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

FORM 10-K

|ý                                           | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|------------------------------------------- | ----------------------------------------------------------------------------------------
|For the fiscal year ended December 31, 2002
|OR                                         
|o                                           | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 1-12644

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

|New York(State or other jurisdiction of incorporation or organization)                                |  | 13-3261323(I.R.S. Employer 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
|------------------------------------------------------- |  | -----------------------------------------
|6.950% Senior Quarterly Income Debt Securities Due 2098 |  | New York Stock Exchange, Inc.            
|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.            

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 12-b2 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 28, 2002 was $34,627,795. 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, 2002.

At
March 14, 2003, there were outstanding 33,220,337 shares of Common Stock, par value $0.01 per share, of the registrant (excludes 297,658 shares of treasury stock).

Documents Incorporated By Reference

None

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TABLE OF CONTENTS

|               |  |                                                                                        |  | Page
|-------------- |  | -------------------------------------------------------------------------------------- |  | ----
|PART I         |  |                                                                                        |  |     
|Item 1.        |  | Business.                                                                              |  | 1   
|Item 2.        |  | Properties.                                                                            |  | 35  
|Item 3.        |  | Legal Proceedings.                                                                     |  | 35  
|Item 4.        |  | Submission of Matters to a Vote of Security Holders                                    |  | 35  
|PART II        |  |                                                                                        |  |     
|Item 5.        |  | Market for Registrant's Common Equity and Related Stockholder Matters.                 |  | 36  
|Item 6.        |  | Selected Financial Data.                                                               |  | 37  
|Item 7.        |  | Management's Discussion and Analysis of Financial Condition and Results of Operations. |  | 38  
|Item 7A.       |  | Quantitative and Qualitative Disclosures About Market Risk.                            |  | 51  
|Item 8.        |  | Financial Statements and Supplementary Data.                                           |  | 52  
|Item 9.        |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.  |  | 87  
|PART III       |  |                                                                                        |  |     
|Item 10.       |  | Directors and Executive Officers of the Registrant.                                    |  | 87  
|Item 11.       |  | Executive Compensation.                                                                |  | 91  
|Item 12.       |  | Security Ownership of Certain Beneficial Owners and Management.                        |  | 96  
|Item 13.       |  | Certain Relationships and Related Transactions.                                        |  | 99  
|Item 14.       |  | Controls and Procedures.                                                               |  | 100 
|PART IV        |  |                                                                                        |  |     
|Item 15.       |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K.                      |  | 101 
|Certifications |  |                                                                                        |  | 106 

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PART I

Item 1. Business.

General

Financial Security Assurance Holdings Ltd. (the "Company"), through its wholly owned subsidiary, Financial Security Assurance Inc. ("FSA"), is
primarily engaged in the business of providing financial guaranty insurance on asset-backed and municipal obligations. The claims-paying ability of FSA is rated "Triple-A" by the major
securities rating agencies and obligations insured by FSA are generally awarded "Triple-A" ratings by reason of such insurance. FSA was the first insurance company organized to insure
asset-backed obligations and has been a leading insurer of asset-backed obligations (based on number of transactions insured) since its inception in 1985. FSA expanded the focus of its business in
1990 to include financial guaranty insurance of municipal obligations. For the year ended December 31, 2002, the Company had gross premiums written of $803.7 million, of which 37%
related to insurance of asset-backed obligations and 63% related to insurance of municipal obligations. At December 31, 2002, the Company had net par outstanding of $263.3 billion, of
which 48% represented insurance of asset-backed obligations and 52% represented insurance 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 its subsidiaries, FSA Capital Markets Services LLC and FSA Capital Management Services LLC (collectively, "CMS"). The amounts stated above exclude the inter-company insurance on GICs.

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

FSA
Global Funding Limited ("FSA Global"), in which the Company owns a 29% equity interest, is a special purpose funding vehicle engaged in the issuance of FSA-insured medium
term notes. FSA Global is not consolidated with the Company for financial accounting purposes. FSA Global 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, 2002, FSA Global had $8.9 billion principal
amount of outstanding notes.

CMS,
wholly owned subsidiaries of the Company, are engaged in issuing FSA-insured GICs. Proceeds from the sale of GICs are lent to FSA Asset Management LLC ("FSAM"). FSAM
generally invests in obligations that would qualify for FSA insurance with a view towards realizing a yield difference between its investments and its obligations. At December 31, 2002, CMS had
$2.4 billion principal of outstanding GICs.

FSA
Portfolio Management Inc. ("FSA Portfolio Management"), a wholly owned subsidiary of the Company, is engaged in the business of managing the investment portfolios of the
Company and its affiliates. FSA Portfolio Management also owns various strategic and other investments originated from time to time by other members of 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.

FSA
Services (Australia) Pty Limited, a wholly owned subsidiary of the Company, provides representative services with respect to financial guaranties issued by FSA and its subsidiaries
in connection with financial transactions that have obligors or assets located in Australia.

1

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The
Company is a 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 in 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. Dexia Crédit Local is a wholly owned subsidiary of Dexia.

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 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 entered into certain agreements providing, among other things, White Mountains options to acquire additional shares of
the Company from MediaOne. In 1994, pursuant to these agreements, the Company issued to White Mountains shares of Series A non-dividend paying voting convertible redeemable
preferred stock. In 1999, White Mountains exercised its stock options and acquired additional shares of common stock from MediaOne. 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"). In connection with the foregoing, 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, Inc., which is an indirect, 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. Dexia also indirectly acquired the Company's redeemable
preferred stock, which was then contributed to the Company's capital. At December 31, 2002, the only holders of the Company's common stock were Dexia Holdings, Inc., White Mountains and
certain current and former directors of the Company who own shares of the Company's common stock or economic interests therein as described under the caption "Director Share Purchase Program" in Item
11. 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 because certain of its debt securities were sold through public offerings and are listed on the NYSE.

The
principal executive offices of the Company are located at 350 Park Avenue, New York, New York 10022. Subsidiaries of the Company maintain offices domestically in San Francisco and
Dallas and abroad in London, Madrid, Paris, Singapore, Sydney, Tokyo and Bermuda.

Industry Overview

Financial guaranty insurance written by FSA typically guarantees scheduled payments on an issuer's obligations. Upon a payment default on an insured obligation,
FSA is generally required to pay the principal, interest or other amounts due in accordance with the obligation's original payment schedule or, at its option, to pay such amounts on an accelerated
basis. FSA's underwriting policy is to insure asset-backed and municipal obligations that would otherwise be investment grade without the benefit of FSA's insurance. 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

2

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obligations
such as credit default swaps and credit-linked notes. Municipal obligations insured by FSA consist primarily of general obligation bonds supported by the issuers' taxing power and special
revenue bonds and other special obligations of state and local governments supported by the issuers' ability to impose and collect fees and charges for public services or specific projects.

The
Company's business objective is to remain a leading insurer of asset-backed and municipal obligations employing transactional and financial skills to generate increased premium
volume at attractive returns while 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 three trends: (i) expansion of asset securitization outside the residential mortgage sector; (ii) substantial
volume of new domestic municipal bonds that are insured, due, in part, to the continued use of municipal bonds to finance repairs and improvements to the nation's infrastructure and municipal bond
purchases by individuals who generally purchase insured obligations; and (iii) growing use of asset securitization and financial guaranty insurance in non-U.S. markets, due, in
part, to a trend towards private financing initiatives for projects that have essential public purposes and regulatory changes encouraging or facilitating credit-enhanced transactions. The Company
also anticipates continued demand over the long term for its GIC business and other asset management programs that employ financial guaranty insurance provided by FSA.

The
Company expects to continue to emphasize a diversified insured portfolio characterized by insurance of both asset-backed and municipal obligations, with a broad geographic
distribution and a variety of revenue sources and transaction structures. In addition to its domestic business, the Company selectively pursues international opportunities primarily in Western
European and Asia Pacific markets.

Business of FSA

General

The business of FSA is managed by the Company's Management Committee, comprised of FSA's Chief Executive Officer, President, General Counsel, Chief Underwriting
Officer, Chief Financial Officer and Managing Director in charge of its Asset Finance Group. FSA is primarily engaged in the business of writing financial guaranty insurance on asset-backed and
municipal obligations. In 1998, FSA commenced insuring medium term notes issued by FSA Global. In 2001, FSA commenced insuring GICs issued by CMS.

Asset-Backed Obligations

Asset-backed obligations are typically issued in connection with structured financings or securitizations, in which the securities being issued are secured by or
payable from a specific pool of assets having an ascertainable cash flow or market value and held by a special purpose issuing entity. While most asset-backed obligations are secured by or represent
interests in diverse pools of assets, such as residential mortgage loans, auto loans, credit card receivables, other consumer receivables, corporate loans or bonds, government debt, small business
loans and multi-family mortgage loans, monoline financial guarantors also insure asset-backed obligations 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 and excess cash flow, to cover credit
risks associated with the related assets. Synthetic asset-backed obligations generally take the form of credit default swap obligations or credit-linked notes that reference a pool of securities or
loans, with a defined deductible to cover credit risks associated with the referenced securities or loans.

3

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According
to industry sources, the par volume of funded U.S. public asset-backed securities, including securities distributed under Rule 144A, since 1997, were as follows:

Year

New Issues of Funded U.S.
Public Asset-Backed Securities(1)(in billions)1997

$
207.61998


245.61999


254.72000


272.82001


324.62002


408.9


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According
to industry sources, par volumes in certain other asset-backed markets from 2000 through 2002 were as follows:

Year

U.S. Public Issues
of Private-Label
Mortgage-Backed Securities(1)

Non-U.S. Asset-Backed
Securities(1)

Worldwide Funded
Collateralized Debt
Obligations(1)(in billions)2000

$
65.8

$
85.6

$
78.52001


143.1


115.2


79.62002


213.8


115.5


72.1


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According
to industry sources, the annual total of asset-backed par insured of financial guaranty insurance originated by monoline guarantors since 1997 were as follows:

Year

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

Non-U.S. Asset-Backed Obligations Insured
by Monoline Insurance Companies(in billions)1997

$
79.8

$
12.81998


103.6


16.51999


117.9


24.22000


116.1


55.22001


167.1


51.42002


N/A
(2)

N/A
(2)


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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 certain of their assets, such as credit card receivables and automobile
loans, in securitized structures to the financial markets. In addition, many 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. Also, some finance companies fund consumer finance and home equity lending through securitization. In recent years, there has been
substantial consolidation and contraction among finance companies, particularly in the subprime mortgage and auto loan finance sectors in which FSA operates.

4

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Since
the late 1990s, there has been significant growth in the market 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. The data with respect to funded CDOs in the table above excludes synthetic
transactions and therefore fails to reflect the substantial growth in this sector. According to survey data published on the website of the International Swaps and Derivatives
Association, Inc., www.isda.org, $1.6 trillion in notional principal amount of credit default swaps were outstanding in world markets at June 30, 2002, compared with
$631.5 billion at June 30, 2001.

Worldwide,
the volume of asset-backed obligations insured by monoline guarantors exceeded the volume of municipal obligations insured by monoline guarantors for the first time in 1999
and again in 2000 and 2001, according to the Association of Financial Guaranty Insurors. Similarly, according to the December 31, 2002 statistical operating supplements published by the four
largest monoline guarantors, those four companies insured, in the aggregate, asset-backed par volume of $216.1 billion, or 52% of the $413.8 billion total insured during 2002 by the four
companies, despite a large increase in issuance of municipal bonds. The asset-backed financial guaranty business has grown because of expansion of U.S. and international asset-backed markets, the
related opportunities for guarantors to improve the credit quality and diversification of their insured portfolios, high demand for credit enhancement on complex asset-backed issues, and the
attraction of higher returns available in the asset-backed market.

Municipal Obligations

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

Until
1999, insurance of municipal obligations represented the largest portion of the financial guaranty insurance business. Both total issuance and refundings of U.S. municipal
obligations increased in 1996, 1997 and 1998, primarily because of lower interest rates. In 1999, rising interest rates caused a steep decline in refundings, which was responsible for much of the
decline in total issuance that year. The year 2000 saw a further decline in both total municipal issuance and percentage of municipal par insured benefiting from bond insurance, attributable in part
to budget surpluses reducing borrowing needs, with strengthened municipal issuers having less need to employ bond insurance. In 2001, new issue volume grew substantially due, in part, to a declining
interest rate environment, and insurance penetration returned to approximately the same level as in 1999. Volume increased dramatically in 2002 as low interest rates, diminished tax revenues and
continuing needs for infrastructure investment drove municipalities to borrow on an unprecedented scale.

5

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The
following table sets forth certain information regarding long-term U.S. municipal new issues sold during the periods indicated:

Insured Municipal Obligations(1)

Year

New
Total Volume

New
Insured Volume

New Insured
Volume
as Percent
of New Total Volume(dollars in billions)1995

$
160.0

$
68.5

42.8
%1996


185.0


85.7

46.31997


220.5


107.5

48.81998


286.7


145.5

50.71999


227.4


105.3

46.32000


200.7


79.5

39.62001


286.6


132.5

46.22002


357.9


176.7

49.4


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GICs/Medium Term Notes

The Company's GIC business, conducted through CMS, provides GICs to municipalities and other market participants. GICs written by CMS are insured by FSA.
Municipal GICs are primarily used by holders to invest bond proceeds required to be maintained in a debt service reserve fund or construction fund for a bond issue. GICs provide for the return of
principal and the payment of interest at a guaranteed rate. Amounts raised through the issuance of GICs are generally raised 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 the positive difference between the borrowing rate (the floating rate on the GICs) and the
floating rate interest on the investments. These investments are owned, and the related risk management function is performed, by FSAM.

FSA-insured
GICs subject the Company to risk associated with early 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 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 AA- by S&P or Aa3 by 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. At December 31, 2002, CMS had approximately $2.4 billion principal of GICs outstanding.

6

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The
Company owns 29% of the equity of FSA Global, a Cayman Islands domiciled issuer of FSA-insured notes and other obligations sold in international markets (generally
referred to as medium term notes or "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. 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 FSA Global notes (taking into account, in some cases, dedicated third party liquidity). The matched funding structure
minimizes the market risks borne by FSA Global and FSA. FSA Global raises funds in U.S. dollars at LIBOR-based floating borrowing rates and invests its funds in obligations insured by FSA, maturing
prior to the maturity of the related FSA Global notes and paying a higher interest rate than the interest rate on the related FSA Global notes. At December 31, 2002, FSA Global had total assets
and total liabilities of $9.2 billion and $9.2 billion, respectively. The foregoing assets and liabilities include assets and matched liabilities that are "economically defeased" in
lease financings in which Company affiliates may play a
number of financing roles. These "economically defeased" liabilities, and associated assets, are held in separate special purpose entities, FSA Global and Premier International Funding Co. At
December 31, 2002 and 2001, FSA Global's "economically defeased" obligations were $6.7 billion and $2.0 billion, respectively. FSA Global's net income for the year ended
December 31, 2002 and 2001 was $1.0 million and $0.6 million, respectively. FSA Global's net income is determined net of premiums paid by FSA Global to FSA. For the years ended
December 31, 2002 and 2001, FSA Global paid premiums to FSA and another insurer of $7.7 million and $7.5 million, respectively. All amounts insured by FSA relating to FSA Global
are included in the Company's outstanding exposure, included in the Notes to the Consolidated Financial Statements for December 31, 2002. As of December 31, 2002, there were no case
basis reserves required for any transactions related to FSA Global.



FSA's insurance is employed in both the new issue and secondary markets. Insurance premium rates take into account the projected return to and risk assumed by
FSA. Critical factors in assessing risk include the credit quality of the issuer, type of issue, sources of repayment, transaction structure and term to maturity. Each obligation is evaluated on the
basis of such factors and subject to FSA's underwriting guidelines. The final premium rate is generally a function of market factors, including, in the case of funded transactions, the interest rate
savings to the issuer from the use of insurance. In transactions under the Company's GIC and MTN programs, transactions involving "repackaging" of outstanding securities and other cases, FSA's premium
may be arbitrage-based, equaling the difference between the effective borrowing cost at a Triple-A rate and the interest rate on the underlying securities.

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

In
the secondary market, FSA's Triple-A Guaranteed Secondary Securities (TAGSS®) 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 security issues, although the evaluation procedures are typically abbreviated.

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. FSA
also issues surety bonds under its Sure-Bid® program, which provides an alternative to traditional types of good faith deposits on competitive municipal bond transactions.

7

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The
following table indicates the Company's percentages of par amount (net of reinsurance) outstanding at December 31, 2002 and 2001 with respect to each type of asset-backed and
municipal program:

Net Par Amount and Percentage Outstanding by Program Type

|                 |       | December 31, 2002 |        
|---------------- | ----- | ----------------- | -------
|
|
|
|New Issue        |       | $                 | 118,332
|Secondary Market |       |                   | 6,590  
|                 |       |                   |        
|                 | Total |                   | $      
|                 |       |                   |        

|                 |       | December 31, 2001 |        
|---------------- | ----- | ----------------- | -------
|
|
|
|New Issue        |       | $                 | 104,274
|Secondary Market |       |                   | 5,507  
|                 |       |                   |        
|                 | Total |                   | $      
|                 |       |                   |        

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Insurance in Force

FSA insures a variety of asset-backed obligations, including obligations backed by residential mortgage loans, consumer or trade receivables, corporate loans and
bonds, government debt and multifamily mortgage loans. Asset-backed obligations insured by FSA include payment obligations of counterparties and issuers under synthetic obligations such as credit
default swaps and credit-linked notes structured to have risks similar to more traditional forms of asset-backed structures. FSA has insured a broad array of municipal obligations. FSA has also
insured investor-owned utility first mortgage bonds and sale/leaseback obligation bonds. In 1990, FSA ceased writing insurance backed by commercial mortgage loans, and today retains only minor net
insurance in force in that sector. FSA has also insured obligations of financial institutions and, on a short-term basis, obligations of highly rated corporate obligors. In recent years,
FSA has insured obligations in connection with various cross-border and municipal leases. In some cases, FSA has insured 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.

FSA
has selectively expanded its insured portfolio in a manner intended to achieve diversification. At December 31, 2002, excluding $2.4 billion of net par outstanding of
FSA-insured GICs, FSA and its subsidiaries had in force policies relating to 837 issues insuring approximately $152.9 billion in gross direct par amount outstanding of asset-backed
obligations and 7,491 issues insuring approximately $200.5 billion in gross direct par amount outstanding of municipal obligations. In addition, at December 31, 2002, FSA had assumed
pursuant to certain reinsurance contracts approximately $1.2 billion and $0.8 billion in par amount outstanding on asset-backed and municipal obligations, respectively, resulting in a
total gross par amount outstanding of approximately $355.4

8

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billion.
At such date, the total net par amount outstanding, determined by reducing the gross par amount outstanding to reflect reinsurance ceded of approximately $92.1 billion, was
approximately $263.3 billion. Net par data does not distinguish between quota share and first loss reinsurance. In light of FSA's substantial use of first loss reinsurance in the asset-backed
sector, net par data tends to overstate FSA's net risk exposure. At December 31, 2002, the weighted average life of the direct principal insured on these policies was approximately 3 and
13 years, respectively, for asset-backed and municipal obligations.

Asset-Backed and Other Non-Municipal Obligations

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

Domestic Residential Mortgage Loans.Obligations primarily backed by residential mortgage loans generally take the form of
conventional pass-through certificates or pay-through debt securities, but also include other structured products. Residential mortgage loans backing these insured obligations
include closed-end first mortgage loans and closed- and open-end second mortgage loans or home equity loans on one-to-four family residential
properties, including condominiums and cooperative apartments. Domestic residential mortgage loan obligations insured by FSA have tended to be concentrated in the "sub-prime" sector,
featuring lower quality borrowers mitigated by higher levels of subordination and/or excess spread. In recent years, FSA has also insured "net interest margin" ("NIM") securities backed by the senior
portion of residual cash flows from securitizations of domestic residential mortgage loans. FSA has generally declined to participate in securitizations of so-called "high cost mortgage
loans," characterized by very high interest rates or "points and fees" and subject to restrictive federal and state regulations.

Domestic Consumer Receivables.Obligations primarily backed by consumer receivables include conventional
pass-through and pay-through securities as well as more highly structured transactions. Consumer receivables backing these insured obligations include automobile loans and
leases, manufactured housing loans and credit card receivables. Consumer receivable transactions insured by FSA have tended to be concentrated in the sub-prime auto loan and credit card
receivable sectors.

