                                                                                                                                                        
|3.1(A)      |  | Certificate of Merger of PAJY Inc. into the Company under Section 904 of the Business Corporation Law of the State of New York (effective July 5, 2000). (Previously filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q (Commission File
No. 1-12644) for the quarterly period ended September 30, 2000 (the "September 30, 2000 10-Q"), and incorporated herein by reference.)
|            |  |                                                                                                                                                                                                                                                                                                                                                                                                 

124

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|3.1(B)  |  | Certificate of Merger of White Mountains Holdings, Inc. and the Company into the Company under Section 904 of the Business Corporation Law (effective July 5, 2000). (Previously filed as Exhibit 3.2 to the September 30, 2000 10-Q, and incorporated
herein by reference.)                                                                                                                                                                          
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.2     |  | Amended and Restated By-laws of the Company, as amended and restated on July 5, 2000. (Previously filed as Exhibit 3.3 to the September 30, 2000 10-Q, and incorporated herein by reference.)                                                                                                                                                                                                                                                         
|4.1     |  | Amended and Restated Trust Indenture dated as of February 24, 1999 (the "Amended and Restated Senior Indenture") between the Company and the Senior Debt Trustee. (Previously filed as Exhibit 4.1 to the Company's Registration Statement on Form S-3
(Reg. No. 33-74165), and incorporated herein by reference.)                                                                                                                                    
|4.1(A)  |  | Form of 67/8% Quarterly Interest Bond Securities due December 15, 2101. (Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated December 12, 2001 (the "December 2001
Form 8-K"), and incorporated herein by reference.)                                                                                                                                                                       
|4.1(B)  |  | Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 3 to the December 2001 Form 8-K, and incorporated herein by reference.)                                                                                                                                                                                                                                           
|4.1(C)  |  | Form of 6.25% Notes due 2102. (Previously filed as Exhibit 3 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated November 6, 2002 and filed November 25, 2002 (the "November 2002 Form 8-K"), and incorporated herein by
reference.)                                                                                                                                                                                      
|4.1(D)  |  | Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 4 to the November 2002 Form 8-K, and incorporated herein by reference.)                                                                                                                                                                                                                                           
|4.1(E)  |  | Form of 5.60% Notes due 2103. (Previously filed as Exhibit 2 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated July 17, 2003 and filed July 30, 2003 (the "July 2003 Form 8-K"), and
incorporated herein by reference.)                                                                                                                                                                                                 
|4.1(F)  |  | Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Amended and Restated Senior Indenture. (Previously filed as Exhibit 3 to the July 2003 Form 8-K, and incorporated herein by reference.)                                                                                                                                                                                                                                               
|10.1    |  | Credit Agreement dated as of August 31, 1998 among FSA, each of its insurance company affiliates listed on Schedule I attached thereto, the Banks from time to time party thereto and Deutsche Bank AG, New York Branch, as agent.
(Previously filed as Exhibit 10 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended September 30, 1998, and incorporated herein by reference.)             
|10.1(A) |  | Amendment No. 6 to the Credit Agreement, dated as of April 25, 2004, among Financial Security Assurance Inc., the additional borrowers party thereto, various banks, U.S. Bank, N.A. and The Bank of New York, as agent. (Previously
filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended June 30, 2004 (the "June 0, 2004 10-Q"), 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.)                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                       