Domestic Pooled Corporate Obligations.Obligations primarily backed by pooled corporate obligations include funded and
synthetic obligations collateralized by corporate debt securities or corporate loans and obligations backed by cash flow or market value of non-consumer indebtedness, and include
"collateralized bond obligations", "collateralized loan obligations" (collectively, "collateralized debt obligations" or "CDOs") and comparable risks under credit default swap obligations. Corporate
obligations include corporate bonds, bank loan participations, trade receivables, franchise loans and equity securities. Obligations under credit default swaps ("CDS") represent a growing percentage
of this sector, comprising approximately 67% at December 31, 2002 on the basis of net par outstanding. CDS obligations expose FSA to elements of market value risk arising from obligations to
pay the difference between par and market value upon the occurrence of a payment default or other defined "credit events" specified in the credit default swap. FSA generally addresses these risks by
requiring large "deductibles" as a condition to payment under CDS insured by FSA.

Other Domestic Non-Municipal Obligations.Other domestic non-municipal obligations include bonds or
other securities backed by government securities, letters of credit or repurchase agreements collateralized by government securities, securities backed by a combination of assets that include elements
of more than one of the categories set forth above and unsecured corporate obligations satisfying FSA's underwriting criteria. Other domestic non-municipal obligations insured by FSA also
include first mortgage bond obligations of for-profit electric or water utilities providing retail, industrial and commercial service, sale-leaseback obligation bonds supported
by such utilities and other obligations backed by investor owned utilities. In each case, these bonds are secured by a mortgage on property owned by or leased to an investor-owned utility.

International Asset-Backed Obligations.International asset-backed obligations include obligations of
non-domestic portions of funded and synthetic CDOs, securitizations of perpetual floating rate notes of non-domestic banks, obligations of non-domestic investor
owned utilities and other obligations having international aspects but otherwise within the asset-backed categories described above.

9

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Municipal Obligations

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

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

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

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

Domestic Health Care Revenue Bonds.Health care revenue bonds include both long-term maturities for capital
construction or improvements of health care facilities and medium-term maturities for equipment purchase, typically secured by an underlying note of the
not-for-profit corporation owning and operating the individual hospital or health care system.

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

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

Other Domestic Municipal Bonds.Other domestic municipal bonds insured by FSA include college and university (primarily
public or state-supported) revenue bonds, moral obligation bonds, financings for stadiums, resource recovery bonds and debt issued, guarantied or otherwise supported by domestic national or local
governmental entities.

International Municipal Obligations.International municipal obligations include obligations of sovereign and
sub-sovereign non-domestic municipal issuers, project finance transactions involving projects leased to or supported by payments from non-domestic governmental or
quasi-governmental entities, toll road transactions supported by toll revenues, obligations arising under leases of equipment or facilities by non-domestic municipal obligors,
non-domestic municipal utility revenue bonds and other obligations having international aspects but otherwise within the municipal categories described above.

10

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A
summary of FSA's insured portfolio at December 31, 2002 is shown below. Please note that exposure amounts are expressed net of reinsurance but do not distinguish between quota
share reinsurance and first loss reinsurance.

Summary of Insured Portfolio at December 31, 2002(1)(2)

|                         |                                              | Number of
Issues In
Force      |       | Net Par
Amount
Outstanding |       | Net
Par and
Interest |         | Percent
of Net
Par and
Interest |       
|------------------------ | -------------------------------------------- | ------------------------------ | ----- | -------------------------- | ----- | -------------------- | ------- | ------------------------------- | ------
|
|Asset-backed obligations |                                              |                                |       |                            |       |                      |         |                                 |       
|                         | Residential mortgages                        |                                | 358   |                            | $     | 21,604               |         | $                               | 24,980
|                         | Consumer receivables                         |                                | 79    |                            |       | 18,776               |         |                                 | 20,257
|                         | Pooled corporate obligations                 |                                | 185   |                            |       | 48,613               |         |                                 | 52,895
|                         | Other domestic asset-backed obligations      |                                | 90    |                            |       | 3,233                |         |                                 | 4,613 
|                         | International obligations                    |                                | 128   |                            |       | 33,867               |         |                                 | 35,741
|                         |                                              |                                |       |                            |       |                      |         |                                 |       
|                         |                                              | Total asset-backed obligations |       | 840                        |       |                      | 126,093 |                                 |       
|                         |                                              |                                |       |                            |       |                      |         |                                 |       
|Municipal obligations    |                                              |                                |       |                            |       |                      |         |                                 |       
|                         | General obligation bonds                     |                                | 4,692 |                            |       | 52,786               |         |                                 | 80,182
|                         | Housing revenue bonds                        |                                | 196   |                            |       | 5,834                |         |                                 | 11,186
|                         | Municipal utility revenue bonds              |                                | 889   |                            |       | 23,442               |         |                                 | 38,883
|                         | Health care revenue bonds                    |                                | 165   |                            |       | 5,970                |         |                                 | 10,605
|                         | Tax-supported (non-general obligation) bonds |                                | 901   |                            |       | 27,556               |         |                                 | 43,658
|                         | Transportation revenue bonds                 |                                | 101   |                            |       | 7,640                |         |                                 | 14,666
|                         | Other domestic municipal bonds               |                                | 632   |                            |       | 9,304                |         |                                 | 14,431
|                         | International obligations                    |                                | 67    |                            |       | 4,645                |         |                                 | 9,960 
|                         |                                              |                                |       |                            |       |                      |         |                                 |       
|                         |                                              | Total municipal obligations    |       | 7,643                      |       |                      | 137,177 |                                 |       
|                         |                                              |                                |       |                            |       |                      |         |                                 |       
|                         |                                              |                                | Total |                            | 8,483 |                      | $       | 263,270                         |       
|                         |                                              |                                |       |                            |       |                      |         |                                 |       

---

11

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Obligation Type

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

Annual New Business Insured by Obligation Type

|                                                 |                                              | Year Ended December 31,        |      
|------------------------------------------------ | -------------------------------------------- | ------------------------------ | -----
|
|Asset-backed and other non-municipal obligations |                                              |                                |      
|                                                 | Residential mortgages                        |                                | 9    
|                                                 | Consumer receivables                         |                                | 10   
|                                                 | Pooled corporate obligations                 |                                | 15   
|                                                 | Other domestic non-municipal obligations(1)  |                                | 1    
|                                                 | International obligations                    |                                | 17   
|                                                 |                                              |                                |      
|                                                 |                                              | Total asset-backed obligations |      
|                                                 |                                              |                                |      
|Municipal obligations                            |                                              |                                |      
|                                                 | General obligations bonds                    |                                | 19   
|                                                 | Housing revenue bonds                        |                                | 2    
|                                                 | Municipal utility revenue bonds              |                                | 9    
|                                                 | Health care revenue bonds                    |                                | 1    
|                                                 | Tax-supported (non-general obligation) bonds |                                | 8    
|                                                 | Transportation revenue bonds                 |                                | 4    
|                                                 | Other domestic municipal bonds               |                                | 3    
|                                                 | International bonds(1)                       |                                | 2    
|                                                 |                                              |                                |      
|                                                 |                                              | Total municipal obligations    |      
|                                                 |                                              |                                |      
|                                                 |                                              |                                | Total
|                                                 |                                              |                                |      

---

12

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Terms to Maturity

The table below sets forth the estimated terms to maturity of FSA's policies at December 31, 2002 and 2001:

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

|                   |       | December 31, 2002 |        | December 31, 2001
|------------------ | ----- | ----------------- | ------ | -----------------
|
|
|0 to 5 years       |       | $                 | 64,158 |                  
|5 to 10 years      |       |                   | 33,908 |                  
|10 to 15 years     |       |                   | 4,781  |                  
|15 to 20 years     |       |                   | 1,667  |                  
|20 years and above |       |                   | 21,579 |                  
|                   |       |                   |        |                  
|                   | Total |                   | $      | 126,093          
|                   |       |                   |        |                  

---

Issue Size

The tables below set forth information with respect to the original net par amount of insurance written per issue insured by FSA at December 31, 2002:

Asset-BackedOriginal Net Par Amount Per Issue(1)(2)

|Original
Net Par Amount |       | Number
of Policies |       | Percent of
Total
Number
of Issues |       | Net Par
Amount
Outstanding |         | Percent of
Total
Net Par
Amount
Outstanding |     
|----------------------- | ----- | ------------------ | ----- | --------------------------------- | ----- | -------------------------- | ------- | ------------------------------------------- | ----
|
|Less than $10 million   |       | 655                |       | 29.1                              | %     | $                          | 648     |                                             | 0.5 
|$10 to $25 million      |       | 260                |       | 11.6                              |       |                            | 1,347   |                                             | 1.1 
|$25 to $50 million      |       | 250                |       | 11.1                              |       |                            | 2,957   |                                             | 2.4 
|$50 million or greater  |       | 1,084              |       | 48.2                              |       |                            | 119,969 |                                             | 96.0
|                        |       |                    |       |                                   |       |                            |         |                                             |     
|                        | Total |                    | 2,249 |                                   | 100.0 | %                          | $       | 124,921                                     |     
|                        |       |                    |       |                                   |       |                            |         |                                             |     

---

13

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MunicipalOriginal Net Par Amount Per Issue(1)

|Original
Net Par Amount |       | Number
of Policies |        | Percent of
Total
Number
of Issues |       | Net Par
Amount
Outstanding |        | Percent of
Total
Net Par
Amount
Outstanding |     
|----------------------- | ----- | ------------------ | ------ | --------------------------------- | ----- | -------------------------- | ------ | ------------------------------------------- | ----
|
|Less than $10 million   |       | 11,214             |        | 71.2                              | %     | $                          | 28,486 |                                             | 20.9
|$10 to $25 million      |       | 2,559              |        | 16.2                              |       |                            | 24,766 |                                             | 18.2
|$25 to $50 million      |       | 972                |        | 6.2                               |       |                            | 19,477 |                                             | 14.3
|$50 million or greater  |       | 1,004              |        | 6.4                               |       |                            | 63,682 |                                             | 46.6
|                        |       |                    |        |                                   |       |                            |        |                                             |     
|                        | Total |                    | 15,749 |                                   | 100.0 | %                          | $      | 136,411                                     |     
|                        |       |                    |        |                                   |       |                            |        |                                             |     

---

Geographic Concentration

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

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

Municipal Insured Portfolio by Jurisdiction
at December 31, 2002

|Jurisdiction                 |       | Number
of Issues |       | Net Par
Amount
Outstanding |        | Percent of Total
Municipal Net
Par Amount
Outstanding |     
|---------------------------- | ----- | ---------------- | ----- | -------------------------- | ------ | ----------------------------------------------------- | ----
|
|California                   |       | 837              |       | $                          | 19,379 |                                                       | 14.1
|New York                     |       | 550              |       |                            | 13,256 |                                                       | 9.7 
|Texas                        |       | 615              |       |                            | 10,052 |                                                       | 7.3 
|Pennsylvania                 |       | 580              |       |                            | 8,496  |                                                       | 6.2 
|Florida                      |       | 230              |       |                            | 7,602  |                                                       | 5.5 
|Illinois                     |       | 580              |       |                            | 6,697  |                                                       | 4.9 
|New Jersey                   |       | 445              |       |                            | 6,322  |                                                       | 4.6 
|Washington                   |       | 239              |       |                            | 5,020  |                                                       | 3.7 
|Massachusetts                |       | 172              |       |                            | 4,088  |                                                       | 3.0 
|Michigan                     |       | 340              |       |                            | 3,864  |                                                       | 2.8 
|Wisconsin                    |       | 393              |       |                            | 3,529  |                                                       | 2.6 
|All other U.S. jurisdictions |       | 2,622            |       |                            | 45,399 |                                                       | 33.1
|International                |       | 40               |       |                            | 3,473  |                                                       | 2.5 
|                             |       |                  |       |                            |        |                                                       |     
|                             | Total |                  | 7,643 |                            | $      | 137,177                                               |     
|                             |       |                  |       |                            |        |                                                       |     

The
Company's 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,
|------------- | -------------- | -----------------------
|
|
|U.S.          |                | $                      
|International |                |                        
|              |                |                        
|              | Total revenues |                        
|              |                |                        

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Issuer Concentration

FSA 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 Standard & Poor's Ratings Services ("S&P") to measure 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 insured by it. In many cases, FSA uses reinsurance to limit net exposure to any one credit. At December 31, 2002,
insurance of asset-backed obligations constituted 48% of FSA's net par outstanding and insurance of municipal obligations constituted 52% of FSA's net par outstanding. At such date, FSA's ten largest
net insured asset-backed transactions represented $17.0 billion, or 6.5%, of its total net par amount outstanding, and FSA's ten largest net insured municipal credits represented
$8.1 billion, or 3.1%, of its total net par amount outstanding. In light of FSA's substantial use of first loss reinsurance in the asset-backed sector, net par data tends to overstate FSA's net
risk exposure. For purposes of the foregoing, different issues of asset-backed securities by the same sponsor have not been aggregated. FSA has, however, adopted underwriting
policies establishing single risk guidelines applicable to asset-backed securities of the same sponsor. In addition, individual corporate names appear in FSA-insured CDO transactions, but
such exposures are not aggregated for purposes of identifying FSA's largest exposures. Instead, FSA addresses these risks by limiting its exposure to the CDO sector in the aggregate. FSA is also
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 written or reinsured by FSA is designed to meet the general underwriting guidelines and specific standards for
particular types of obligations approved by its Board of Directors. In addition, the Company's Board of Directors has established an Underwriting Committee that periodically reviews completed
transactions to ensure conformity with underwriting guidelines and standards.

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 credit support. In this regard, asset-backed obligations insured by FSA are generally issued in structured transactions and backed by pools of assets such as consumer or trade
receivables, residential mortgage loans, securities or other assets having an ascertainable cash flow or market value. In addition, FSA seeks to insure asset-backed obligations that generally provide
for one or more forms of overcollateralization (such as excess collateral value, excess cash flow or "spread," reserves or, in the case of credit default swaps, 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 third-party protection need not indemnify
FSA against all loss, but is generally intended to assume the primary risk of financial loss. Asset-backed obligations insured by FSA also often benefit from self-adjusting mechanisms,
such as cash traps or accelerated amortization that take effect upon a failure of the transaction to satisfy performance based triggers. Overcollateralization 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 bonds issued to refinance other bonds insured by FSA as to which the issuer is or may be in default. FSA's general policy has been to insure 100% of the
principal, interest and other amounts due in respect of funded asset-backed obligations rather than providing partial or first loss coverage sufficient to confer a Triple-A rating on the
insured obligations.

FSA's
underwriting guidelines for municipal obligations require that a transaction be rated investment grade by Moody's Investors Service, Inc. ("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

15

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of
additional security (e.g., mortgages on real property, liens on equipment or revenue pledges) to secure the obligation.

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

The
underwriting process that implements these underwriting guidelines and standards is supported by 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 has a senior underwriting officer 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 from FSA's Municipal Underwriting Committee (the "MUNC") for
municipal transactions. Approval is usually based upon both a written and an oral presentation by the underwriting group to the respective committee. The MRC is comprised of FSA's Chief Executive
Officer, President, Chief Underwriting Officer, Chief International Underwriting Officer, General Counsel, Associate General Counsel for Asset-Backed Transactions and a senior underwriting officer.
The Chief Executive Officer, President and General Counsel do not participate in MRC meetings for transactions not classified as presenting new issues. The MUNC is comprised of FSA's Chief Executive
Officer, President, Chief Municipal Underwriting Officer, Managing Director of Public Finance, Associate General Counsel for Municipal Transactions and Managing Director for Municipal Oversight.
Following approval, minor transaction modifications may be approved by the Chairs of the underwriting groups. Major changes require the concurrence of the appropriate underwriting committee. Subject
to applicable limits, secondary market and portions of senior classes of asset-backed transactions that meet certain credit and return criteria may be approved by one member of FSA's Risk Management
Group and the head of the department involved, with a third signature required from a member of the Risk Management Group for larger transactions. Subject to applicable limits, municipal transactions
that meet certain credit and return criteria may be approved by a committee comprised of the Chief Municipal Underwriting Officer or the Managing Director for Municipal Oversight, or Associate General
Counsel for Municipal Transactions and any one of certain managing directors and directors designated by the MUNC.

Corporate Research

FSA's Corporate Research Department is comprised of a professional staff under the direction of the Chief Underwriting Officer. The Corporate Research Department
is responsible for evaluating the credit of entities participating or providing recourse on obligations insured by FSA. The Corporate Research Department 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 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 Underwriting Officer and Chief Municipal
Underwriting Officer. This function also reports to a Risk Management Committee comprised of FSA's

16

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Chief
Underwriting Officer, Chief Municipal Underwriting Officer, Chief International Underwriting Officer and a senior underwriting officer, with FSA's Chief Executive Officer, President, General
Counsel and Chief Financial Officer as ex officio members. The Transaction Oversight Departments review insured transactions to confirm compliance with transaction covenants, monitor credit and other
developments affecting transaction participants and collateral, and determine the steps, if any, required to protect the interests of FSA and the holders of FSA-insured obligations.
Reviews for asset-backed transactions typically include an examination of reports provided by, and (as circumstances warrant) discussions with, issuers, servicers, trustees and other transaction
participants. Reviews of asset-backed transactions often include servicer audits, site visits or evaluations by third-party appraisers, engineers or other experts retained by FSA. The Transaction
Oversight Departments review each transaction to determine the level of ongoing attention it will require. These judgments relate to current credit quality and other factors, including compliance with
reporting or other requirements, legal or regulatory actions involving transaction participants and liquidity or other concerns that may not have a direct bearing on credit quality. Transactions with
the highest risk profile are generally subject to more intensive review and, if appropriate, remedial action. The Transaction Oversight 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.

Legal

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

Loss Reserves

FSA establishes a case basis reserve for the net present value of an estimated loss when, in management's opinion, the likelihood of a future loss on a particular
insured obligation is probable and determinable at the balance sheet date. The case basis reserve represents FSA's estimate of the present value of the anticipated shortfall, net of reinsurance,
between (i) scheduled payments on the insured obligations plus anticipated loss adjustment expenses and (ii) anticipated cash flow from and proceeds to be received on sales of any
collateral supporting the obligation and other anticipated recoveries. For CDOs, the need for a case basis reserve is assessed when the overcollateralization ratio (non-defaulted
collateral at par divided by the debt insured) has fallen below 100%.

In
addition to its case basis reserves, FSA maintains a non-specific general reserve in order to account for unidentified risks inherent in its overall portfolio, that is,
when the loss cannot be attributed to a particular insured obligation. FSA does not consider traditional actuarial approaches used in the property/casualty insurance industry to be applicable to the
determination of its loss reserves because of the absence of a sufficient number of losses in its financial guaranty insurance activities and in the financial guaranty industry generally to establish
a meaningful statistical base. The general reserve amount is calculated by applying a loss factor to the total net par amount of FSA's insured obligations outstanding over the term of such insured
obligations and discounting the result at the then current risk-free rate. The loss factor used for this purpose has been determined based upon an independent rating agency study of bond
defaults and FSA's portfolio characteristics and history. Management, beginning in the second quarter of 2002, has refined the loss factor it applies to its net par underwritten when calculating the
general reserve in order to reflect its recent adverse experience (see discussion below). The general reserve is available to be applied against future additions or accretions to existing case basis
reserves or to new case basis reserves to be established in the future. To the extent that any such future additions to case basis reserves are applied from the available general reserve, there will
be no impact on the Company's earnings for that period. To the extent that

17

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additions
to case basis reserves for any period are not applied from the general reserve, the excess will be charged against the Company's earnings for that period. Any addition to the general reserve
which results from applying the loss factor to net par written will result in a charge to earnings at that time. FSA maintains losses and loss adjustment expense reserves in an amount believed by its
management to be sufficient to pay the net present value of its estimated ultimate liability for losses and loss adjustment expenses with respect to obligations it has insured.

Activity
in the liability for losses and loss adjustment expenses, consisting of case basis and general reserves, is summarized as follows:

|                                                      |                        | Year Ended December 31,
|----------------------------------------------------- | ---------------------- | -----------------------
|
|
|Balance at January 1                                  |                        | $                      
|Less reinsurance recoverable                          |                        |                        
|                                                      |                        |                        
|Net balance at January 1                              |                        |                        
|Incurred losses and loss adjustment expenses:         |                        |                        
|                                                      | Current year           |                        
|                                                      | Prior years            |                        
|Recovered (paid) losses and loss adjustment expenses: |                        |                        
|                                                      | Prior years            |                        
|                                                      |                        |                        
|Net balance December 31                               |                        |                        
|Plus reinsurance recoverable                          |                        |                        
|                                                      |                        |                        
|                                                      | Balance at December 31 |                        
|                                                      |                        |                        

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 analyzed all CDO transactions in its insured portfolio that breached overcollateralization triggers, which were included in such transactions as one measure of adverse
performance. A present value "deterministic" approach was utilized as a basis to estimate the loss inherent in this portfolio. The deterministic model applies a run of the collateral portfolio for
each transaction considering each CDO transaction's unique attributes (such as reinsurance, individual collateral ratings and status, derivatives purchased, premiums due to the guarantor, etc.)
utilizing a Moody's default pattern for frequency of defaults, an estimate of collateral recovery values for severity, and a risk-free rate of interest. 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 result, management selected Moody's 1992 idealized default curve as a predictor of future defaults on the CDO collateral. 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 and more 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. As described in more detail below, management addressed this net present value
of expected loss ($51.5 million) through (i) an increase in the Company's general reserve ($31.0 million) and (b) amounts already existing in its general reserve
($20.5 million), including general reserve amounts reallocated to case basis reserves ($11.3 million). The $31.0 million increase in the Company's general reserve resulted in a
corresponding increase to losses and loss adjustment expense in the income statement 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 has established a methodology of recording case basis reserves on CDO transactions to the extent that 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 in respect of these transactions until 2010, but may elect to do so at an earlier date at its discretion. Over time, management expects to reallocate amounts in its
general reserve (including accretions thereto) to case basis reserves as specific losses on its insured CDO portfolio become probable and estimable in accordance with the undercollateralization
methodology described above.

18

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Application
of this methodology resulted in recording $68.8 million in gross case basis reserves and $29.8 million in reinsurance recoverable on unpaid losses, resulting in a
$39.0 million increase in net case basis reserves. Management, beginning in the second quarter of 2002, refined the loss factor it applies to its net par underwritten when calculating the
general reserve in order to reflect its recent adverse experience. As a result, the general reserve accrual for the year ended December 31, 2002 was $65.6 million, rather than the
approximate $14.9 million that would have been accrued using the prior assumptions. Management expects future reserve contributions to be approximately double the amounts under the prior
practice, exclusive of the additions to the general reserve as a result of the insured CDO portfolio of $41.1 million in 2002.

During
2000, the Company increased its general reserve by $9.4 million, of which $6.7 million was for originations of new business and $2.7 million was for the
accretion of the discount on prior years' reserves. Also during 2000, the Company transferred to the general reserve $2.0 million, representing recoveries received on prior-year
transactions, and transferred $1.2 million from the general reserve to case basis reserves. Giving effect to these transfers, the general reserve totaled $65.2 million at
December 31, 2000.

During
2001, the Company increased its general reserve by $12.5 million, of which $8.2 million was for originations of new business and $4.3 million was for the
accretion of the discount on prior years' reserves. Also during 2001, the Company transferred to the general reserve $0.1 million, representing recoveries received on prior-year
transactions, and transferred $8.7 million from the general reserve to case basis reserves. Giving effect to these transfers, the general reserve totaled $69.1 million at
December 31, 2001.

During
2002, the Company increased its general reserve by $65.6 million, of which $41.1 million related to the CDO portfolio discussed above, $21.1 million was for
originations of new business and $3.4 million was for the accretion of the discount on prior years' reserves. Also during 2002, the Company transferred to the general reserve
$0.8 million representing recoveries received on prior-year transactions and transferred $45.8 million from the general reserve to case basis reserves. Giving effect to these
transfers, the general reserve totaled $89.7 million at December 31, 2002.

Reserves
for losses and loss adjustment expenses are discounted at the then current risk-free rates for the general reserve and at rates between 4.77% and 6.1% for case basis
reserves. The cumulative amount of discount taken was approximately $44.7 million, $29.6 million and $28.7 million at December 31, 2002, 2001 and 2000, respectively.

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

Competition and Industry Concentration

FSA faces competition from both other providers of and alternatives to third-party credit enhancement. The majority of asset-backed and municipal obligations are
sold without third-party credit enhancement. Accordingly, each transaction FSA proposes to insure must generally compete against an alternative execution that does not employ third-party credit
enhancement. FSA also 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"). Two market participants previously engaged directly or through
affiliates primarily in reinsurance (ACE Guaranty Inc. and Radian Asset Guaranty Inc.) have announced a greater commitment to the primary financial guaranty insurance market. Although
FGIC has limited its business in recent years primarily to underwriting certain categories of municipal risks, the owner of FGIC has indicated that FGIC may be sold, raising the prospect that FGIC's
new owner would allow FGIC to compete more broadly in asset-backed and municipal sectors not presently being serviced by FGIC. Likewise, XLCA and CIFG, as new entrants to the market, may provide
increasing competition to more established market participants such as FSA as they attempt to grow their market share.

19

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Traditional
credit enhancers such as bank letter of credit providers and mortgage pool insurers also provide significant competition to FSA as providers of credit enhancement for
asset-backed obligations. While actions by securities rating agencies in recent years have significantly reduced the number of Triple-A rated financial 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, 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, credit default swaps,
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. Recent
legislation may facilitate the direct participation by bank affiliates in the U.S. insurance business, including the financial guaranty insurance business. In addition, 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 additional 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 (i) assembling the group of experts required to operate a financial guaranty insurance business,
(ii) establishing the Triple-A claims-paying ability ratings with the credit rating agencies, (iii) complying with substantial capital requirements, (iv) developing
name recognition and market acceptance with issuers, investment bankers and investors and (v) organizing a monoline insurance company and obtaining insurance licenses to do business in the
applicable jurisdictions.

FSA's
net insurance in force is the outstanding principal, interest and other amounts to be paid over the remaining life of all obligations insured by FSA, net of ceded reinsurance and
refunded bonds secured by United States government securities held in escrow or other qualified 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. Set forth below are FSA's aggregate gross insurance in force, net
insurance in force, qualified statutory capital and leverage ratio (represented by the ratio of its net insurance in force to qualified statutory capital) and the average industry leverage ratio at
the dates indicated. Net insurance data does not distinguish between quota share reinsurance and first loss reinsurance. In light of FSA's substantial use of first loss reinsurance in the asset-
backed sector, the data below tends to overstate FSA's risk leverage in comparison to its industry counterparts.

|                                                      |                             | December 31,
|----------------------------------------------------- | --------------------------- | ------------
|
|
|Financial guaranty primary insurers, excluding FSA(1) |                             |             
|                                                      | Leverage ratio              |             
|FSA(3)                                                |                             |             
|                                                      | Gross insurance in force    |             
|                                                      | Net insurance in force      |             
|                                                      | Qualified statutory capital |             
|                                                      | Leverage ratio              |             

---

20

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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 ceding commissions to cover costs
of business generation. Because the insured party contracts for coverage solely with the ceding company, the failure of the reinsurer to perform does not relieve the ceding company of its obligation
to the insured party under the terms of the insurance contract.

FSA
obtains reinsurance to increase its policy writing capacity, both on an aggregate-risk and a single-risk basis, to meet rating agency, internal and state
insurance regulatory limits; to diversify risks; to reduce the need for additional capital; and to strengthen financial ratios. At December 31, 2002, FSA had reinsured approximately 26.0% of
its principal amount outstanding. Most of FSA's reinsurance is on a quota share or first-loss basis, with a small portion being provided on an 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 selected by it
subject to certain limitations. The reinsurer's participation in a treaty 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 conditions, FSA generally has the right to reassume all of the business reinsured. As required by applicable state law, reinsurance agreements may be subject to certain other
termination conditions.

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, 2002 were American Re-insurance Company, ACE
Guaranty Inc., Radian Reinsurance Inc. (formerly Enhance Reinsurance Company), RAM Reinsurance Co. Ltd., Swiss Reinsurance Company, Tokio Marine and XLFA.

Securities
rating agencies allow FSA "credit" for reinsurance based upon the reinsurer's ratings. Generally, 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 the rating agency capital adequacy models.

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
(i) FSA-UK reinsures with FSA its retention under its policies after third party reinsurance based on an agreed-upon percentage that is substantially in proportion to
the Statutory Capital of FSA-UK to the total Statutory Capital of FSA and its subsidiary insurers (including FSA-UK) and (ii) subject to certain limits, FSA is required
to make payments to FSA-UK when FSA-UK's annual net incurred losses and expenses exceeds FSA-UK's annual net earned premiums plus draws on FSA-UK's
equalization reserves to pay incurred losses. Under this agreement, FSA-UK ceded to FSA approximately 99% of its retention after other reinsurance of its policies issued in 2002.

21

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Rating Agencies

The value of the insurance product sold by FSA is generally a function of the "rating" applied to obligations insured by FSA. The insurance financial strength,
insurer financial strength and claims-paying ability, as the case may be, of FSA and its operating 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. These rating agencies periodically review the business and financial condition of FSA, 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, and 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. See "Credit
Underwriting Guidelines, Standards and Procedures" above. FSA's ability to compete with other Triple-A rated financial guarantors, and its results of operations and financial condition,
would be materially adversely affected by any reduction in its ratings.

Moody's
and S&P apply their own capital adequacy models in assessing the financial strength of FSA. Financial factors considered in assessing capital adequacy include: (i) capital
charges or other assessments of credit risks for FSA's insured portfolio; (ii) the quality of FSA's investment portfolio; (iii) the degree of risk embedded in FSA's GIC business;
(iv) the credit quality of FSA's reinsurers and the type of reinsurance provided thereby; (v) credit lines and other capital support arrangements ("soft capital"); (vi) premium
revenues expected to be generated from outstanding policies; and (vii) anticipated future new business originations and anticipated future losses. Given the importance of its ratings to its
on-going business, underwriting and business decisions by FSA generally include an analysis of the impact on rating agency
capital determinations in addition to other measures of creditworthiness. Reference is made to the published reports of Moody's and S&P regarding FSA, the Company, capital adequacy models and the bond
insurance business in general for further information on such subjects, as well as FSA's relative standing to its industry peers using various yardsticks considered material by the rating agencies,
including 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") (the last
such examination having been conducted in 2000 for the period ended December 31, 1999) and other state insurance regulatory authorities.

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.

22

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

Article 69
establishes single risk limits for financial guaranty insurers applicable to all obligations issued by a single entity and backed by a single revenue source. For
example, under the limit applicable to qualifying asset-backed securities, the lesser of (i) the insured average annual debt service for a single risk or (ii) the insured unpaid
principal (reduced by the extent to which the unpaid principal of the supporting assets exceeds the insured unpaid principal) divided by nine, net of qualifying reinsurance and collateral, may not
exceed 10% of the sum of the insurer's policyholders' surplus and contingency 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 guarantied obligations

23

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insured,
net of qualifying reinsurance and collateral. Under these limits, policyholders' surplus and contingency reserves must not be less than a percentage of aggregate net liability equal to the
sum of various percentages of aggregate net liability for various categories of specified obligations. The percentage varies from 0.33% for certain municipal obligations to 4% for certain
non-investment grade obligations.

Dividend Restrictions

FSA's ability to pay dividends is dependent upon FSA's financial condition, results of operations, cash requirements, rating agency confirmation of
non-impairment of FSA's ratings and other related factors, and is also subject to restrictions contained in the insurance laws and related regulations of New York ("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 (i) 10% of policyholders' surplus as of its last statement filed with the New York Superintendent or (ii) adjusted
net investment income during this period. Based upon FSA's statutory statements for the year ended December 31, 2002, the maximum amount available for payment of dividends by FSA without
regulatory approval over the following 12 months is approximately $114.0 million. In 2002 and 2001, FSA International paid a preferred dividend of $8.7 million and
$1.6 million, respectively, to its minority interest owner.

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 France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain from its home office
in the United Kingdom. FSA has received a determination from the Australian Insurance and Superannuation Commissioner that the financial guaranties issued by it with respect to Australian transactions
do not constitute insurance for which a license is required. The Monetary Authority of Singapore regulates activities of FSA's Singapore branch.

Investment Portfolio

FSA's primary objective in managing its investment portfolio is generation of an optimal level of after-tax investment income while preserving capital
and maintaining adequate liquidity. FSA's investment portfolio, excluding the investments of the proceeds of FSA-insured GIC's managed by FSAM (the "GIC Portfolio"), is managed primarily
by unaffiliated professional investment managers, with a portion of its municipal portfolio managed by its affiliate, FSA Portfolio Management. FSA's investment management is overseen by an Investment
Committee comprised of FSA's Chief Executive Officer, Chief Financial Officer, Chief Underwriting Officer and Treasurer. 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 FSA assets in investments which are readily marketable with no legal or contractual restrictions on resale. Eligible fixed income investments include U.S. Treasury and agency
obligations, corporate bonds, tax-exempt bonds and mortgage pass-through instruments. Formerly, the Company and its subsidiaries also invested a small portion of their
portfolios in equity securities and/or convertible debt securities. The Company has investments in various strategic partners, including (i) XLFA; (ii) Fairbanks Capital Holding Corp.
(Fairbanks), which owns a residential mortgage loan servicer; (iii) creditex, Inc., which operates an exchange for credit-derivative products; and (iv) TheMuniCenter, L.L.C.,
which operates an on-line exchange for municipal bonds. In addition, the Company has from time to time invested in sponsors of, or interests in, transactions insured or proposed to be
insured by FSA, none of which investments is material to the Company.

The
weighted average maturity of the Company's investment portfolio, excluding the GIC Portfolio, at December 31, 2002 was approximately 8.5 years. The Company's current
investment strategy is to invest in quality,

24

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readily
marketable instruments of intermediate average duration so as to generate stable investment earnings with minimal market value or credit risk.

The
following tables set forth certain information concerning the investment portfolio of the Company, excluding the GIC Portfolio:

Investment Portfolio by Rating
at December 31, 2002(1)

Rating

Percent of
Investment
PortfolioAAA(2)

75.8
%AA

19.7A

4.5100.0
%


---

Summary of Investments

|                          |                             | December 31, |        
|------------------------- | --------------------------- | ------------ | -------
|
|
|
|Long-term investments:    |                             |              |        
|                          | Taxable bonds               |              | $      
|                          | Tax-exempt bonds            |              |        
|                          |                             |              |        
|                          | Total long-term investments |              |        
|Short-term investments(2) |                             |              | 250,697
|                          |                             |              |        
|                          | Total investments(3)        |              | $      
|                          |                             |              |        

---

Investment Portfolio by Security Type

|                           |  | December 31, |          
|-------------------------- |  | ------------ | ---------
|
|
|
|U.S. government securities |  | $            | 68,429   
|Mortgage-backed securities |  |              | 252,970  
|Municipal bonds            |  |              | 2,034,691

25

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|Asset-backed securities   |                        |  | 74,781  |           | 3.99 |      |   | 44,862  |           | 7.31 |      |   | 37,867  |           | 7.86 |     
|------------------------- | ---------------------- |  | ------- | --------- | ---- | ---- | - | ------- | --------- | ---- | ---- | - | ------- | --------- | ---- | ----
|Corporate securities      |                        |  | 184,302 |           | 5.48 |      |   | 183,837 |           | 6.66 |      |   | 154,786 |           | 7.04 |     
|Foreign securities        |                        |  |         |           |      |      |   | 5,780   |           | 7.66 |      |   | 15,240  |           | 7.91 |     
|                          |                        |  |         |           |      |      |   |         |           |      |      |   |        
|                          | Total fixed maturities |  |         | 2,615,173 |      | 5.48 |   |         | 2,236,979 |      | 5.92 |   |         | 1,998,143 |      | 6.12
|Short-term investments(2) |                        |  | 250,697 |           | 1.46 |      |   | 166,248 |           | 1.82 |      |   | 75,980  |           | 6.09 |     
|                          |                        |  |         |           |      |      |   |         |           |      |      |   |        
|                          | Total investments(3)   |  | $       | 2,865,870 |      | 5.13 | % | $       | 2,403,227 |      | 5.63 | % | $       | 2,074,123 |      | 6.12
|                          |                        |  |         |           |      |      |   |         |           |      |      |   |        

---

26

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Distribution of Investments by Maturity

|                                       |                      | December 31,
|-------------------------------------- | -------------------- | ------------
|
|
|
|Due in one year or less(1)             |                      | $           
|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(2) |             
|                                       |                      |             

---

Mortgage-Backed Securities
Cost and Market Value by Investment Category

|                                               |                                  | December 31, 2002
|---------------------------------------------- | -------------------------------- | -----------------
|
|
|Pass-through securitiesU.S. Government agency |                                  | $                
|CMO'sU.S. Government agency                   |                                  |                  
|CMO'snon-agency                               |                                  |                  
|                                               |                                  |                  
|                                               | Total mortgage-backed securities |                  
|                                               |                                  |                  

The
Company's investments in mortgage-backed securities consisted of pass-through certificates and collateralized mortgage obligations ("CMO's"), which are secured by
mortgage loans 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, 2002, Triple-A rated CMO's, which are not guaranteed by government agencies. Secondary market quotations are available for these securities, although they are not as
liquid as the government agency-backed securities.

The
CMO's held at December 31, 2002 have stated maturities ranging from 1 to 30 years, and expected average lives ranging from 1 to 11 years based on anticipated
prepayments of principal. None of the Company's holdings of CMO's is subject to extraordinary interest rate sensitivity. At December 31, 2002, the Company did not own any
interest-only stripped mortgage securities or inverse floating rate CMO tranches.

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

27

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GIC Portfolio

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

Investment Portfolio by Rating
at December 31, 2002(1)

Rating

Percent of
Investment
PortfolioAAA

96.6
%AA

0.9A

0.7Other

1.8100.0
%


---

Summary of Investments

|                          |                             | December 31, |      
|------------------------- | --------------------------- | ------------ | -----
|
|
|
|Long-term investments:    |                             |              |      
|                          | Taxable bonds               |              | $    
|                          |                             |              |      
|                          | Total long-term investments |              |      
|Short-term investments(2) |                             |              | 4,632
|                          |                             |              |      
|                          | Total investments           |              | $    
|                          |                             |              |      

---

Investment Portfolio by Security Type

|                           |                        | December 31, |          
|-------------------------- | ---------------------- | ------------ | ---------
|
|
|
|Mortgage-backed securities |                        | $            | 556,922  
|Municipal bonds            |                        |              | 5,236    
|U.S. government securities |                        |              | 99,768   
|Asset-backed securities    |                        |              | 1,091,557
|Corporate securities       |                        |              | 46,623   
|                           |                        |              |          
|                           | Total fixed maturities |              |          
|Short-term investments(2)  |                        |              | 4,632    
|                           |                        |              |          
|                           | Total investments      |              | $        
|                           |                        |              |          

---

28

---

Distribution of Investments by Maturity

|                                      |                   | December 31, 2002
|------------------------------------- | ----------------- | -----------------
|
|
|Due in one year or less(1)            |                   | $                
|Due after one year through five years |                   |                  
|Due after five year through ten years |                   |                  
|Due after ten years                   |                   |                  
|Mortgage-backed securities            |                   |                  
|Asset-backed securities               |                   |                  
|                                      |                   |                  
|                                      | Total investments |                  
|                                      |                   |                  

---

The
mortgage-backed securities included in the GIC Portfolio included pass-through certificates of $550.1 million and $549.5 million at amortized cost and
market value, respectively. These securities are rated Triple-A and are highly liquid with readily determinable market prices.

Employees

At December 31, 2002, the Company and its subsidiaries had 317 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
Securities Exchange Act of 1934, as soon as reasonably practicable after the Company electronically files such materials with, or furnishes it to, the Securities and Exchange Commission.

Forward-Looking Statements

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

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

The
Company cautions that a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in
forward-looking statements made by the Company. These factors include: (i) changes in capital requirements or other criteria of securities rating agencies applicable to financial guaranty
insurers in general or to FSA specifically; (ii) competitive forces, including the conduct of other financial guaranty insurers in general; (iii) changes in domestic or foreign laws or
regulations applicable to the Company, its competitors or its clients; (iv) changes in accounting principles or practices that may

29

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result
in a decline in securitization transactions; (v) an economic downturn or other economic conditions (such as a rising interest rate environment) adversely affecting transactions insured
by FSA or its investment portfolio; (vi) inadequacy of loss reserves established by the Company; (vii) temporary or permanent disruptions in cash flow on FSA-insured
structured transactions attributable to legal challenges to such structures; (viii) downgrade or default of one or more of FSA's reinsurers; (ix) the amount and nature of business
opportunities that may be presented to the Company; (x) market conditions, including the credit quality and market pricing of securities issued; (xi) capacity limitations that may impair
investor appetite for FSA-insured obligations; (xii) market spreads and pricing on insured credit default swap exposures, which may result in gain or loss due to
mark-to-market accounting requirements; (xiii) adequacy of losses and loss adjustment expense reserves; (xiv) prepayment speeds on FSA-insured
asset-backed securities and other factors that may influence the amount of installment premiums paid to FSA; and (xv) other factors, most of which are beyond the Company's control. 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. The Company's telephone number at its principal executive offices is
(212) 826-0100. 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 real property.

Item 3. Legal Proceedings.