125

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|10.3    |  | Second Amended and Restated Credit Agreement dated as of April 30, 1999, among FSA, FSA Insurance Company, the Banks party thereto from time to time and Bayerische Landesbank Girozentrale, New York Branch, as Agent. (Previously filed as
Exhibit 10 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period ended June 30, 1999, and incorporated herein by reference.)            
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.3(A) |  | Fifth Amendment to Second Amended and Restated Credit Agreement dated as of April 30, 2004 among Financial Security Assurance Inc., FSA Insurance Company, the Banks party thereto and Bayerische Landesbank (formerly known as Bayerische
Landesbank Girozentrale), acting through its New York Branch in its capacity as Agent. (Previously filed as Exhibit 10.2 to the June 30, 2004 10-Q, and incorporated herein by reference.)
|10.4   |  | 1989 Supplemental Executive Retirement Plan (amended and restated as of December 17, 2004). (Previously filed as Exhibit 10.4 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated December 17, 2004
and filed on December 17, 2004 (the "December 2004 Form 8-K"), and incorporated herein by reference.)                                                                                                
|10.5   |  | 2004 Supplemental Executive Retirement Plan, dated as of December 17, 2004. (Previously filed as Exhibit 10.3 to the December 2004 Form 8-K, and incorporated herein by reference.                                                                                                                                                                                                                                                   
|10.6   |  | Amended and Restated 1993 Equity Participation Plan (amended and restated as of May 17, 2001). (Previously filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period
ended June 30, 2001 (the "June 30, 2001 10-Q"), and incorporated herein by reference.)                                                                                                        
|10.7   |  | 2004 Equity Participation Plan (Previously filed as Exhibit 10.1 to the Company's current report on Form 8-K (Commission File No. 1-12644) dated November 18, 2004 and filed on November 23, 2004 (the "November 2004 Form 8-K")
and incorporated herein by reference.)                                                                                                                                                              
|10.8   |  | Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Dexia Restricted Stock. (Previously filed as Exhibit 10.2 to the November 2004 8-K, and incorporated herein by reference.)                                                                                                                                                                                                                       
|10.9   |  | Form of Financial Security Assurance Holdings Ltd. Agreement Evidencing an Award of Performance Shares. (Previously filed as Exhibit 99.1 to the Current Report on Form 8-K (Commission File No. 1-12644) dated February 16, 2005, and
incorporated herein by reference.)                                                                                                                                                            
|10.10  |  | 1995 Deferred Compensation Plan (amended and restated as of December 17, 2004). (Previously filed as Exhibit 10.2 to the December 2004 8-K, and incorporated herein by reference.)                                                                                                                                                                                                                                                   
|10.11  |  | 2004 Deferred Compensation Plan, dated December 17, 2004. (Previously filed as Exhibit 10.1 to the December 2004 8-K, and incorporated herein by reference.)                                                                                                                                                                                                                                                                         
|10.12  |  | Severance Policy for Senior Management (amended and restated as of November 13, 2003). (Previously filed as Exhibit 10.7 to the Company's Annual Report on Form 10-K (Commission File No. 1-12644) for the fiscal year ended
December 31, 2003, and incorporated herein by reference.)                                                                                                                                               
|10.13  |  | Share Purchase Program Agreement dated as of December 15, 2000, among Dexia Public Finance Bank, Dexia Holdings, Inc. and the Company. (Previously filed as Exhibit 10.9(B) to the Company's Annual Report on Form 10-K (Commission File
No. 1-12644) for the fiscal year ended December 31, 2000 (the "December 31, 2000 10-K"), and incorporated herein by reference.)                                                             
|        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                      