In the ordinary course of business, the Company and certain subsidiaries have become party to certain litigation. The Company believes that none of these matters,
if decided against the Company, would have a material impact on the Company's consolidated financial position, results of operations or cash flows.

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

No matters were submitted to a vote of the Company's shareholders during the fourth quarter of 2002.

30

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Part II

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

On July 5, 2000, the Company completed a merger (the "Merger") in which the Company became an indirect wholly owned subsidiary of Dexia S.A., a Belgian
corporation whose shares are traded in the Euronext Brussels and Euronext Paris markets as well as on the Luxembourg Stock Exchange. Dexia S.A. also indirectly acquired the Company's redeemable
preferred stock and caused such stock to be contributed to the Company's capital. 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 2003, the only holders of the Company's common stock were Dexia Holdings, Inc.; an affiliate of White
Mountains Insurance Group Ltd. (a major shareholder of the Company prior to the Merger) and seven current and former directors of the Company who own shares of the Company's common stock or
economic interests therein as described under the caption "Director Share Purchase Program" in Item 11.

The
Company did not pay any dividends during the year following the Merger. The Company paid a dividend on its Common Stock of $0.76125 per share (comprised of a regular quarterly
dividend of $0.17625 per share and a special dividend of $0.585 per share intended as a "catch-up" for regular quarterly dividends omitted for the four prior quarters) for the quarter
ended September 30, 2001, and of $0.17625 per share for the quarter ended December 31, 2001 and each of the first two quarters of 2002. During the third quarter of 2002, the Company
determined that it would suspend payment of dividends for the immediate future. Information concerning restrictions on the payment of dividends is set forth in Item 1 above under the caption
"Insurance Regulatory MattersDividend Restrictions."

Information
about securities available for issuance under the Company's equity compensation plans is set forth under the caption "Securities Available Under Equity Compensation Plans" in
Item 12.

31

---

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.

|                                                   |  | 2002 |           | 2001 |   | 2000      |   | 1999 |           | 1998
|-------------------------------------------------- |  | ---- | --------- | ---- | - | --------- | - | ---- | --------- | ----
|
|SUMMARY OF OPERATIONS(a)                           |  |      |           |      |   |           |   |      |           |     
|Gross premiums written                             |  | $    | 803.7     |      | $ | 485.6     |   | $    | 372.3     |     
|Net premiums written                               |  |      | 532.7     |      |   | 319.6     |   |      | 218.1     |     
|Net premiums earned                                |  |      | 314.9     |      |   | 231.0     |   |      | 192.1     |     
|Net investment income                              |  |      | 139.1     |      |   | 128.9     |   |      | 121.1     |     
|GIC operations net interest margin                 |  |      | 7.8       |      |   | (0.2      | ) |      |           |     
|Net income                                         |  |      | 181.1     |      |   | 209.5     |   |      | 63.3      | (d) 
|BALANCE SHEET DATA(a)                              |  |      |           |      |   |           |   |      |           |     
|Total investments                                  |  | $    | 5,037.4   |      | $ | 3,214.1   |   | $    | 2,234.9   |     
|Total assets                                       |  |      | 7,027.5   |      |   | 4,306.9   |   |      | 3,148.7   |     
|Deferred premium revenue, net                      |  |      | 892.6     |      |   | 669.5     |   |      | 582.7     |     
|Losses and loss adjustment expense reserve, net    |  |      | 147.7     |      |   | 85.5      |   |      | 91.7      |     
|Notes payable                                      |  |      | 430.0     |      |   | 330.0     |   |      | 230.0     |     
|GICs                                               |  |      | 2,449.0   |      |   | 600.0     |   |      |           |     
|Preferred stock                                    |  |      |           |      |   |           |   |      |           |     
|Common shareholders' equity                        |  |      | 1,868.4   |      |   | 1,636.0   |   |      | 1,465.7   |     
|ADDITIONAL DATA                                    |  |      |           |      |   |           |   |      |           |     
|Qualified statutory capital(b)                     |  | $    | 1,876.1   |      | $ | 1,593.6   |   | $    | 1,436.7   |     
|Total claims-paying resources(b)(c)                |  | $    | 3,819.1   |      | $ | 3,217.3   |   | $    | 2,805.1   |     
|Net par outstanding(b)                             |  | $    | 265,700.4 |      | $ | 217,110.8 |   | $    | 154,019.8 |     
|Net insurance in force (principal + interest)(b)   |  | $    | 365,256.1 |      | $ | 300,637.1 |   | $    | 225,426.4 |     
|Policyholders' leverage (risk-to-capital ratio)(b) |  |      | 195:1     |      |   | 189:1     |   |      | 157:1     |     
|Total dividends                                    |  | $    | 20.4      |      | $ | 32.7      |   | $    | 7.9       |     

---

32

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

Results of Operations

Management and investors consider the following measures important in analyzing the financial results of the Company: adjusted book value, operating earnings and
gross present value of originations (PV originations). However, none of these measures are promulgated in accordance with accounting principles generally accepted in the United States of America
(GAAP) and should not be considered as substitutes for shareholders' equity (book value), net income and gross premiums written.

Year Ended December 31, 2002 versus Year Ended December 31, 2001

Book value of the Company at December 31, 2002 and 2001 was $1,868.4 million and $1,635.9 million, respectively.    Management
and some equity analysts use adjusted book value as a proxy for the Company's intrinsic value, exclusive of franchise value. It is defined as book value plus the after-tax present value of
net deferred premium revenue, installment premiums and future net interest margin less deferred expenses. Following is a reconciliation of book value to adjusted book value:

December 31,2002

2001(in millions)Book value(1)

$
1,868.4

$
1,635.9After-tax value of:Net deferred premium revenue, net of deferred acquisition cost


407.6


274.0Present value of installment premiums and future net interest margin


411.3


384.6Adjusted book value

$
2,687.3

$
2,294.5


---

During
2002, adjusted book value, including dividends, grew 13.9% excluding realized and unrealized capital gains and losses in the investment portfolio and 17.4% including such gains
and losses.

The
Company's 2002 net income was $181.1 million, compared with $209.5 million for 2001, a decrease of 13.6%. Operating earnings reached $215.2 million for 2002
versus $205.1 million for 2001, an increase of $10.1 million, or 4.9%. In 2002, net income was negatively affected by $34.1 million of mark-to-market
adjustments for pooled credit default swaps (CDS) under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS
No. 133). Additional derivative losses have been reflected in net income and operating earnings and relate primarily to the termination of the single-name CDS program described in
more detail below.

The
Company has revised its definition of operating earnings from that used in prior periods.Operating earningsis now defined as net
income before the effects of SFAS No. 133 mark-to-market adjustments for pooled CDS and 2000 merger expenses. For purposes of calculating operating earnings, pooled CDS
are defined as FSA-insured credit default swaps that reference pools of financial obligations and require payments by the Company if losses exceed a defined deductible providing an
investment-grade level of protection to the Company. Management considers operating earnings a key measure of normal operating results, as the SFAS No. 133 adjustments for each guaranteed CDS
are expected to sum to zero over the life of the transaction. Operating earnings for 2001 and 2000 disclosed in this discussion differ from those previously disclosed due to the revised definition of
operating earnings.

33

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The
Company employs two measures of gross premiums originated for a given period.Gross premiums writtencaptures premiums collected in
the period, whether collected up front for business originated in the period, or in installments for business originated in prior periods. An alternative measure,gross present
value of premiums written(PV premiums), reflects future installment premiums discounted to their present value, as well as upfront premiums, but only for business originated
in the period. Business ceded through reinsurance placed by a third party is excluded from PV premiums. The Company considers PV premiums to be the better indicator of a given period's insurance
origination activity because a substantial portion of the Company's premiums is collected in installments, a practice typical of the asset-backed business. To calculate PV premiums, management
estimates the life of each transaction that has installment premiums and discounts the future installment premium payments. The present value of the future net interest margin from the Company's asset
management business represents the present value of the difference between the estimated interest to be received on the investments of the Company's asset management group and the estimated interest
to be paid on the guaranteed investment contracts (GICs) issued by the Company's asset management group over the estimated life of each transaction, giving effect to swaps and other derivatives which
convert fixed-rate assets and liabilities to floating rates. PV premiums and the present value of the future net interest margin from the Company's asset management group are collectively referred to
asPV originations. The Company calculates the discount rate for PV originations as the average pre-tax yield on its investment portfolio
for the previous three years. Accordingly, year-to-year comparisons of PV originations are affected by the application of different discount factors. The rates for 2002 and
2001 were 5.91% and 5.79%, respectively. Management intends to revise the discount rate in future years according to the same formula, in order to reflect interest rate changes.

The
Company's principal insurance operating subsidiary, Financial Security Assurance Inc. (FSA), and the asset management business generated PV originations of
$881.8 million for the year ended December 31, 2002, an increase of 26.6% over the 2001 result. In 2002, the annual gross par value of obligations insured by
FSA declined 3.9%, to $109.7 billion. The table below shows the components ofPV originationsfor 2002 and 2001:

Year Ended December 31,2002

2001(in millions)U.S municipal obligations(1)

$
420.7

$
222.3U.S. asset-backed obligations(1)(2)


196.1


350.1International obligations(1)


199.3


120.3Asset management products(3)


65.7


3.8Total

$
881.8

$
696.5


---

During
2002, new issue volume in the U.S. municipal bond market reached a record $357.9 billion, and insurance penetration increased to approximately 49% from 46% in the prior
year. In this environment, FSA insured approximately 27% of the insured new issues sold during the year. FSA insured a par amount of $51.6 billion of U.S. primary and secondary municipal
obligations with closing dates in 2002, an increase of 41.6% over the amount insured in the prior year. FSA's U.S. municipal PV premiums in 2002 increased 89.2% over PV premiums in 2001. FSA's
municipal premiums increased more rapidly than par insured because a smaller portion of par was generated by general obligations, which tend to have lower premium rates than more complex issues of
similar credit quality. In the 2002 U.S. asset-backed market, the par volume insured by FSA declined 36.4% to $35.6 billion, reflecting FSA's decision to take a hiatus in the collateralized
debt obligation (CDO) business at mid-year 2002 in order to confirm its underwriting standards, as well as FSA's generally heightened selectivity in all asset-backed sectors during a
period of economic
weakness. In addition, FSA did not insure any large U.S. asset-backed transactions comparable to two 2001 transactions that together contributed $90 million of PV premiums that year (see "Year
Ended December 31, 2001 versus Year Ended December 31, 2000" below). In international markets, FSA insured international obligations with an aggregate par amount of $19.8 billion,
a decrease of 6.3%. International PV premiums rose 65.6% to $199.3 million because Triple-A and Double-A shadow-rated CDO transactions, which tend

34

---

to have low premiums relative to par, represented a smaller part of the business mix. FSA insured several transactions in the infrastructure finance sector, including public-private partnership
financings such as those under the U.K. Private Finance Initiative. It also guaranteed CDS in the pooled corporate and residential mortgage sectors and completed several funded consumer finance
securitizations. In 2002, the Company's asset management group completed its first full year of operations, generating $65.7 million in present value of future net interest margin.

Premiums

The Company's gross premiums written increased 65.5% to $803.7 million for 2002 from $485.6 million for 2001. Net premiums written were
$532.7 million during 2002, an increase of 66.7% compared with 2001 results. Reinsurance cessions totaled 33.7% of 2002 gross premiums written, compared with 34.2% in 2001. Net premiums earned
in 2002 were $314.9 million, compared with $231.0 million in 2001, an increase of 36.3%. Premiums earned from refundings and prepayments were $28.0 million for 2002 and
$9.1 million for 2001, contributing $15.4 million and $4.4 million, respectively, to after-tax earnings. Excluding the effects of refundings, net premiums earned grew
29.3% over the comparable 2001 result. No assurance can be given that refundings and prepayments will continue at the level experienced in 2002 or 2001.

Net Investment Income

Net investment income was $139.1 million for 2002 and $128.9 million for 2001, an increase of 7.9%. This increase was due primarily to higher
invested balances arising from new business writings. For further discussion, see "Liquidity and Capital Resources" below. The Company's effective tax rate on investment income was 10.4% for 2002,
compared with 11.0% for 2001. In 2002, the Company realized $29.2 million in net capital gains, compared with $7.2 million of net capital gains in 2001. Capital gains and losses are
generally a by-product of the normal investment management process and can vary substantially from period to period.

Interest Expense

Interest expense in 2002 and 2001 was $28.1 million and $16.9 million, respectively. For further discussion, see "Liquidity and Capital Resources"
below.

Losses and Loss Adjustment Expenses

The provision for losses and loss adjustment expenses in 2002 was $65.6 million, compared with $12.5 million in 2001. 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 analyzed all CDO
transactions in its insured portfolio that breached 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 applies a run of the collateral portfolio for each CDO transaction considering each transaction's unique
attributes (such as reinsurance, individual collateral ratings and status, derivatives purchased, premiums due to the guarantor, etc.) utilizing a Moody's default pattern for frequency of defaults, an
estimate of collateral recovery values for severity, and a risk-free rate of interest. 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 result, management selected Moody's 1992 idealized default curve as
a predictor of future defaults on the CDO collateral. 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 and more 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 general reserve
($31.0 million) and (ii) amounts already existing in its general reserve ($20.5 million), including general reserve amounts reallocated to case basis reserves
($11.3 million). The $31.0 million increase in the Company's general reserve resulted in a corresponding increase to losses and loss adjustment expense in the income statement of
$31.0 million. An additional adjustment of $10.1 million was made to the general reserve in the fourth quarter of 2002 as a result of further deterioration of the CDO portfolio.
Management has established a methodology of recording case basis reserves on CDO transactions to the extent that the

35

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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 in respect of these transactions until 2010, but may elect to do so at an earlier date at its discretion. Over time, management expects
to reallocate amounts in its general reserve (including accretions thereto) to case basis reserves as specific losses on its insured CDO portfolio become probable and estimable in accordance with the
undercollateralization methodology described above. Application of this methodology resulted in recording $68.8 million in gross case basis reserves and $29.8 million in reinsurance
recoverable on unpaid losses, resulting in a $39.0 million increase in net case basis reserves.

Beginning
in the second quarter of 2002, management refined the loss factor it applies to its net par underwritten when calculating the general reserve in order to reflect its recent
adverse experience. As a result, and in connection with $41.1 million of CDO adjustments, the general reserve accrual for the year ended December 31, 2002 was $65.6 million,
rather than the approximate $14.9 million that would have been accrued using the prior assumptions and assuming a similar mix and volume of business. Management expects future reserve
contributions to be approximately double the amounts under the prior practice. Since
the reserves are based upon 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.

In
2002, FSA exercised certain rights available under its financial guaranty policies and indentures relating to loan-backed notes issued by FMAC Loan Receivables Trust
1998-D and 2000-A (the Trusts). Those rights allowed FSA to accelerate the insured notes and pay claims under its insurance policy on an accelerated basis. Refinancing vehicles
reimbursed FSA in whole for its claims payments in exchange for assignments of certain of FSA's rights against the Trusts. The refinancing vehicles obtained funds from the proceeds of
FSA-insured GICs issued in the ordinary course of business by FSA Capital Markets Services LLC and FSA Capital Management Services LLC (collectively, CMS). Since the notes represent 100%
of the debt capitalization of the Trusts and since FSA maintains all of the risk of further asset decline and maintains control over key decisions regarding the Trusts (i.e., removal of servicer, sale
of assets, liquidation of the entity), the Trusts were consolidated with FSA for accounting purposes. Although the securitized loans are included on FSA's balance sheet, the securitized loans continue
to support FSA-insured transactions exclusively, subject to considerable first-loss and quota share reinsurance. In accordance with AICPA Practice Bulletin 6, "Amortization of
Discounts on Certain Acquired Loans", the Company has recorded the securitized loans at cost, has determined cash flows from the pools of securitized loans, net of reinsurance, and is recording income
based upon the constant yield method. The cash flows on the securitized loans will be monitored and the constant yield modified to reflect any change in the cash flow estimates. As a result of these
transactions, the Company recorded $437.5 million of securitized loans and $6.3 million of other income related to those securitized loans during the year ended December 31, 2002.

Guaranteed Investment Contract Net Interest Margin

In the fourth quarter of 2001, the Company's newly formed asset management group began issuing FSA-insured GICs and recorded $2.5 billion and
$600.0 million of GICs as of December 31, 2002 and 2001, respectively. These transactions resulted in a net interest margin of $7.8 million and $(0.2) million for the year ended
December 31, 2002 and 2001, respectively.

Net Realized and Unrealized Gains (Losses) on Derivatives

Over the past two years, a growing percentage of FSA's business has been in the form of insured CDS referencing diversified pools of corporate obligations. Many
of these require periodic adjustments to reflect an estimate of fair value under SFAS No. 133. These transactions have generally been underwritten with Triple-A or higher levels of
credit protection provided by a significant deductible that must be exhausted prior to any claim under FSA's guaranty. Adjustments required by SFAS No. 133 resulted in a pre-tax
charge to income for the year ended December 31, 2002 of $50.2 million. The charge resulted primarily from widening spreads in the CDS market and does not indicate any material
deterioration in the underlying

36

---

credit quality of FSA's insured CDS portfolio. While a small number of transactions have been downgraded from their original levels, the underlying credit quality of FSA's insured pooled corporate
CDS transactions, based on net par outstanding at December 31, 2002, was 53% Super Triple-A (defined as having first-loss protection of at least 1.3 times the level
required for a Triple-A rating) and 96% Double-A or higher. Excluding CDS referencing collateralized loan obligations (CLOs) and CDS referencing collateralized bond obligations
(CBOs), the pooled corporate CDS portfolio was 64% Super Triple-A and 96% Double-A or higher. From a credit perspective, the Company generally groups CDS of CLOs with CLOs and groups CDS
of CBOs with CBOs. 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 guaranty. Fair value is defined as the amount 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 upon 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 upon 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 can vary substantially from period to period. Absent any claims under FSA's guaranty, any "losses" recorded in marking a
guaranty to market will be reversed by an equivalent mark-to-market "gain" at or prior to the expiration of the guaranty. Given the very high credit quality of FSA's insured
CDS portfolio, management believes that "losses" or "gains" attributable to marking these exposures to market do not reflect upon 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.

Income
before income taxes for 2002 and 2001 was $216.2 million and $269.5 million, respectively.

Taxes

The Company's effective tax rate for 2002 was 16.2%, compared with 22.3% for 2001. In the third quarter of 2002, the Company changed its method of taxing its
equity earnings on Fairbanks Capital Holding Corp. (Fairbanks), an unconsolidated affiliate of the Company. Prior to 2002, the Company taxed 100% of its equity earnings from Fairbanks at the statutory
rate of 35%. Following a change in Fairbanks' 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 earnings from Fairbanks, based upon 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. In 2002, the effective tax rate differs from the statutory rate of 35% due
primarily to this change in taxing method as well as tax-exempt interest income and income from Financial Security Assurance International Ltd. (FSA International). Although FSA
International is subject to U.S. income taxes as a controlled foreign corporation, it nonetheless benefits from a lower overall effective tax rate than the Company's domestic insurance company
subsidiaries.

Market Risk

The primary objective in managing the Company's investment portfolio, excluding the GIC bond portfolio, is generation of an optimal level of after-tax
investment income while preserving capital and maintaining adequate liquidity. Investment strategies are based on many factors, including the Company's tax position, fluctuation 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. These investment decisions are based on guidelines established by management and approved by the board of
directors.

FSA
Asset Management LLC (FSAM) manages the investments in the GIC bond portfolio. The primary objective in managing the GIC bond portfolio is to generate stable net interest margin,
maintain liquidity and optimize risk-adjusted returns.

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Market
risk represents the potential for loss due to adverse changes in the fair value of financial instruments. The market risks related to financial instruments of the Company relate
primarily to its investment portfolio, of which over 87.4% (excluding the GIC bond portfolio) was invested in long-term fixed-income securities at December 31, 2002. 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. 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 2002, this hypothetical increase in interest rates would
result in an after-tax decrease of $127.1 million in the net fair value of the Company's fixed-income portfolio, excluding the GIC bond portfolio, and an after-tax
decrease of $26.9 million for the GIC bond portfolio. 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.

FSAM
generally converts all fixed-rate assets and liabilities to floating rates using hedging instruments. As interest rates change, 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.

The
Company's investment portfolio holdings, excluding the GIC bond portfolio, are primarily U.S. dollar-denominated fixed-income securities, including municipal bonds, U.S. government
and agency bonds, and mortgage-backed, asset-backed and corporate securities. In calculating the sensitivity to interest rates for the taxable securities, U.S. Treasury rates are changed
instantaneously by 1.0%, and the option-adjusted spreads of the securities are held constant. 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.

The
GIC bond portfolio consists primarily of U.S. dollar-denominated U.S. agency securities, mortgage-backed securities and asset-backed securities.

FSA-insured
GICs subject the Company to risk associated with unexpected 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 the event of a downgrade of FSA, typically below AA- by S&P or Aa3 by Moody's, unless the GIC provider
posts collateral or otherwise enhances its credit.

Critical Accounting Policies

The Company's losses and loss adjustment expenses comprise case basis reserves and a non-specific general reserve. FSA establishes a case basis
reserve for the net present value of an estimated loss when, in management's opinion, the likelihood of a future loss on a particular insured obligation is probable and determinable at the balance
sheet date. A case basis reserve is determined using primarily cash flow or similar models and represents FSA's estimate of the net present value of the anticipated shortfall, net of reinsurance,
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. For CDOs, a case basis reserve is recorded to the extent that the overcollateralization ratio (non-defaulted
collateral at par divided by the debt insured) has fallen below 100%. The non-specific general reserve is available to be applied against future additions or accretions to existing case
basis reserves or to new case basis reserves. The general reserve is calculated by applying a loss factor to the total net par amount outstanding of the Company's insured obligations over the terms of
such insured obligations and discounting the result at the then current risk-free rates. The loss factors used for this purpose are determined on the basis of an independent rating agency
study of default rates and the Company's portfolio characteristics and history. The selection of loss factors and a discount rate involves judgment as to which factors to use and whether those factors
are reflective of the Company's insured obligations. Management's judgments may also consider macroeconomic factors, political developments and changes in underwriting standards or mix of business.

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Management conducts periodic credit reviews of its exposures to identify events, as they occur, that might cause a default on a transaction. With timely
identification of these events, the Company may limit its potential for loss by taking actions to improve transaction performance. Certain events have occurred in the past, such as the decline in
commercial real estate in the early 1990s and the CDO portfolio in 2002, that have had a significant impact on the Company's losses and loss adjustment expenses. Although these events are difficult to
predict, the Company's credit review process is designed to identify such events early so the Company can act to limit its exposure. In addition, management may decide to exercise its rights to
accelerate insured obligations in order to mitigate expected losses by lowering financing costs when market conditions so permit. See "Losses and Loss Adjustment Expenses", above, for a discussion of
the FMAC refinancings.

Management
of the Company periodically evaluates the assumptions and judgments underlying its estimate for losses and loss adjustment expenses and establishes a liability that management
believes is adequate to cover the present value of the ultimate net cost of claims. Management has consistently applied this approach from period to period. Since the reserves are based upon
estimates, there can be no assurance that the ultimate liability will not differ from such estimates.

A
large portion of the Company's investment portfolio and its derivative instruments are carried at fair value. Fair value is defined as the amount at which an asset or a liability could
be bought or sold in a current transaction between willing parties. The fair value of substantially all of the Company's investment portfolio and derivative instruments used in hedging the interest
rate risk of the asset management business is determined based upon quoted market prices. For derivative instruments where a quoted market price exists, the Company uses that price. If quoted market
prices are not available (as is the case primarily with CDS referencing pools of assets and the determination of the fair value change of interest rate risk of a hedged asset or liability), then the
determination of fair value is based upon internally developed estimates.
Management applies judgment when developing estimates for CDS 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.

Premiums
are received either upfront or over time on an installment basis. Premiums 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. 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. Some industry peers receive so-called structuring or advisory fees in
connection with transactions insured by them or their affiliates, and earn such fees upon receipt. Unlike these industry peers, the Company allocates all fees (net of reimbursed expenses) received for
its account on closed transactions to premiums (or ceding commissions) that are earned (or, in the case of ceding commissions, employed to offset deferred acquisition costs) over time as described
above. When the Company, through its ongoing credit review process, identifies transactions where certain triggers have been breached, the Company ceases to earn premiums. If a case basis reserve is
established for these transactions, the unearned premium will reduce such reserve.

Deferred
acquisition costs comprise those expenses that vary with, and are primarily 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. As acquisition costs are incurred, they are allocated to individual cost centers and a percentage of those costs are deferred based on a weighted average calculation of
time spent on the production of new business by the personnel in that cost center. Variable costs that are a direct result of acquiring business are deferred in their entirety. The Company does not
defer acquisition costs relating to GICs issued by CMS, except for brokerage fees. Deferred acquisition costs are grouped by the underwriting year in which they were incurred and amortized over the
period in which the related underwriting year's premium is earned. Deferred variable direct costs and ceding commission income are grouped by upfront or installments as well as by underwriting year
and 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 coverage, the remaining deferred acquisition
cost is recognized. Adjustments to the amortization of the deferred acquisition costs are made periodically to reflect changes in assumptions based on prepayment speeds of the underlying insured
asset-backed securities. Recoverability of deferred acquisition costs is determined by considering anticipated losses and loss adjustment expenses.

Year Ended December 31, 2001 versus Year Ended December 31, 2000

The Company's 2001 net income was $209.5 million, compared with $63.3 million ($138.8 million excluding merger-related costs) for 2000, an
increase of 231.1%. Operating earnings were $205.1 million for 2001 versus $138.8 million for 2000. Operating earnings have been restated to reflect the Company's change in the
definition of operating earnings, as previously discussed.

FSA
had an exceptional year in 2001, with strong results across its three core businessesU.S. municipal, U.S. asset-backed and international. Asset-backed business was
particularly strong, in both the United States and Europe, due to market uncertainty, widening credit spreads and demand for liquidity. The Company generated $696.5 million of PV originations
in 2001, 55.4% higher than the $448.3 million in 2000. In 2001, the annual gross par value of obligations insured by FSA rose 82.4% to $114.2 billion.

In
the U.S. asset-backed market, FSA achieved record results, with business well balanced across the consumer, residential mortgage and structured finance sectors. In consumer finance,
the Company enjoyed steady transaction flow from repeat issuers of asset-backed securities backed by automobile loans and credit card receivables. In the residential mortgage market, FSA developed new
applications for its guaranty and, late in the year, saw increased demand for the guaranty as a way to enhance liquidity of mortgage-backed issues already rated Triple-A. In addition,
funded and synthetic CDO business was strong because of a favorable credit spread environment. Fourth quarter 2001 gross PV premiums were amplified by an unusually large residential mortgage
transaction and a complex, high-premium structured financial institution obligation, which together contributed $90.0 million in PV premiums. For the year, par value reached
$56.7 billion and PV premiums totaled $350.1 million, compared with $28.0 billion and $198.9 million, respectively, for 2000. Par insured increased more than gross PV
premiums primarily because of increased originations in the Triple-A shadow-rated CDO sector, which carries a low premium rate relative to par insured.

During
2001, new issue volume in the U.S. municipal bond market reached $286.3 billion, the second highest level in history, due in part to a decline in interest rates that
encouraged municipal borrowing, and insurance

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penetration increased to 46% from 40% in the prior year. In this positive environment, FSA held the leading market share for the first time, insuring approximately 27% of the
insured new issues that were sold during the year. FSA's market share leadership does not reflect any change in business strategy, which is for FSA to insure all the transactions meeting its
underwriting criteria that it can insure at appropriate returns. The U.S. municipal business contributed $222.3 million in PV premiums in 2001, compared with $140.1 million in 2000.
FSA's U.S. municipal par insured increased to $36.5 billion in 2001 from $21.5 billion in 2000.

In
international markets, FSA's asset-backed business continued to grow during 2001, led by European synthetic and funded CDOs and other structured finance transactions. The Asia Pacific
group also closed a number of synthetic CDOs and consumer asset securitizations during the year. In addition, FSA made progress in global public infrastructure markets, where transactions generally
have long lead times, and ended the year with mandates for a number of transactions scheduled to close in 2002. During 2001, FSA insured $21.1 billion of international par, compared with
$13.2 billion in 2000, to generate gross PV premiums of $120.3 million, compared with $109.3 million in 2000.

In
the fourth quarter of 2001, the Company's newly formed asset management group began issuing FSA-insured GICs and had recorded $600.0 million of GICs as of
December 31, 2001. These transactions resulted in a net interest margin of $(0.2) million for the year ended December 31, 2001 and a present value of future net interest margin of
$3.8 million.

FSA's
gross premiums written increased 30.4% to $485.6 million for 2001 from $372.3 million for 2000. Net premiums written were $319.6 million during 2001, an
increase of 46.5% compared with the 2000 result. Reinsurance cessions totaled 34.2% of 2001 gross premiums written, compared with 41.4% in 2000. The amount ceded decreased in 2001 primarily due to
some large facultative cessions on health care business in 2000 to comply with new internal single-risk limits. Net premiums earned in 2001 were $231.0 million, compared with
$192.1 million in 2000, an increase of 20.2%. Premiums earned from refundings and prepayments were $9.1 million for 2001 and $11.7 million for 2000, contributing
$4.4 million and $5.5 million, respectively, to after-tax earnings. Excluding the effects of refundings, net premiums earned grew 23.0% over the comparable 2000 result. No
assurance can be given that refundings and prepayments will continue at the level experienced in 2001 or 2000.

Net
investment income was $128.9 million for 2001 and $121.1 million for 2000, an increase of 6.4%. This increase was due primarily to higher invested balances arising from
new business writings. For further discussion, see "Liquidity and Capital Resources" below. The Company's effective tax rate on investment income was 11.0% for 2001, compared with 13.1% for 2000. In
2001, the Company realized $7.2 million in net capital gains, compared with $36.8 million of net capital losses in 2000. Capital losses in 2000 were affected by losses purposely incurred
to take advantage of expiring tax loss carry-back opportunities against previously realized capital gains. Capital gains and losses are generally a by-product of the normal
investment management process and can vary substantially from period to period.

Interest
expense in 2001 and 2000 was $16.9 million and $16.6 million, respectively. For further discussion, see "Liquidity and Capital Resources" below.

The
provision for losses and loss adjustment expenses in 2001 was $12.5 million, compared with $9.4 million in 2000, representing additions to the Company's general
reserve. The additions to the general reserve represent management's estimate of the amount required to cover the present value of the net cost of future claims. The Company will, on an ongoing basis,
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. At
December 31, 2001, the general reserve totaled $69.1 million.

Total
policy acquisition and other operating expenses (excluding the cost of equity-based compensation programs, which was $25.2 million for 2001 and $27.1 million for
2000) were $56.9 million in 2001, compared with $51.2 million in 2000, an increase of $5.7 million. Further excluding the effect of refundings, total policy acquisition and other
operating expenses were $54.5 million in 2001, compared with $47.9 million in 2000, an increase of $6.6 million. The increase resulted from higher personnel costs. In 2000, the
Company recognized $105.5 million in merger-related expenses, of which $85.8 million represented an increase in equity-based compensation and $19.7 million was for various fees.

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Income before income taxes for 2001 and 2000 was $269.5 million and $67.4 million ($172.9 million excluding merger-related costs), respectively.

The
Company's effective tax rate for 2001 was 22.3%, compared with 6.1% for 2000. The effective tax rate increased because, in 2000, merger-related expenses reduced net income, resulting
in a higher than normal proportion of income derived from the Company's tax-exempt investment securities. The increase was partially offset by higher income from FSA International, which,
while subject to U.S. income taxes as a controlled foreign corporation, nonetheless benefits from a lower overall effective tax rate than the Company's domestic insurance company subsidiaries.

Liquidity and Capital Resources

The Company's consolidated invested assets at December 31, 2002, net of unsettled security transactions, were $5,027.2 million, compared with the
December 31, 2001 balance of $3,132.6 million. These balances include the change in the market value of the investment portfolio, which had an unrealized gain position of
$242.0 million at December 31, 2002, compared with an unrealized gain position of $92.4 million at December 31, 2001. In addition to the increase in unrealized gains, the
growth of the Company's asset management business contributed to the increase in the Company's consolidated invested assets and cash equivalents. At December 31, 2002, the Company had, at the
holding company level, an investment portfolio of $21.8 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 upon its receipt of dividends from, or payment on surplus notes
by, FSA.

FSA's
ability to pay dividends is dependent upon 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
(i) 10% of policyholders' surplus as of its last statement filed with the Superintendent of Insurance of the State of New York (the New York Superintendent) or (ii) adjusted net
investment income during this period. FSA paid no dividends in 2002 and 2001. Based upon FSA's statutory statements for the year ended December 31, 2002, 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 $114.0 million. In
2002 and 2001, FSA International paid preferred dividends of $8.7 million and $1.6 million, respectively, to its minority interest owner.

At
December 31, 2001, the Company held $144.0 million of surplus notes of FSA. During 2002, FSA repaid $28.0 million of such surplus notes. In November 2002,
the Company purchased an additional $96.9 million of surplus notes from FSA. At December 31, 2002, the Company held $212.9 million of FSA surplus notes. Payments of principal or
interest on such notes may be made only with the approval of the New York Superintendent. The Company employs surplus note purchases in lieu of capital contributions in order to allow the Company to
withdraw funds from FSA through surplus note payments without reducing earned surplus.

Dividends
paid by the Company to its shareholders were $11.7 million, $31.1 million and $7.9 million in 2002, 2001 and 2000, respectively.

In
the second quarter of 2000, in connection with the merger of the Company with a subsidiary of Dexia S.A., FSA repurchased $55.0 million of its stock from the Company, and the
Company sold 511,031 of its shares held in a rabbi trust to Dexia for $38.6 million. The proceeds from these transactions were used to fund the Company's obligations under certain of its
long-term, equity-based compensation programs.

On
November 26, 2002, the Company issued $230.0 million of 6.25% Notes due November 1, 2102 and callable without premium or penalty in whole or in part at any time
on or after November 26, 2007. The Company used the proceeds of this issuance to redeem in whole the Company's $130.0 million of 7.375% Senior Quarterly

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Income
Debt Securities (Senior QUIDS) due September 30, 2097. The Company had two other debt issues outstanding at December 31, 2002: $100.0 million of 67/8%
Quarterly Income Bond Securities due December 15, 2101 and callable without premium or penalty on or after December 19, 2006; and $100.0 million of 6.950% Senior QUIDS due
November 1, 2098 and callable on or after November 1, 2003.

In
2002 and 2001, the Company contributed an additional $13.4 million and $15.0 million, respectively, to Fairbanks. At December 31, 2002, the Company had an equity
ownership in Fairbanks of 29.8%.

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.

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

FSA
has a standby line of credit in the amount of $240.0 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 $240.0 million or the average annual debt service of the covered portfolio multiplied by 5.00%, which
amounted to $704.6 million at December 31, 2002. The obligation to repay loans made under this agreement is a limited recourse obligation payable solely from, and collateralized by, a
pledge of recoveries realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This commitment has a term that will expire on
April 30, 2009 and contains an annual renewal provision subject to approval by the banks. No amounts have been utilized under this commitment as of December 31, 2002.

FSA
has a credit arrangement, aggregating $125.0 million at December 31, 2002, that is provided by commercial banks and intended for general application to transactions
insured by FSA and its insurance company subsidiaries. At December 31, 2002, there were no borrowings under this arrangement, which expires on April 26, 2003, unless extended.

The
Company's asset management group has a $100 million line of credit with UBS AG, Stamford Branch, which expires December 12, 2003, unless extended. This line of credit
provides an additional source of liquidity should there be unexpected draws on GICs issued by CMS. There were no borrowings under this arrangement at December 31, 2002.

Standard &
Poor's Ratings Services (S&P), Moody's Investors Service, Inc. (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. S&P
has placed a number of the Triple-A reinsurers used by FSA either on "negative outlook" or "credit watch." Downgrade of these reinsurers by S&P to the Double-A category would
result in a decline in the credit

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allowed
for reinsurance by S&P from 100% to 70% or 65% under present criteria. S&P has also undertaken to consider an increase in the credit allowed for Double-A reinsurance. While a
downgrade by S&P of all
such reinsurers to the Double-A category would not impair FSA's Triple-A ratings, it may 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 to ultimately 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 S&P from its capital adequacy assessment of FSA due to any such
reinsurer downgrades or increased capital charges.

FSA-insured
GICs subject the Company to risk associated with early 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 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 AA- by S&P or Aa3 by Moody's, 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 A- by S&P or A3 by Moody's, 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.

The
Company has no plans for material capital expenditures during the next twelve months.

Variable Interest Entities

Asset-backed and, to a lesser extent, municipal transactions insured by FSA may employ variable interest entities (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 obligations insured by FSA. 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, but in most situations FSA's financial guaranty policy will not expose it to significant variability due to the significant level of
other credit protection. 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 December 31, 2002, the assets and liabilities of these VIEs have not been consolidated with those of the
Company for financial reporting purposes and are considered "off-balance sheet" obligations. The Company believes two such VIEs, Canadian Global Funding Corporation (Canadian Global) and
FSA Global Funding Limited (FSA Global), will be consolidated with the Company for financial accounting purposes during 2003 under the consolidation
guidance recently issued by the Financial Accounting Standards Board (FASB) under FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN No. 46).

In
August 1994, FSA entered into a facility agreement with Canadian Global and Hambros Bank Limited. Canadian Global was established to provide a source of liquidity to refinance
FSA-insured transactions that experienced difficulty in meeting debt service obligations. Canadian Global was capitalized with $180.6 million of

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debt
securities (which were effectively converted to U.S. dollar LIBOR rate through a cross-currency swap with terms matching the underlying debt instrument) and $6.3 million in preferred
equity sold to third-party investors. Under the agreement, FSA pays an annual fee to Canadian Global to compensate it for making its liquidity available and can arrange financing for transactions
subject to certain conditions. When Canadian Global purchases an FSA-insured obligation, the new obligation is insured by FSA for a premium, and case basis reserves are established when
required. As of December 31, 2002, FSA was carrying gross and net case basis reserves of $16.7 million and $4.2 million, respectively, against transactions refinanced by Canadian
Global. Canadian Global has total assets of $196.8 million, of which $87.6 million has been invested in a GIC issued by CMS. The amount of this facility was $186.9 million, of
which $125.2 million was unutilized, at December 31, 2002. The facility terminates in 2004, after which Canadian Global will be liquidated.

The
Company owns 29% of the equity of FSA Global, a Cayman Islands domiciled issuer of FSA-insured notes and other obligations sold in international markets (generally
referred to as medium term notes or "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. 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 FSA Global notes (taking into account, in some cases, dedicated third-party liquidity). The matched funding structure
minimizes the market risks borne by FSA Global and FSA. FSA Global raises funds in U.S. dollars at LIBOR-based floating borrowing rates and invests its funds in obligations insured by FSA, maturing
prior to the maturity of the related FSA Global notes and paying a higher interest rate than the interest rate on the related FSA Global notes. At December 31, 2002, FSA Global had total assets
and total liabilities of $9.2 billion and $9.2 billion, respectively. The foregoing assets and liabilities include assets and matched liabilities that are "economically defeased" in
lease financings in which Company affiliates may play a number of financing roles. These economically defeased liabilities and associated assets are held in separate special purpose entities, FSA
Global and Premier International Funding Co. At December 31, 2002 and 2001, FSA Global's economically defeased obligations were $6.7 billion and $2.0 billion, respectively. FSA
Global's net income for the year ended December 31, 2002 and 2001 was $1.0 million and $0.6 million, respectively. FSA Global's net income is determined net of premiums paid by
FSA Global to FSA. For the years ended December 31, 2002 and 2001, FSA Global paid premiums to FSA of $7.7 million and $7.5 million, respectively. All amounts insured by FSA
relating to FSA Global are included in the Company's outstanding exposure, included in the Notes to the Consolidated Financial Statements for December 31, 2002. As of December 31, 2002,
there were no case basis reserves required for any transactions related to FSA Global.

In
January 2003, the FASB issued FIN No. 46, which is an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN
No. 46 addresses consolidation of VIEs that have one or both of the following characteristics: (i) 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 (ii) 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. The provisions for FIN No. 46 will be effective immediately for
VIEs created after January 31, 2003 and to VIEs in which an enterprise obtains an interest after that date. For VIEs in which an enterprise holds a variable interest that it acquired prior to
February 1, 2003, the interpretation is effective in the first fiscal year or interim period beginning after June 15, 2003. Management believes that the implementation of this
interpretation, on July 1, 2003, will cause the Company to consolidate for financial reporting purposes, for the first time, FSA Global and Canadian Global. FIN No. 46 requires that,
upon consolidation, the Company shall initially measure the VIEs' 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). Any differences upon consolidation on July 1, 2003 will be reflected as a cumulative effect of a change in accounting
principle. The carrying amounts of assets, liabilities and minority interest may change significantly from December 31, 2002 to July 1, 2003 as a result of transactions entered

44

---

into
during that period. The Company will continue to analyze the effects of the standard, considering the timing of its release and the complexity of practical application to the Company's
transactions.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Quantitative and qualitative disclosures about market risk are set forth in Item 7 under the caption "Management's Discussion and Analysis of Financial Condition
and Results of OperationsResults of OperationsMarket Risk".