126

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|10.14 |  | Employment Agreement dated as of July 5, 2004 by and between the Company and Robert P. Cochran. (Previously filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly
period ended September 30, 2004 (the "September 30, 2004 10-Q"), and incorporated herein by reference.)
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.15 |  | Employment Agreement dated as of July 5, 2004 by and between the Company and Séan W. McCarthy. (Previously filed as Exhibit 10.2 to the September 30, 2004 10-Q, and incorporated herein by reference.)                                                                                                                                 
|10.16 |  | Financial Security Assurance Holdings Ltd. Annual Bonus Pool Guideline. (Previously filed as Exhibit 10.3 to the September 30, 2004 10-Q, and incorporated herein by reference.)                                                                                                                                                        
|10.17  |  | Put Option Agreement, dated as of June 23, 2003 by and between FSA and Sutton Capital Trust I. (Previously filed as Exhibit 99.5 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644) for the quarterly period
ended June 30, 2003 (the "June 30, 2003 10-Q"), and incorporated herein by reference.)           
|10.18  |  | Put Option Agreement, dated as of June 23, 2003 by and between FSA and Sutton Capital Trust II. (Previously filed as Exhibit 99.6 to the June 30, 2003 10-Q, and incorporated herein by reference.)                                                                                                                                     
|10.19  |  | Put Option Agreement, dated as of June 23, 2003 by and between FSA and Sutton Capital Trust III. (Previously filed as Exhibit 99.7 to the June 30, 2003 10-Q, and incorporated herein by reference.)                                                                                                                                    
|10.20  |  | Put Option Agreement, dated as of June 23, 2003 by and between FSA and Sutton Capital Trust IV. (Previously filed as Exhibit 99.8 to the June 30, 2003 10-Q, and incorporated herein by reference.)                                                                                                                                     
|21*    |  | List of Subsidiaries.                                                                                                                                                                                                                                                                                                                   
|23*    |  | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                                                                                                                                                  
|24.1   |  | 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 year ended December 31, 2002 and incorporated herein by reference.)                                                                                                                        
|24.2*  |  | Powers of Attorney.                                                                                                                                                                                                                                                                                                                     
|31.1*  |  | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                
|31.2*  |  | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                
|32.1** |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                 
|32.2** |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                 
|99.1*  |  | Financial Security Assurance Inc. and Subsidiaries 2004 Consolidated Financial Statements and Report of Independent Registered Public Accounting Firm.                                                                                                                                                                                  

---

127

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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.
| |  | ------------------------------------------
| |  | By:                                       

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 Executive Officer and Director
(Principal Executive Officer) |  | March 30, 2005
|/s/SÉAN W. MCCARTHY*Séan W. McCarthy   |  | President, Chief Operating Officer and Director                              |  | March 30, 2005
|/s/JOSEPH W. SIMON*Joseph W. Simon     |  | Managing Director and Chief Financial Officer (Principal Financial Officer)  |  | March 30, 2005
|/s/LAURA A. BIELING*Laura A. Bieling   |  | Managing Director and Controller (Principal Accounting Officer)              |  | March 30, 2005
|/s/DIRK BRUNEEL*Dirk Bruneel           |  | Director                                                                     |  | March 30, 2005
|/s/BRUNO DELETRE*Bruno Deletre         |  | Director                                                                     |  | March 30, 2005
|/s/ROBERT N. DOWNEY*Robert N. Downey   |  | Director                                                                     |  | March 30, 2005
|/s/JACQUES GUERBER*Jacques Guerber     |  | Director                                                                     |  | March 30, 2005
|                                       |  |                                                                              |  |               

128

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|/s/DAVID O. MAXWELL*David O. Maxwell   |  | Director                   |  | March 30, 2005
|-------------------------------------- |  | -------------------------- |  | --------------
|/s/JAMES H. OZANNE*James H. Ozanne     |  | Director                   |  | March 30, 2005
|/s/PIERRE RICHARD*Pierre Richard       |  | Vice Chairman and Director |  | March 30, 2005
|/s/ROGER K. TAYLOR*Roger K. Taylor     |  | Director                   |  | March 30, 2005
|/s/REMBERT VON LOWIS*Rembert von Lowis |  | Director                   |  | March 30, 2005
|/s/GEORGE U. WYPER*George U. Wyper     |  | Director                   |  | March 30, 2005

---

| |  | By: | /s/ROBERT P. COCHRANRobert P. Cochran, Attorney-in-fact
| |  | --- | -------------------------------------------------------

129

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Schedule II  Parent Company Condensed Financial Information

Condensed Balance Sheets  (in thousands)

|                                                              |  | December 31,
|------------------------------------------------------------- |  | ------------
|
|Assets:                                                       |  |             
|Bonds at market value (amortized cost of $25,301 and $20,397) |  | $           
|Short-term investments                                        |  |             
|Cash                                                          |  |             
|Investment in subsidiaries, at equity in net assets           |  |             
|Notes receivable from subsidiary                              |  |             
|Deferred compensation                                         |  |             
|Deferred taxes                                                |  |             
|Due from subsidiaries                                         |  |             
|Other assets                                                  |  |             
|                                                              |  |             
|Total Assets                                                  |  | $           
|                                                              |  |             
|Liabilities and Shareholders' Equity:                         |  |             
|Notes Payable                                                 |  | $           
|Other Liabilities                                             |  |             
|Due to subsidiaries                                           |  |             
|Deferred compensation                                         |  |             
|Taxes payable                                                 |  |             
|Shareholders' equity                                          |  |             
|                                                              |  |             
|Total Liabilities and Shareholders' Equity                    |  | $           
|                                                              |  |             

Condensed Statement of Income  (in thousands)

|                                                        |  | Year Ended December 31, |        
|------------------------------------------------------- |  | ----------------------- | -------
|
|Investment Income                                       |  | $                       | 7,379  
|Net realized gains (losses)                             |  |                         | 497    
|Other income (loss)                                     |  |                         | (21    
|Interest and amortization expense                       |  |                         | (26,993
|Commissions                                             |  |                         |       
|Other expenses                                          |  |                         | (292   
|Net unrealized gains (losses) on derivative instruments |  |                         | 1,589  
|                                                        |  |                         |        
|                                                        |  |                         | (17,841
|Equity in undistributed net income of subsidiaries      |  |                         | 355,305
|                                                        |  |                         |        
|Income before taxes                                     |  |                         | 337,464
|Income tax benefit                                      |  |                         | 26,320 
|                                                        |  |                         |        
|Net Income                                              |  | $                       | 363,784
|                                                        |  |                         |        

The
Parent Company Condensed Financial Information should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in
Item 8.

130

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Schedule II  Parent Company Condensed Financial Information (Continued)

Condensed Statements of Cash Flows  (in thousands)

|                                      |                                                   | Year Ended December 31,                   |      
|------------------------------------- | ------------------------------------------------- | ----------------------------------------- | -----
|
|Cash flows from operating activities: |                                                   |                                           |      
|                                      | Other operating expenses recovered (paid), net    |                                           | $    
|                                      | Net investment income received                    |                                           |      
|                                      | Federal income taxes received (paid)              |                                           |      
|                                      | Interest paid                                     |                                           |      
|                                      | Other                                             |                                           |      
|                                      |                                                   |                                           |      
|                                      |                                                   | Net cash used for operating activities    |      
|Cash flows from investing activities: |                                                   |                                           |      
|                                      | Proceeds from sales of bonds                      |                                           |      
|                                      | Purchases of bonds                                |                                           |      
|                                      | Dividend from subsidiary                          |                                           |      
|                                      | Capital contribution                              |                                           |      
|                                      | Net decrease (increase) in short-term investments |                                           |      
|                                      | Other investments                                 |                                           |      
|                                      |                                                   |                                           |      
|                                      |                                                   | Net cash used for investing activities    |      
|Cash flows from financing activities: |                                                   |                                           |      
|                                      | Issuance of notes payable                         |                                           |      
|                                      | Repayment of notes payable                        |                                           |      
|                                      | Surplus notes redeemed (purchased), net           |                                           |      
|                                      | Dividends paid                                    |                                           |      
|                                      |                                                   |                                           |      
|                                      |                                                   | Net cash provided by financing activities |      
|Net increase (decrease) in cash       |                                                   |                                           | (188 
|Cash at beginning of year             |                                                   |                                           | 1,246
|                                      |                                                   |                                           |      
|Cash at end of year                   |                                                   | $                                         | 1,058
|                                      |                                                   |                                           |      

In
2004, 2003 and 2002, the Company's subsidiaries received a tax benefit of $20,164, $10,645 and $18,812, respectively, by utilizing the Company's losses. These balances were recorded
as capital contributions.