45

---



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 Accountants                                                                                                                                         |  | 47  
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                                                                                              |  | 48  
|Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2002, 2001 and 2000                                                       |  | 49  
|Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2002, 2001 and 2000                                                           |  | 50  
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000                                                                                |  | 51  
|Notes to Consolidated Financial Statements                                                                                                                                |  | 53  
|Schedule:                                                                                                                                                                 |  |     
|II Condensed Financial Statements of Financial Security Assurance Holdings Ltd. as of December 31, 2002 and 2001 and for the Years Ended December 31, 2002, 2001 and 2000 |  | 100 

46

---

REPORT OF INDEPENDENT ACCOUNTANTS

To
the Shareholders and Board of Directors
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 at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31,
2002 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 auditing standards generally accepted in the United States of America, which 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.

/s/
PricewaterhouseCoopers LLP

PricewaterhouseCoopers
LLP
New York, New York
February 6, 2003

47

---



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

|                                                                                                          |                   | December 31,
2002                       |                                                                  | December 31,
2001 |          
|--------------------------------------------------------------------------------------------------------- | ----------------- | --------------------------------------- | ---------------------------------------------------------------- | ----------------- | ---------
|ASSETS                                                                                                    |                   |                                         |                                                                  |                   |          
|Bonds at market value (amortized cost of $2,615,173 and $2,236,979)                                       |                   | $                                       | 2,829,763                                                        |                   | $        
|Equity investments at market value (cost of $10,000)                                                      |                   |                                         |                                                                  |                   |          
|Short-term investments                                                                                    |                   |                                         | 375,688                                                          |                   |          
|Guaranteed investment contract bond portfolio at market value (amortized cost of $1,800,106 and $428,016) |                   |                                         | 1,827,312                                                        |                   |          
|Guaranteed investment contract short-term investment portfolio                                            |                   |                                         | 4,632                                                            |                   |          
|                                                                                                          |                   |                                         |                                                                  |                   |          
|                                                                                                          | Total investments |                                         |                                                                  | 5,037,395         |          
|Cash                                                                                                      |                   |                                         | 31,368                                                           |                   |          
|Securitized loans                                                                                         |                   |                                         | 437,462                                                          |                   |          
|Securities purchased under agreements to resell                                                           |                   |                                         | 90,000                                                           |                   |          
|Deferred acquisition costs                                                                                |                   |                                         | 253,777                                                          |                   |          
|Prepaid reinsurance premiums                                                                              |                   |                                         | 557,659                                                          |                   |          
|Reinsurance recoverable on unpaid losses                                                                  |                   |                                         | 75,950                                                           |                   |          
|Investment in unconsolidated affiliates                                                                   |                   |                                         | 115,833                                                          |                   |          
|Other assets                                                                                              |                   |                                         | 428,039                                                          |                   |          
|                                                                                                          |                   |                                         |                                                                  |                   |          
|                                                                                                          |                   | TOTAL ASSETS                            |                                                                  | $                 | 7,027,483
|                                                                                                          |                   |                                         |                                                                  |                   |          
|LIABILITIES AND MINORITY INTEREST AND SHAREHOLDERS' EQUITY                                                |                   |                                         |                                                                  |                   |          
|Deferred premium revenue                                                                                  |                   | $                                       | 1,450,211                                                        |                   | $        
|Losses and loss adjustment expenses                                                                       |                   |                                         | 223,618                                                          |                   |          
|Guaranteed investment contracts                                                                           |                   |                                         | 2,449,033                                                        |                   |          
|Deferred federal income taxes                                                                             |                   |                                         | 124,310                                                          |                   |          
|Ceded reinsurance balances payable                                                                        |                   |                                         | 79,870                                                           |                   |          
|Notes payable                                                                                             |                   |                                         | 430,000                                                          |                   |          
|Deferred compensation                                                                                     |                   |                                         | 83,031                                                           |                   |          
|Minority interest                                                                                         |                   |                                         | 52,841                                                           |                   |          
|Payable for securities purchased                                                                          |                   |                                         | 10,490                                                           |                   |          
|Accrued expenses and other liabilities                                                                    |                   |                                         | 255,709                                                          |                   |          
|                                                                                                          |                   |                                         |                                                                  |                   |          
|                                                                                                          |                   | TOTAL LIABILITIES AND MINORITY INTEREST |                                                                  |                   | 5,159,113
|                                                                                                          |                   |                                         |                                                                  |                   |          
|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                                                                         |                   |                                         | 903,494                                                          |                   |          
|Accumulated other comprehensive income (net of deferred income tax provision of $66,270 and $29,394)      |                   |                                         | 134,683                                                          |                   |          
|Accumulated earnings                                                                                      |                   |                                         | 829,858                                                          |                   |          
|Deferred equity compensation                                                                              |                   |                                         | 23,445                                                           |                   |          
|Less treasury stock at cost (297,658 and 301,095 shares held)                                             |                   |                                         | (23,445                                                          | )                 |          
|                                                                                                          |                   |                                         |                                                                  |                   |          
|                                                                                                          |                   | TOTAL SHAREHOLDERS' EQUITY              |                                                                  |                   | 1,868,370
|                                                                                                          |                   |                                         |                                                                  |                   |          
|                                                                                                          |                   |                                         | TOTAL LIABILITIES AND MINORITY INTEREST AND SHAREHOLDERS' EQUITY |                   | $        
|                                                                                                          |                   |                                         |                                                                  |                   |          

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

48

---



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

|                                                |                                                                                                                                                              | Year Ended December 31, |        
|----------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------- | -------
|
|REVENUES:                                       |                                                                                                                                                              |                         |        
|                                                | Net premiums written                                                                                                                                         |                         | $      
|                                                |                                                                                                                                                              |                         |        
|                                                | Net premiums earned                                                                                                                                          |                         | $      
|                                                | Net investment income                                                                                                                                        |                         |        
|                                                | Net realized gains (losses)                                                                                                                                  |                         |        
|                                                | Guaranteed investment contract net interest income                                                                                                           |                         |        
|                                                | Guaranteed investment contract net realized losses                                                                                                           |                         |        
|                                                | Net realized and unrealized gains (losses) on derivative instruments                                                                                         |                         |        
|                                                | Other income                                                                                                                                                 |                         |        
|                                                |                                                                                                                                                              |                         |        
|TOTAL REVENUES                                  |                                                                                                                                                              |                         | 420,098
|EXPENSES:                                       |                                                                                                                                                              |                         |        
|                                                | Losses and loss adjustment expenses                                                                                                                          |                         |        
|                                                | Interest expense                                                                                                                                             |                         |        
|                                                | Policy acquisition costs                                                                                                                                     |                         |        
|                                                | Guaranteed investment contract net interest expense                                                                                                          |                         |        
|                                                | Merger-related expenses                                                                                                                                      |                         |        
|                                                | Other operating expenses                                                                                                                                     |                         |        
|                                                |                                                                                                                                                              |                         |        
|TOTAL EXPENSES                                  |                                                                                                                                                              |                         | 226,550
|                                                |                                                                                                                                                              |                         |        
|Minority interest                               |                                                                                                                                                              |                         | (6,684 
|Equity in earnings of unconsolidated affiliates |                                                                                                                                                              |                         | 29,315 
|                                                |                                                                                                                                                              |                         |        
|INCOME BEFORE INCOME TAXES                      |                                                                                                                                                              |                         | 216,179
|Provision (benefit) for income taxes:           |                                                                                                                                                              |                         |        
|                                                | Current                                                                                                                                                      |                         |        
|                                                | Deferred                                                                                                                                                     |                         |        
|                                                |                                                                                                                                                              |                         |        
|                                                | Total provision                                                                                                                                              |                         |        
|                                                |                                                                                                                                                              |                         |        
|NET INCOME                                      |                                                                                                                                                              |                         | 181,075
|OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:  |                                                                                                                                                              |                         |        
|                                                | Unrealized gains (losses) arising during period [net of deferred income tax provision (benefit) of $44,750, $(3,291) and $48,304]                            |                         |        
|                                                | Less: reclassification adjustment for gains (losses) included in net income [net of deferred income tax provision (benefit) of $7,874, $2,133 and $(12,241)] |                         |        
|                                                |                                                                                                                                                              |                         |        
|                                                | Other comprehensive income (loss)                                                                                                                            |                         |        
|                                                |                                                                                                                                                              |                         |        
|COMPREHENSIVE INCOME                            |                                                                                                                                                              | $                       | 252,792
|                                                |                                                                                                                                                              |                         |        

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

49

---



FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.  AND SUBSIDIARIES  CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY  (Dollars in thousands, except per share data)

|                                                                                                 |  | Common
Stock |     | Additional
Paid-In
Capital
Common |   | Unrealized
Gain
(Loss) on
Investments |   | Accumulated Earnings |         | Deferred
Equity
Compensation |   | Treasury
Stock |   | Total |        
|------------------------------------------------------------------------------------------------ |  | ------------ | --- | ---------------------------------- | - | ------------------------------------- | - | -------------------- | ------- | ---------------------------- | - | -------------- | - | ----- | -------
|BALANCE, December 31, 1999                                                                       |  | $            | 337 |                                    | $ | 836,853                               |   | $                    | (47,779 | )                            | $ | 436,417        |   | $     | 52,670 
|Net income for the year                                                                          |  |              |     |                                    |   |                                       |   |                      |         |                              |   | 63,283         |   |       |        
|Net change in accumulated comprehensive income (net of deferred income tax provision of $60,545) |  |              |     |                                    |   |                                       |   |                      | 117,874 |                              |   |                |   |       |        
|Dividends paid on common stock ($0.24 per share)                                                 |  |              |     |                                    |   |                                       |   |                      |         |                              |   | (7,876         | ) |       |        
|Deferred equity compensation                                                                     |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       | 29,419 
|Deferred equity payout                                                                           |  |              |     |                                    |   | 6,524                                 |   |                      |         |                              |   |                |   |       | (18,811
|Purchase of 2,989 shares of common stock                                                         |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       |        
|Sale of 511,031 shares of treasury stock                                                         |  |              |     |                                    |   | 23,113                                |   |                      |         |                              |   |                |   |       |        
|Settlement of forward shares                                                                     |  |              |     |                                    |   | 39,408                                |   |                      |         |                              |   |                |   |       |        
|Recharacterization of deferred compensation                                                      |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       | (62,832
|Retirement of treasury stock                                                                     |  |              | (2  | )                                  |   | (3,570                                | ) |                      |         |                              |   |                |   |       |        
|Contribution of redeemable preferred stock                                                       |  |              |     |                                    |   | 700                                   |   |                      |         |                              |   |                |   |       |        
|Purchase of 304,757 shares of treasury stock                                                     |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       | 24,004 
|Other                                                                                            |  |              |     |                                    |   | 451                                   |   |                      |         |                              |   |                |   |       | (446   
|                                                                                                 |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       |        
|BALANCE, December 31, 2000                                                                       |  |              | 335 |                                    |   | 903,479                               |   |                      | 70,095  |                              |   | 491,824        |   |       | 24,004 
|Net income for the year                                                                          |  |              |     |                                    |   |                                       |   |                      |         |                              |   | 209,496        |   |       |        
|Net change in accumulated comprehensive income (net of deferred income tax benefit of $5,424)    |  |              |     |                                    |   |                                       |   |                      | (7,129  | )                            |   |                |   |       |        
|Dividends paid                                                                                   |  |              |     |                                    |   |                                       |   |                      |         |                              |   | (32,729        | ) |       |        
|Other                                                                                            |  |              |     |                                    |   | (1                                    | ) |                      |         |                              |   | 572            |   |       |        
|Deferred equity payout                                                                           |  |              |     |                                    |   | 16                                    |   |                      |         |                              |   |                |   |       | (288   
|                                                                                                 |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       |        
|BALANCE, December 31, 2001                                                                       |  |              | 335 |                                    |   | 903,494                               |   |                      | 62,966  |                              |   | 669,163        |   |       | 23,716 
|Net income for the year                                                                          |  |              |     |                                    |   |                                       |   |                      |         |                              |   | 181,075        |   |       |        
|Net change in accumulated comprehensive income (net of deferred income tax benefit 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 
|                                                                                                 |  |              |     |                                    |   |                                       |   |                      |         |                              |   |                |   |       |        

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

50

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

|                                      |                                                                                  | Year Ended December 31,                   |       
|------------------------------------- | -------------------------------------------------------------------------------- | ----------------------------------------- | ------
|
|Cash flows from operating activities: |                                                                                  |                                           |       
|                                      | Premiums received, net                                                           |                                           | $     
|                                      | Policy acquisition, merger-related and other operating expenses paid, net        |                                           |       
|                                      | Termination fee on derivatives                                                   |                                           |       
|                                      | Recoverable advances recovered (paid)                                            |                                           |       
|                                      | Losses and loss adjustment expenses recovered (paid)                             |                                           |       
|                                      | Net investment income received                                                   |                                           |       
|                                      | Federal income taxes paid                                                        |                                           |       
|                                      | Interest paid                                                                    |                                           |       
|                                      | Other                                                                            |                                           |       
|                                      |                                                                                  |                                           |       
|                                      |                                                                                  | Net cash provided by operating activities |       
|                                      |                                                                                  |                                           |       
|Cash flows from investing activities: |                                                                                  |                                           |       
|                                      | Proceeds from sales of bonds                                                     |                                           |       
|                                      | Proceeds from sales of equity investments                                        |                                           |       
|                                      | Purchases of bonds                                                               |                                           |       
|                                      | Purchases of equity investments                                                  |                                           |       
|                                      | Proceeds from sale of guaranteed investment contract bonds                       |                                           |       
|                                      | Purchases of guaranteed investment contract bonds                                |                                           |       
|                                      | Purchases of property and equipment                                              |                                           |       
|                                      | Net decrease (increase) in guaranteed investment contract short-term investments |                                           |       
|                                      | 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                                                       |                                           |       
|                                      | Dividends paid                                                                   |                                           |       
|                                      | Proceeds from issuance of guaranteed investment contracts                        |                                           |       
|                                      | Purchase of common stock                                                         |                                           |       
|                                      | Sale of treasury stock(a)                                                        |                                           |       
|                                      | Settlement of forward shares                                                     |                                           |       
|                                      | Other                                                                            |                                           |       
|                                      |                                                                                  |                                           |       
|                                      |                                                                                  | Net cash provided by financing activities |       
|                                      |                                                                                  |                                           |       
|Net increase (decrease) in cash       |                                                                                  |                                           | 23,584
|Cash at beginning of year             |                                                                                  |                                           | 7,784 
|                                      |                                                                                  |                                           |       
|Cash at end of year                   |                                                                                  | $                                         | 31,368
|                                      |                                                                                  |                                           |       

---

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

51

---

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

|                                                                          |                                                                              | Year Ended December 31, |        
|------------------------------------------------------------------------- | ---------------------------------------------------------------------------- | ----------------------- | -------
|
|Reconciliation of net income to net cash flows from operating activities: |                                                                              |                         |        
|Net income                                                                |                                                                              | $                       | 181,075
|                                                                          | Increase in accrued investment income                                        |                         |        
|                                                                          | Increase in deferred premium revenue and related foreign exchange adjustment |                         |        
|                                                                          | Increase in deferred acquisition costs                                       |                         |        
|                                                                          | Increase (decrease) in current federal income taxes payable                  |                         |        
|                                                                          | Increase (decrease) in unpaid losses and loss adjustment expenses            |                         |        
|                                                                          | Increase (decrease) in amounts withheld for others                           |                         |        
|                                                                          | Provision (benefit) for deferred income taxes                                |                         |        
|                                                                          | Net realized losses (gains) on investments                                   |                         |        
|                                                                          | Deferred equity compensation                                                 |                         |        
|                                                                          | Depreciation and accretion of bond discount                                  |                         |        
|                                                                          | Minority interest and equity in earnings of unconsolidated affiliates        |                         |        
|                                                                          | Change in other assets and liabilities                                       |                         |        
|                                                                          |                                                                              |                         |        
|Cash provided by operating activities                                     |                                                                              | $                       | 448,573
|                                                                          |                                                                              |                         |        

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

52

---



FINANCIAL SECURITY ASSURANCE HOLDINGS LTD.  AND SUBSIDIARIES        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000

1. ORGANIZATION AND OWNERSHIP

Financial Security Assurance Holdings Ltd. (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. 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 or trade 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. 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.

In
the fourth quarter of 2001, the Company began offering guaranteed investment contracts (GICs) through its wholly owned subsidiaries, FSA Capital Markets Services LLC and FSA Capital
Management Services LLC (collectively, CMS). The GICs are provided to municipalities and other market participants, and are insured by the Company's insurance company subsidiary. The GICs provide for
the return of principal and the payment of interest at a guaranteed rate.

On
July 5, 2000, the Company completed a merger in which the Company 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. Dexia also indirectly acquired the Company's redeemable preferred stock, which was then contributed to the Company's capital. As a result of this transaction, the Company valued its
liabilities under the Company's equity-based compensation plans at the transaction price and changed its assumption regarding those plans by assuming all future payments will be settled in cash. It
also reflected the settlement of its forward share agreements at the merger price and the sale of 511,031 shares of the Company's common stock to Dexia at the merger price. The net effect of the
merger, reflected in the December 31, 2000 financial statements, was to decrease net income by $75.5 million and decrease shareholders' equity by $36.1 million. At
December 31, 2002, the only holders of the Company's common stock were Dexia Holdings, Inc., 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 in the Company's common stock under the Director Share Purchase Program (see Note 11).

53

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2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The
accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), which, 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, 2002 and 2001 and the reported amounts of revenues and expenses in the consolidated statements of operations and comprehensive
income during the years ended December 31, 2002, 2001 and 2000. 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 deferred policy acquisition costs. Actual results may differ from those estimates. Significant accounting policies under GAAP are as follows:



The consolidated financial statements include the accounts of the Company and its direct and indirect subsidiaries, Financial Security Assurance Inc.
(FSA), FSA Insurance Company, Financial Security Assurance International Ltd. (FSA International), Financial Security Assurance (U.K.) Limited, FSA Capital Markets Services LLC, FSA Capital
Management Services LLC, FSA Asset Management LLC (FSAM), FSA Portfolio Management Inc., Transaction Services Corporation, FSA Services (Australia) Pty Limited and FSA Services (Japan)
(collectively, the Subsidiaries). All intercompany accounts and transactions have been eliminated. Certain prior-year balances have been reclassified to conform to the 2002 presentation.



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

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 market value, which
approximates cost. 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.

Investments
in unconsolidated affiliates are based on the equity method of accounting (see Note 19).



Derivative instruments, which are primarily designated as fair value hedges, are entered into to manage the interest rate exposure of the Company's GICs and GIC
bond portfolio and are recorded at fair value. These derivatives generally include interest rate futures and interest rate swap agreements, which are primarily utilized to convert the Company's
fixed-rate obligations on its GICs and GIC bond portfolio into floating-rate obligations. The gains and losses relating to these fair value hedges are included in guaranteed
investment contract net interest income and 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. Any ineffective portion of the hedge is recognized in earnings. Gains and losses relating to derivatives that fail hedge effectiveness
are marked to market through earnings and included in guaranteed investment contract net interest income and net interest expense, as appropriate.

54

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The
Company has also insured a number of credit default swap 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.
The Company uses quoted market prices, when available, to determine fair value. If quoted prices are not available, management uses internally developed estimates. 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.



Gross and ceded premiums 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. 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. When the Company, through its ongoing credit review process, identifies transactions where certain triggers have
been breached, the Company ceases to earn premiums. If a case basis reserve is established for these transactions, the unearned premium will reduce such reserve.



The Company establishes a case basis reserve for unpaid losses and loss adjustment expenses for the net present value of the estimated loss when, in management's
opinion, the likelihood of a future loss on a particular insured obligation is probable and determinable at the balance sheet date. The estimated loss on a transaction is discounted using the then
current risk-free rates ranging from 4.77% to 6.1%. For collateralized debt obligations (CDOs), a case basis reserve is recorded to the extent that the overcollateralization ratio
(non-defaulted collateral at par value divided by the debt insured) has fallen below 100%.

The
Company also maintains a non-specific general reserve, which is available to be applied against future additions or accretions to existing case basis reserves or to new
case basis reserves to be established in the future. The general reserve is calculated by applying a loss factor to the total net par amount outstanding of the Company's insured obligations over the
term of such insured obligations and discounting the result at the then current risk-free rates. The loss factor used for this purpose has been determined based upon an independent rating
agency study of bond defaults and the Company's portfolio characteristics and history.

Management
of the Company periodically evaluates its estimates for losses and loss adjustment expenses and establishes reserves that management believes are adequate to cover the net
present value of the ultimate net cost of claims. The reserves are necessarily based on estimates, and there can be no assurance that the ultimate liability will not differ from such estimates. The
Company will, on an ongoing basis, monitor these reserves and may periodically adjust such reserves based on the Company's actual loss experience, its future mix of business, and future economic
conditions.



Deferred acquisition costs comprise those expenses that vary with, and are primarily 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. The Company does not defer acquisition costs relating to GICs issued by CMS, except for brokerage fees. Deferred acquisition costs and the cost of
acquired business are

55

---

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 anticipated losses and loss adjustment expenses.



The Company enters into GICs whereby the Company receives deposits at a contractual interest rate. These contracts are recorded at amortized cost. Additionally,
the Company may enter into associated transactions in order to reduce the Company's exposure to fluctuations in interest rates related to the GICs. 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, attributable to the hedged risk, adjusts the carrying amount of the hedged item and is
recognized in income currently.



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

Bonds
at amortized cost of $8,474,000 and $8,493,000 at December 31, 2002 and 2001, respectively, were on deposit with state regulatory authorities as required by insurance
regulations.

Consolidated
net investment income, excluding income attributable to the GIC bond portfolio and the GIC short-term investment portfolio (collectively, the GIC Portfolio),
consisted of the following (in thousands):

Year Ended December 31,2002

2001

2000Bonds

$
138,095

$
126,750

$
115,815Equity investments


336


504


635Short-term investments


3,092


3,874


6,472Investment expenses


(2,403
)

(2,207
)

(1,778
)Net investment income

$
139,120

$
128,921

$
121,144


The
credit quality of bonds, excluding the GIC bond portfolio, at December 31, 2002 was as follows:

Rating

Percent of BondsAAA

75.8
%AA

19.7A

4.5


Of
the AAA rated bonds included in the investment portfolio, 8.7% were AAA by virtue of insurance provided by FSA.

56

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The
amortized cost and estimated market value of bonds, excluding the GIC bond portfolio, were as follows (in thousands):

|December 31, 2002                                                                     |       | Amortized Cost |           | Gross Unrealized Gains |   | Gross Unrealized Losses |         | Estimated Market Value
|------------------------------------------------------------------------------------- | ----- | -------------- | --------- | ---------------------- | - | ----------------------- | ------- | ----------------------
|U.S. Treasury securities and obligations of U.S. government corporations and agencies |       | $              | 68,429    |                        | $ | 7,178                   |         | $                     
|Obligations of states and political subdivisions                                      |       |                | 2,034,691 |                        |   | 186,352                 |         |                       
|Mortgage-backed securities                                                            |       |                | 252,970   |                        |   | 8,203                   |         |                       
|Corporate securities                                                                  |       |                | 184,302   |                        |   | 10,992                  |         |                       
|Asset-backed securities                                                               |       |                | 74,781    |                        |   | 2,244                   |         |                       
|                                                                                      |       |                |           |                        |   |                         |         |                       
|                                                                                      | Total |                | $         | 2,615,173              |   | $                       | 214,969 |                       
|                                                                                      |       |                |           |                        |   |                         |         |                       

|December 31, 2001                                                                     |       | Amortized Cost |           | Gross Unrealized Gains |   | Gross Unrealized Losses |        | Estimated Market Value
|------------------------------------------------------------------------------------- | ----- | -------------- | --------- | ---------------------- | - | ----------------------- | ------ | ----------------------
|U.S. Treasury securities and obligations of U.S. government corporations and agencies |       | $              | 81,149    |                        | $ | 2,295                   |        | $                     
|Obligations of states and political subdivisions                                      |       |                | 1,692,288 |                        |   | 78,706                  |        |                       
|Foreign securities                                                                    |       |                | 5,780     |                        |   | 807                     |        |                       
|Mortgage-backed securities                                                            |       |                | 229,063   |                        |   | 8,623                   |        |                       
|Corporate securities                                                                  |       |                | 183,837   |                        |   | 6,772                   |        |                       
|Asset-backed securities                                                               |       |                | 44,862    |                        |   | 1,984                   |        |                       
|                                                                                      |       |                |           |                        |   |                         |        |                       
|                                                                                      | Total |                | $         | 2,236,979              |   | $                       | 99,187 |                       
|                                                                                      |       |                |           |                        |   |                         |        |                       

The
change in net unrealized gains (losses) consisted of (in thousands):

Year Ended December 31,2002

2001

2000Bonds

$
122,300

$
(12,883
)
$
172,180Equity investments


(70
)

329


6,239Change in net unrealized gains (losses)

$
122,230

$
(12,554
)
$
178,419


57

---

The
amortized cost and estimated market value of bonds, excluding the GIC bond portfolio, at December 31, 2002, 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

Estimated
Market ValueDue in one year or less

$
999

$
1,027Due after one year through five years


149,770


156,384Due after five years through ten years


269,917


297,690Due after ten years


1,866,736


2,036,604Mortgage-backed securities (stated maturities of 1 to 30 years)


252,970


261,033Asset-backed securities (stated maturities of 1 to 14 years)


74,781


77,025Total

$
2,615,173

$
2,829,763


Proceeds
from sales of bonds, excluding the GIC bond portfolio, during 2002, 2001 and 2000 were $772,034,000, $537,062,000 and $1,452,485,000, respectively. Gross gains of $30,312,000,
$9,120,000 and $10,262,000 and gross losses of $1,303,000, $1,763,000 and $41,217,000 were realized on sales in 2002, 2001 and 2000, respectively.

Proceeds
from sales of equity investments during 2002, 2001 and 2000 were $0, $0 and $14,167,000, respectively. Gross losses of $0, $0 and $5,927,000 were realized on such sales in 2002,
2001 and 2000, respectively. Equity investments had gross unrealized gains of $0 and $75,000 and gross unrealized losses of $0 and $5,000 as of December 31, 2002 and 2001, respectively.

The
Company held open positions in U.S. Treasury bond futures contracts, Eurodollar futures contracts, and municipal bond index futures during 2000. Such positions were marked to market
on a daily basis and, for the year ended December 31, 2000, resulted in net realized gains of $480,000. In 2002, the Company purchased foreign currency calls with a notional amount of
$74.1 million. These calls were marked to market through earnings and for the year ended December 31, 2002, resulted in net unrealized gains of $195,000.

GIC Portfolio

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

2002

2001Bonds

$
42,803

$
931Short-term investments


1,015


409Net investment income

$
43,818

$
1,340


The
credit quality of bonds held in the GIC bond portfolio at December 31, 2002 was as follows:

Rating

Percent of BondsAAA

96.6
%AA

0.9A

0.7Other

1.8


Of
the AAA rated bonds included in the investment portfolio, 9.4% were AAA by virtue of insurance provided by FSA. For purposes of the foregoing, the GIC bond portfolio excludes
$523,477,000 of FSA-insured securities issued in connection with refinancing transactions (see Notes 23 and 24).

58

---

The
amortized cost and estimated market value of bonds held in the GIC bond portfolio were as follows (in thousands):

|December 31, 2002                                |       | Amortized Cost |           | Gross Unrealized Gains |   | Gross Unrealized Losses |        | Estimated Market Value
|------------------------------------------------ | ----- | -------------- | --------- | ---------------------- | - | ----------------------- | ------ | ----------------------
|Obligations of states and political subdivisions |       | $              | 105,004   |                        | $ | 9,487                   |        | $                     
|Mortgage-backed securities                       |       |                | 556,922   |                        |   | 16,715                  |        |                       
|Corporate securities                             |       |                | 46,623    |                        |   | 251                     |        |                       
|Asset-backed securities                          |       |                | 1,091,557 |                        |   | 3,098                   |        |                       
|                                                 |       |                |           |                        |   |                         |        |                       
|                                                 | Total |                | $         | 1,800,106              |   | $                       | 29,551 |                       
|                                                 |       |                |           |                        |   |                         |        |                       

|December 31, 2001                                |       | Amortized Cost |         | Gross Unrealized Gains |   | Gross Unrealized Losses |       | Estimated Market Value
|------------------------------------------------ | ----- | -------------- | ------- | ---------------------- | - | ----------------------- | ----- | ----------------------
|Obligations of states and political subdivisions |       | $              | 5,245   |                        | $ |                         |       | $                     
|Mortgage-backed securities                       |       |                | 95,090  |                        |   | 1,259                   |       |                       
|Corporate securities                             |       |                | 41,613  |                        |   | 70                      |       |                       
|Asset-backed securities                          |       |                | 286,068 |                        |   | 128                     |       |                       
|                                                 |       |                |         |                        |   |                         |       |                       
|                                                 | Total |                | $       | 428,016                |   | $                       | 1,457 |                       
|                                                 |       |                |         |                        |   |                         |       |                       

The
amortized cost and estimated market value of the GIC bond portfolio, at December 31, 2002, 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

Estimated Market ValueDue in one year or less

$
17,905

$
17,893Due after one year through five years


28,718


28,961Due after five years through ten years


49,768


50,750Due after ten years


55,236


63,741Mortgage-backed securities (stated maturities of 2 to 34 years)


556,922


573,105Asset-backed securities (stated maturities of 1 to 37 years)


1,091,557


1,092,862Total

$
1,800,106

$
1,827,312


Proceeds
from sales of bonds held in the GIC Portfolio during 2002 and 2001 were $274,085,000 and $174,195,000, respectively. Gross losses of $154,000 and $346,000 were
realized on sales in 2002 and 2001, respectively. The change in net unrealized gains in 2002 was $27,229,000 and the net change in unrealized losses was as $23,000 for 2001.

59

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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 31,2002

2001

2000Balance, beginning of period

$
240,492

$
201,136

$
198,048Costs deferred during the period:Ceding commission income


(68,464
)

(41,935
)

(42,496
)Premium taxes


13,401


9,653


5,934Compensation and other acquisition costs


122,441


113,013


77,252Total


67,378


80,731


40,690Costs amortized during the period


(54,093
)

(41,375
)

(37,602
)Balance, end of period

$
253,777

$
240,492

$
201,136


5. STATUTORY ACCOUNTING PRACTICES

GAAP for the Subsidiaries differs in certain significant respects from accounting practices prescribed or permitted by insurance regulatory authorities. The
principal differences result from the following statutory accounting practices:





60

---



A
reconciliation of net income for the calendar years 2002, 2001 and 2000 and shareholders' equity at December 31, 2002 and 2001, reported by the Company on a GAAP basis, to the
amounts reported by the Subsidiaries on a statutory basis, is as follows (in thousands):

Net Income:

2002

2001

2000GAAP BASIS

$
181,075

$
209,496

$
63,283Non-insurance companies net loss


1,704


3,083


60,052Premium revenue recognition


(19,624
)

(23,113
)

(13,824
)Losses and loss adjustment expenses incurred


20,585


3,867


10,233Deferred acquisition costs


(13,285
)

(39,356
)

(3,088
)Deferred income tax provision


(23,888
)

15,949


11,725Current income tax


(8,162
)

(6,239
)

837Change in fair value of derivatives


48,788Accrual of deferred compensation, net








(20,328
)Other


7,895


9,383


4,869STATUTORY BASIS

$
195,088

$
173,070

$
113,759


December 31,Shareholders' Equity:2002

2001GAAP BASIS

$
1,868,370

$
1,635,958Non-insurance companies liabilities, net


102,954


62,724Premium revenue recognition


(162,788
)

(141,365
)Loss and loss adjustment expense reserves


89,656


69,071Deferred acquisition costs


(253,777
)

(240,492
)Contingency reserve


(691,955
)

(784,591
)Unrealized loss (gain) on investments, net of deferred tax


(214,148
)

(92,254
)Deferred income taxes


168,452


134,655Surplus notes


214,865


146,752Other


62,533


18,521STATUTORY BASIS SURPLUS

$
1,184,162

$
808,979SURPLUS PLUS CONTINGENCY RESERVE

$
1,876,117

$
1,593,570


The
U.S. domiciled insurance subsidiaries file statutory-basis financial statements with state insurance departments in all states in which they are licensed. On January 1, 2001,
significant changes to the statutory basis of accounting became effective. The cumulative effect of these changes, known as Codification
guidance, was recorded as a direct adjustment to statutory surplus. The effect of adoption, at January 1, 2001, was a $50,293,000 decrease to statutory surplus, which related primarily to the
accrual of deferred compensation obligations.

6. FEDERAL INCOME TAXES

Prior to the Dexia merger, the Company and its Subsidiaries, except FSA International, filed a consolidated federal income tax return. The calculation of each
company's tax benefit or liability was controlled by a tax-sharing agreement that based the allocation of such benefit or liability upon a separate return calculation. Dexia
Holdings, Inc. and the Company and its Subsidiaries, except FSA International, filed a consolidated federal income tax return for periods subsequent to the merger, under a new
tax-sharing agreement.

61

---

Federal
income taxes have not been provided on substantially all of the undistributed earnings of FSA International, since it is the Company's practice and intent to reinvest such
earnings in the operations of this subsidiary. The cumulative amount of such untaxed earnings was $57,063,000, $41,899,000 and $18,629,000 at December 31, 2002, 2001 and 2000, respectively.

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

December 31,2002

2001Deferred acquisition costs

$
80,815

$
78,008Deferred premium revenue adjustments


17,663


17,420Unrealized capital gains


67,116


30,204Contingency reserves


78,433


70,350Mark-to-market adjustments





2,253Undistributed earnings


3,552


3,248Total deferred federal income tax liabilities


247,579


201,483Loss and loss adjustment expense reserves


(27,526
)

(21,384
)Deferred compensation


(80,446
)

(76,276
)Mark-to-market adjustments


(15,288
)Other, net


(9
)

(1,852
)Total deferred federal income tax assets


(123,269
)

(99,512
)Total deferred federal income taxes

$
124,310

$
101,971


No
valuation allowance was necessary at December 31, 2002 or 2001.

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

Year Ended December 31,2002

2001

2000Tax at statutory rate

35.0
%
35.0
%
35.0
%Tax-exempt investments

(16.4
)
(9.8
)
(33.8
)Income of foreign subsidiary

(2.5
)
(3.0
)
(5.8
)Merger-related expenses





10.2Other

0.1

0.1

0.5Provision for income taxes

16.2
%
22.3
%
6.1
%


In
2002, the Company changed its method of accounting for taxes in respect of its equity earnings from Fairbanks Capital Holding Corp. (Fairbanks), an unconsolidated affiliate of the
Company (see Note 19). Prior to 2002, the Company accounted for its equity earnings from Fairbanks net of income tax at the statutory rate of 35%. Following a change in Fairbanks' 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
Fairbanks based upon 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.

7. SHAREHOLDERS' EQUITY

The Company was party to forward share agreements with certain counterparties and made the economic benefit and risk of a number of these shares available for
subscription by certain of the Company's employees and directors. As part of the merger, the Company settled all of its forward share agreements and corresponding employee and director subscriptions
at the merger price. In 2000, the Company recognized compensation expense of $30,324,000 as a result of the settlement.

62

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On
November 3, 1998, the Company and XL Capital Ltd (XL) closed a transaction to create two new Bermuda-based financial guaranty insurance companies. Each of the new
companies was initially capitalized with approximately $100,000,000. One company, FSA International, is an indirect subsidiary of FSA, and the other company, XL Financial Assurance Ltd, is a
subsidiary of XL. The Company has a minority interest in the XL subsidiary, and XL has a minority interest in the FSA indirect subsidiary. In conjunction with forming the new companies, the Company
and XL exchanged $80,000,000 of their respective common shares, with the Company delivering to XL 1,632,653 common shares out of treasury. Prior to the closing of the transaction with XL, the Company
had entered into an agreement with an unrelated third party to sell for cash, at no gain or loss, $60,000,000 of the XL shares. This $60,000,000 was used to fund, in part, the Company's investment in
FSA International. In 2000, the Company sold its remaining investment in XL.

8. 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 twelve 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 twelve-month period. As of December 31, 2002, FSA had $113,983,000 available for the payment of dividends over the next twelve months. In 2002 and 2001, FSA
International paid preferred dividends of $8,671,000 and $1,589,000, respectively, to its minority interest owner. In addition, at December 31, 2002, the Company held $212,850,000 of surplus
notes of FSA. Payments of principal or interest on such notes may be made with the approval of the New York Superintendent. In 2002 and 2001, with the approval of the New York Superintendent, FSA
repaid $28,000,000 and $26,000,000, respectively, of principal on such notes and subsequently issued an additional $96,850,000 and $50,000,000 in 2002 and 2001, respectively, of surplus notes to the
Company.

9. CREDIT ARRANGEMENTS AND ADDITIONAL CLAIMS-PAYING RESOURCES

FSA has a credit arrangement aggregating $125,000,000 at December 31, 2002, which is provided by commercial banks and intended for general application to
transactions insured by the Subsidiaries. At December 31, 2002, there were no borrowings under this arrangement, which expires on April 25, 2003, if not extended. In addition, there are
credit arrangements assigned to specific insured transactions. In August 1994, FSA entered into a facility agreement with Canadian Global Funding Corporation (Canadian Global) and Hambros Bank
Limited. Under the agreement, which expires in August 2004, FSA can arrange financing for transactions subject to certain conditions. Canadian Global has total assets of $196.8 million,
of which $87.6 million has been invested in a GIC issued by CMS. The amount of this facility was $186,911,000, of which $125,161,000 was unutilized at December 31, 2002.

FSA
has a standby line of credit commitment in the amount of $240,000,000 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 $240,000,000 or the average annual debt service of the covered portfolio multiplied by 5.00%, which amounted
to $704,553,000 at December 31, 2002. The obligation to repay loans made under this agreement is a limited recourse obligation payable solely from, and collateralized by, a pledge of recoveries
realized on defaulted insured obligations in the covered portfolio, including certain installment premiums and other collateral. This commitment has a term expiring on April 30, 2009 and
contains an annual renewal provision subject to approval by the banks. No amounts have been utilized under this commitment as of December 31, 2002.

The
Company's asset management group has a $100 million line of credit with UBS AG, Stamford Branch, which expires December 12, 2003, unless extended. There were no
borrowings under this agreement at December 31, 2002.

63

---

10. LONG-TERM DEBT

On November 26, 2002, the Company issued $230,000,000 principal amount of 6.25% Notes due November 1, 2102 and callable without premium or penalty
in whole or in part at any time on or after November 26, 2007. The Company used a portion of the proceeds of this issuance to redeem in whole the Company's $130,000,000 principal amount of
7.375% Senior Quarterly Income Debt Securities (Senior QUIDS) due September 30, 2097. Unamortized debt issuance costs of the retired debt, at the date of redemption, of $4,097,000 were charged
to earnings. Interest on the notes is payable quarterly beginning on February 1, 2003. Debt issuance costs of the new debt of $7,395,000 are being amortized over the life of the debt.

On
November 13, 1998, the Company issued $100,000,000 of 6.950% Senior QUIDS due November 1, 2098 and callable without premium or penalty on or after November 1,
2003. Interest is payable quarterly. Debt issuance costs of $3,375,000 are being amortized over the life of the debt.

On
December 19, 2001, the Company issued $100,000,000 of 67/8% Quarterly Income Bond Securities due December 15, 2101 and callable without premium or penalty
on or after December 19, 2006. Interest is payable quarterly. Debt issuance costs of $3,250,000 are being amortized over the life of the debt.

11. EMPLOYEE BENEFIT PLANS

The Company and its Subsidiaries maintain both qualified and non-qualified, non-contributory defined contribution pension plans for the
benefit of all eligible employees. The Company and its Subsidiaries' contributions are based upon a fixed percentage of employee compensation. Pension expense, which is funded as accrued, amounted to
$5,066,000, $3,570,000 and $3,521,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

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

Performance
shares are awarded under the Company's 1993 Equity Participation Plan. The Plan authorizes the discretionary grant of performance shares by the Human Resources Committee to
key employees of the Company and its Subsidiaries. The amount earned for each performance share depends upon the attainment by the Company of certain growth rates of adjusted book value (or in the
case of performance shares issued after January 1, 2001, growth rates of adjusted book value and book value) per outstanding share over a three-year period. At the election of the
participant at the time of award, growth rates may be determined including or excluding realized and unrealized gains and losses on the Company's investment portfolio. No payout occurs if the compound
annual growth rate of the Company's 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 Date
|---- |  | -------------------------------- |  | ----------------------- |  | ---------------------- |  | ------------------------- |  | -------------------------- |  | -----------------------------
|2000 |  | 1,223,025                        |  | 437,300                 |  | 540,710                |  | 24,781                    |  | 1,094,834                  |  | 52.1250                      
|2001 |  | 1,094,834                        |  | 310,200                 |  | 261,034                |  | 12,250                    |  | 1,131,750                  |  | 79.0400                      
|2002 |  | 1,131,750                        |  | 376,775                 |  | 380,279                |  | 13,901                    |  | 1,114,345                  |  | 85.6300                      

64

---

The
Company applies APB Opinion 25 and related Interpretations in accounting for its performance shares. The Company estimates the final cost of these performance shares and accrues for
this expense over the performance period. The accrued expense for the performance shares was $58,916,000, $48,238,000 and $50,076,000 for the years ended December 31, 2002, 2001 and 2000,
respectively. The accrued expense for 2000 includes $26,177,000 of merger-related costs. Prior to the merger, in tandem with this accrued expense, the Company estimated those performance shares that
it expected to settle in stock and recorded this amount in shareholders' equity as deferred compensation. The remainder of the accrual, which represented the amount of performance shares that the
Company estimated it would settle in cash, was recorded in accrued expenses and other liabilities. As a result of the merger, the Company revised its assumption by assuming that all future payments
would be settled in cash and recharacterized $39,599,000 from shareholders' equity to a liability. Had the compensation cost for the Company's performance shares been determined based upon the
provisions of SFAS No. 123, there would have been no effect on the Company's reported net income.