The
Parent Company Condensed Financial Information should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in
Item 8.

131

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Schedule II  Parent Company Condensed Financial Information (Continued)

Condensed Statements of Cash Flows (Continued)  (in thousands)

|                                                                           |                                                  | Year Ended December 31, |        
|-------------------------------------------------------------------------- | ------------------------------------------------ | ----------------------- | -------
|
|Reconciliation of net income to net cash provided by operating activities: |                                                  |                         |        
|Net income                                                                 |                                                  | $                       | 363,784
|                                                                           | Equity in undistributed net income of subsidiary |                         |        
|                                                                           | Decrease (increase) in accrued investment income |                         |        
|                                                                           | Increase (decrease) in accrued income taxes      |                         |        
|                                                                           | Provision (benefit) for deferred income taxes    |                         |        
|                                                                           | Net realized losses (gains) on investments       |                         |        
|                                                                           | Accretion of bond discount                       |                         |        
|                                                                           | Change in other assets and liabilities           |                         |        
|                                                                           |                                                  |                         |        
|Cash used for operating activities                                         |                                                  | $                       | (17,774
|                                                                           |                                                  |                         |        

The
Parent Company Condensed Financial Information should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in
Item 8.

132

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SCHEDULE II  Financial Security Assurance Holdings Ltd. (Parent Company)  Notes to Condensed Financial Statements

Certain
information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of
America 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. Certain
reclassifications have been made to conform to the 2004 presentation.

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

On
July 31, 2003, the Company issued $100.0 million principal amount of 5.60% Notes due July 15, 2103, which are callable without premium or penalty in whole or in part at any
time on or after July 31, 2008. Debt issuance costs of $3.3 million are being amortized over the life of the Notes. In September 2003, the Company called for redemption, on
November 1, 2003, $100.0 million of its 6.950% Senior Quarterly Income Debt Securities ("Senior QUIDS") due November 1, 2098 and delivered to the trustee sufficient collateral to
legally defease the 6.950% Senior QUIDS. Unamortized debt issuance costs of $3.2 million for the 6.950% Senior QUIDS were charged to interest expense in 2003. Subsequently, the trustee used the
defeasance collateral to redeem all of the 6.950% Senior QUIDS.

On
November 26, 2002, the Company issued $230.0 million principal amount of 6.25% Notes due November 1, 2102, which are callable without premium or penalty in whole
or in part at any time on or after November 26, 2007. Debt issuance costs of $7.4 million are being amortized over the life of the debt. The Company used a portion of the proceeds of
this issuance to redeem in whole the Company's $130.0 million principal amount of 7.375% Senior QUIDS due September 30, 2097. Unamortized debt issuance costs of the retired debt of
$4.1 million were charged to interest expense in 2002.

In
connection with the Dexia group's acquisition of the Company in July 2000, the Company became the successor, for tax purposes, to White Mountains Holdings, Inc. ("WMH"). WMH had
previously sold an insurance subsidiary to a third party that was indemnified by White Mountains Insurance Group for certain future adverse loss development up to $50.0 million. In 2004, the Company
made an indemnity payment of $47.0 million to the third party with funds provided for such purpose by White Mountains Insurance Group. While the Company had no legal liability in connection with the
indemnity payment, the payment should be treated for tax purposes as a $47.0 million loss deduction to the Company, as successor to WMH. The Company therefore recorded a deferred tax asset with a
corresponding deferred tax benefit of $16.5 million. There can be no assurance that the deferred tax benefit will not be reversed in the future. In addition, under certain circumstances, which are not
probable, the Company expects to agree to share 50% of the deferred tax benefit with White Mountains Insurance Group.

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