For
obligations under the Company's Deferred Compensation Plan (DCP) and Supplemental Executive Retirement Plan (SERP), the Company generally purchases investments, which should 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 $24,004,000. 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 2002 and 2001, $271,000 and $288,000, respectively, of restricted treasury stock was distributed to a
director as a deferred equity plan payout.

The
Company does not currently provide post-retirement benefits, other than under its defined contribution plans, to its employees, nor does it provide
post-employment benefits to former employees other than under its severance plans or employment agreements with members of senior management.

12.  COMMITMENTS AND CONTINGENCIES

The Company and its Subsidiaries lease office space and equipment under non-cancelable operating leases, which expire at various dates through 2007.
Future minimum rental payments are as follows (in thousands):

Year Ended December 31,2003

$
5,5312004


5,3972005


4,3492006


1,4602007


841Total

$
17,578


Rent
expense for the years ended December 31, 2002, 2001 and 2000 was $6,207,000, $6,207,000 and $5,067,000, respectively.

During
the ordinary course of business, the Company and its Subsidiaries become parties to certain litigation. Management believes that these matters will be resolved with no material
impact on the Company's financial position, results of operations or cash flows.

13. REINSURANCE

The Subsidiaries obtain reinsurance to increase their 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 Subsidiaries reinsure portions of
their risks with

65

---

affiliated
(see Note 15) 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 to the Subsidiaries, or contest such obligations, the Subsidiaries would be liable for such
defaulted amounts. Certain of the reinsuring companies have provided collateral to the Subsidiaries to secure their reinsurance obligations. The Subsidiaries have also assumed reinsurance of municipal
obligations from unaffiliated insurers.

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

Year Ended December 31,2002

2001

2000Written premiums ceded

$
270,954

$
165,932

$
154,187Written premiums assumed


2,443


3,130


9,702Earned premiums ceded


134,093


99,251


85,175Earned premiums assumed


4,079


3,653


3,312Losses and loss adjustment expense payments ceded


(2,513
)

(4,199
)

1,616Losses and loss adjustment expense payments assumed








26


December 31,2002

2001Principal outstanding ceded

$
92,141,112

$
75,407,703Principal outstanding assumed


2,000,422


2,171,588Deferred premium revenue ceded


557,659


420,798Deferred premium revenue assumed


13,331


14,967Losses and loss adjustment expense reserves ceded


75,950


28,880Losses and loss adjustment expense reserves assumed


728


703


14. OUTSTANDING EXPOSURE AND COLLATERAL

The Company's policies insure the scheduled payments of principal and interest on asset-backed and municipal obligations. The principal amount insured (in
millions) as of December 31, 2002 and 2001 (net of amounts ceded to other insurers) and the terms to maturity are as follows:

|                   |       | December 31, 2002 |        | December 31, 2001
|------------------ | ----- | ----------------- | ------ | -----------------
|
|
|0 to 5 years       |       | $                 | 64,158 |                  
|5 to 10 years      |       |                   | 33,908 |                  
|10 to 15 years     |       |                   | 4,781  |                  
|15 to 20 years     |       |                   | 1,667  |                  
|20 years and above |       |                   | 21,579 |                  
|                   |       |                   |        |                  
|                   | Total |                   | $      | 126,093          
|                   |       |                   |        |                  

---

66

---

The
principal amount ceded as of December 31, 2002 and 2001 and the terms to maturity are as follows (in millions):

|                   |       | December 31, 2002 |        | December 31, 2001
|------------------ | ----- | ----------------- | ------ | -----------------
|
|
|0 to 5 years       |       | $                 | 10,130 |                  
|5 to 10 years      |       |                   | 6,851  |                  
|10 to 15 years     |       |                   | 3,699  |                  
|15 to 20 years     |       |                   | 1,428  |                  
|20 years and above |       |                   | 5,906  |                  
|                   |       |                   |        |                  
|                   | Total |                   | $      | 28,014           
|                   |       |                   |        |                  

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

|                                   |                                | Net of Amounts Ceded(1) December 31, |        | Ceded
December 31,
|---------------------------------- | ------------------------------ | ------------------------------------ | ------ | ------------------
|
|
|Residential mortgages              |                                | $                                    | 23,379 |                   
|Consumer receivables               |                                |                                      | 19,454 |                   
|Pooled corporate obligations       |                                |                                      | 78,113 |                   
|Investor-owned utility obligations |                                |                                      | 619    |                   
|Other asset-backed obligations     |                                |                                      | 4,528  |                   
|                                   |                                |                                      |        |                   
|                                   | Total asset-backed obligations |                                      | $      | 126,093           
|                                   |                                |                                      |        |                   

---

The
principal amount of insured obligations in the municipal insured portfolio includes the following types of issues (in millions):

|                                             |                             | Net of Amounts Ceded
December 31, |        | Ceded
December 31,
|-------------------------------------------- | --------------------------- | --------------------------------- | ------ | ------------------
|
|
|General obligation bonds                     |                             | $                                 | 54,563 |                   
|Housing revenue bonds                        |                             |                                   | 5,833  |                   
|Municipal utility revenue bonds              |                             |                                   | 23,442 |                   
|Health care revenue bonds                    |                             |                                   | 5,970  |                   
|Tax-supported bonds (non-general obligation) |                             |                                   | 27,556 |                   
|Transportation revenue bonds                 |                             |                                   | 7,640  |                   
|Other municipal bonds                        |                             |                                   | 12,173 |                   
|                                             |                             |                                   |        |                   
|                                             | Total municipal obligations |                                   | $      | 137,177           
|                                             |                             |                                   |        |                   

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

67

---

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 municipalities located therein issued an aggregate of 2% or more of the Company's net par amount outstanding of insured municipal securities as of December 31, 2002:

|State                        |       | Number
of Issues |       | Net Par
Amount
Outstanding |        | Percent of Total
Municipal Net Par
Amount Outstanding |      | Ceded Par
Amount
Outstanding
|---------------------------- | ----- | ---------------- | ----- | -------------------------- | ------ | ----------------------------------------------------- | ---- | ----------------------------
|
|California                   |       | 837              |       | $                          | 19,379 |                                                       | 14.1 | %                           
|New York                     |       | 550              |       |                            | 13,256 |                                                       | 9.7  |                             
|Texas                        |       | 615              |       |                            | 10,052 |                                                       | 7.3  |                             
|Pennsylvania                 |       | 580              |       |                            | 8,496  |                                                       | 6.2  |                             
|Florida                      |       | 230              |       |                            | 7,602  |                                                       | 5.5  |                             
|Illinois                     |       | 580              |       |                            | 6,697  |                                                       | 4.9  |                             
|New Jersey                   |       | 445              |       |                            | 6,322  |                                                       | 4.6  |                             
|Washington                   |       | 239              |       |                            | 5,020  |                                                       | 3.7  |                             
|Massachusetts                |       | 172              |       |                            | 4,088  |                                                       | 3.0  |                             
|Michigan                     |       | 340              |       |                            | 3,864  |                                                       | 2.8  |                             
|Wisconsin                    |       | 393              |       |                            | 3,529  |                                                       | 2.6  |                             
|All other U.S. jurisdictions |       | 2,622            |       |                            | 45,399 |                                                       | 33.1 |                             
|International                |       | 40               |       |                            | 3,473  |                                                       | 2.5  |                             
|                             |       |                  |       |                            |        |                                                       |      |                             
|                             | Total |                  | 7,643 |                            | $      | 137,177                                               |      | 100.0                       
|                             |       |                  |       |                            |        |                                                       |      |                             

15. RELATED PARTY TRANSACTIONS

The Subsidiaries ceded premiums of $30,701,000 to Tokio Marine and Fire Insurance Co., Ltd. (Tokio Marine), a partial owner of the Company prior to the
merger, for the year ended December 31, 2000. The Subsidiaries ceded losses and loss adjustment expenses of $2,935,000 to Tokio Marine for the year ended
December 31, 2000. The Subsidiaries ceded premiums of $23,393,000, $12,795,000 and $22,581,000 to subsidiaries of XL, a partial owner of the Company prior to the merger and a current owner of
an interest in FSA International, for the years ended December 31, 2002, 2001 and 2000, respectively. The amounts included in prepaid reinsurance premiums at December 31, 2002 and 2001
for reinsurance ceded to subsidiaries of XL were $31,976,000 and $27,509,000, respectively.

The
Subsidiaries ceded premiums of $(1,401,000) on a quota share basis to Commercial Reinsurance Company (Comm Re), an affiliate of MediaOne Capital Corporation (MediaOne), a partial
owner of the Company prior to the merger, for the year ended December 31, 2000. The Subsidiaries assumed premiums of $8,568,000 from Comm Re for the year ended December 31, 2000, in
connection with the acquisition of Comm Re by the Company in June 2000. The sellers have either posted a letter of credit or assumed Comm Re's exposure themselves to cover any losses on its
exposure at the time of the acquisition, all of which is being accounted for as reinsurance by the Company. The Subsidiaries ceded losses and loss adjustment expense recoveries of $501,000 to this
affiliate for the year ended December 31, 2000.

The
Subsidiaries had premiums written of $59,103,000, $54,295,000 and $4,412,000 in 2002, 2001 and 2000, respectively, relating to the guaranty of debt issued and of debt obligations
purchased by FSA Global Funding Limited (FSA Global), in which the Company holds a 29% ownership interest (see Note 19). The amounts included in deferred premium revenue relating to FSA Global
transactions are $35,452,000 and $40,090,000 at December 31,

68

---

2002
and 2001, respectively.

The
Subsidiaries had premiums earned of $17,272,000 and $7,159,000 for the years ended December 31, 2002 and 2001, respectively, relating to business with affiliates of Dexia.
Deferred premium revenue relating to those transactions was $7,675,000 and $4,336,000 at December 31, 2002 and 2001, respectively. Gross par outstanding relating to those transactions were
$16,165,980,000 and $10,906,755,000 at December 31, 2002 and 2001, respectively. The Company also paid Dexia a fee of $3,300,000 relating to business in which both Dexia and the Company are
involved.

16. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS

The following estimated fair values have been determined by the Company 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.

Bonds,
equity investments and GIC bond portfolioThe carrying amount represents fair value. The fair value is based upon quoted market price.

Short-term
investments, including the GIC short-term investment portfolioThe carrying amount is fair value, which approximates cost due to the short
maturity of these instruments.

Cash,
receivable for investments sold and payable for investments purchasedThe carrying amount approximates fair value because of the short maturity of these instruments.

Securitized
loansThe fair value of the loans is the present value of the expected cash flows as of the reporting date.

Deferred
premium revenue, net of prepaid reinsurance premiumsThe carrying amount of deferred premium revenue, net of prepaid reinsurance premiums, represents the Company's
future premium revenue, net of reinsurance, on policies where the premium was received at the inception of the insurance contract. 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.

Notes
payableThe carrying amount of notes payable represents the principal amount. The fair value is based upon quoted market price.

Installment
premiumsConsistent with industry practice, there is no carrying amount for installment premiums since the Company will receive premiums on an installment basis
over the term of the insurance contract. Similar to deferred premium revenue, the fair value of installment premiums is the estimated present value of the future contractual premium revenues 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 premium retained by the Company to compensate it for
originating and servicing the insurance contract.

GICsThe
fair value of a GIC is the present value of the expected cash flows as of the reporting date.

Losses
and loss adjustment expenses, net of reinsurance recoverable on unpaid lossesThe carrying amount is fair value, which is the net present value of the expected cash
flows for specifically identified claims and potential losses in the Company's insured portfolio.

69

---

|                               |                                                                                      | December 31, 2002 |   | December 31, 2001
|------------------------------ | ------------------------------------------------------------------------------------ | ----------------- | - | -----------------
|
|
|Assets:                        |                                                                                      |                   |   |                  
|                               | Bonds                                                                                |                   | $ | 2,829,763        
|                               | Equity investments                                                                   |                   |   |                  
|                               | Short-term investments                                                               |                   |   | 375,688          
|                               | GIC bond portfolio                                                                   |                   |   | 1,827,312        
|                               | GIC short-term investment portfolio                                                  |                   |   | 4,632            
|                               | Cash                                                                                 |                   |   | 31,368           
|                               | Securitized loans                                                                    |                   |   | 437,462          
|                               | Receivable for securities sold                                                       |                   |   | 92               
|Liabilities:                   |                                                                                      |                   |   |                  
|                               | Deferred premium revenue, net of prepaid reinsurance premiums                        |                   | $ | 892,552          
|                               | Losses and loss adjustment expenses, net of reinsurance recoverable on unpaid losses |                   |   | 147,668          
|                               | GICs                                                                                 |                   |   | 2,449,033        
|                               | Notes payable                                                                        |                   |   | 430,000          
|                               | Payable for investments purchased                                                    |                   |   | 10,490           
|Off-balance-sheet instruments: |                                                                                      |                   |   |                  
|                               | Installment premiums                                                                 |                   |   |                 

17. LIABILITY FOR LOSSES AND LOSS ADJUSTMENT EXPENSES

Activity in the liability for losses and loss adjustment expenses, which consists of the case basis and general reserves, is summarized as follows (in thousands):

Year Ended December 31,2002

2001

2000Balance at January 1

$
114,428

$
116,336

$
87,309Less reinsurance recoverable


28,880


24,617


9,492Net balance at January 1


85,548


91,719


77,817Incurred losses and loss adjustment expenses:Current year


21,133


8,203


6,672Prior years


44,480


4,294


2,731Recovered (paid) losses and loss adjustment expenses, net:Prior years


(3,493
)

(18,668
)

4,499Net balance December 31


147,668


85,548


91,719Plus reinsurance recoverable


75,950


28,880


24,617Balance at December 31

$
223,618

$
114,428

$
116,336


During
2000, the Company increased its general reserve by $9,403,000, of which $6,672,000 was for originations of new business and $2,731,000 was for the accretion of the discount on
prior years' reserves. Also during 2000, the Company transferred to the general reserve $2,053,000 representing recoveries received on prior-year transactions and transferred $1,223,000
from the general reserve to case basis reserves. Giving effect to these transfers, the general reserve totaled $65,204,000 at December 31, 2000.

70

---

During 2001, the Company increased its general reserve by $12,497,000, of which $8,203,000 was for originations of new business and $4,294,000 was for the accretion of the discount on
prior years' reserves. Also during 2001, the Company transferred to the general reserve $89,000 representing recoveries received on prior-year transactions and transferred $8,719,000 from
the general reserve to case basis reserves. Giving effect to these transfers, the general reserve totaled $69,071,000 at December 31, 2001.

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
collateralized debt obligations (CDOs). As a result, management analyzed all CDO transactions in its insured portfolio that breached 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 applies a run of the
collateral portfolio for each transaction considering each CDO transaction's unique attributes (such as reinsurance, individual collateral ratings and status, derivatives purchased, premiums due to
the guarantor, etc.) utilizing a Moody's default pattern for frequency of defaults, an estimate of collateral recovery values for severity, and a risk-free rate of interest. 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 result, management selected Moody's 1992 idealized default curve as a predictor of future defaults on the CDO collateral. 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 and more 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. As described in more detail below, management addressed this net present value
of expected loss ($51.5 million) through (i) an increase in the Company's general reserve ($31.0 million) and (ii) amounts already existing in its general reserve
($20.5 million), including general reserve amounts reallocated to case basis reserves ($11.3 million). The $31.0 million increase in the Company's general reserve resulted in a
corresponding increase to losses and loss adjustment expense in the income statement 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 has established a methodology of recording case basis reserves on CDO transactions to the extent that 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 in respect of these transactions until 2010, but may elect to do so at an earlier date at its discretion. Application of this methodology resulted in recording
$68.8 million in gross case basis reserves and $29.8 million in reinsurance recoverable on unpaid losses, resulting in a $39.0 million increase in net case basis reserves.
Management, beginning in the second quarter of 2002, has refined the loss factor it applies to its net par underwritten when calculating the general reserve in order to reflect its recent adverse
experience.
As a result, the general reserve accrual for the year ended December 31, 2002 was $65.6 million, rather than the approximate $14.9 million that would have been accrued using the
prior assumptions.

During
2002, the Company increased its general reserve by $65.6 million, of which $41.1 million related to the CDO portfolio discussed above, $21.1 million was for
originations of new business and $3.4 million was for the accretion of the discount on prior years' reserves. Also during 2002, the Company transferred to the general reserve
$0.8 million representing recoveries received on prior-year transactions and transferred $45.8 million from the general reserve to case basis reserves. Giving effect to these
transfers, the general reserve totaled $89.7 million at December 31, 2002.

The
cumulative amount of discount taken was approximately $44,690,000, $29,578,000 and $28,748,000 at December 31, 2002, 2001 and 2000, respectively.

71

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18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

|     |                                     | First      |   | Second  |        | Third |         | Fourth |   | Full Year
|---- | ----------------------------------- | ---------- | - | ------- | ------ | ----- | ------- | ------ | - | ---------
|
|2002 |                                     |            |   |         |        |       |         |        |   |          
|     | Gross premiums written              |            | $ | 144,591 |        | $     | 170,838 |        | $ | 215,170  
|     | Net premiums written                |            |   | 95,241  |        |       | 125,186 |        |   | 149,304  
|     | Net premiums earned                 |            |   | 69,698  |        |       | 77,053  |        |   | 80,087   
|     | Net investment income               |            |   | 33,398  |        |       | 35,100  |        |   | 34,457   
|     | Losses and loss adjustment expenses |            |   | 2,912   |        |       | 39,207  |        |   | 8,876    
|     | Income before taxes                 |            |   | 70,033  |        |       | 56,252  |        |   | 33,437   
|     |                                     | Net income |   |         | 54,120 |       |         | 45,405 |   |          
|2001 |                                     |            |   |         |        |       |         |        |   |          
|     | Gross premiums written              |            | $ | 103,689 |        | $     | 133,162 |        | $ | 105,985  
|     | Net premiums written                |            |   | 71,373  |        |       | 89,982  |        |   | 69,164   
|     | Net premiums earned                 |            |   | 51,264  |        |       | 56,496  |        |   | 57,639   
|     | Net investment income               |            |   | 31,714  |        |       | 31,537  |        |   | 32,239   
|     | Losses and loss adjustment expenses |            |   | 2,778   |        |       | 3,195   |        |   | 3,139    
|     | Income before taxes                 |            |   | 60,843  |        |       | 66,279  |        |   | 68,151   
|     |                                     | Net income |   |         | 47,690 |       |         | 51,801 |   |          

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

19. INVESTMENTS IN UNCONSOLIDATED AFFILIATES

In June 1998, the Company invested $10,000,000 to purchase 1,000,000 shares of common stock, representing a 25% interest, in Fairbanks, which buys, sells
and services residential mortgage loans. In October 1999, the Company invested $4,517,000 to purchase 361,333 shares of Fairbanks preferred stock, resulting in the Company owning a 22.2%
interest in Fairbanks as of December 31, 1999. In December 2001, the Company invested an additional $14,980,000 in Fairbanks, resulting in the Company owning a 28.36% interest in
Fairbanks as of December 31, 2001. In August of 2002, the Company invested an additional $13,391,000 in Fairbanks, resulting in the Company owning a 29.8% interest in Fairbanks as of
December 31, 2002. The Company's investment in Fairbanks is accounted for using the equity method of accounting. Amounts recorded by the Company in connection with Fairbanks as of
December 31, 2002, 2001 and 2000 were as follows (in thousands):

2002

2001

2000Investment in Fairbanks

$
59,971

$
32,785

$
13,889Equity in earnings from Fairbanks, net of goodwill amortization (in 2001 and 2000)


13,795


3,916


811


72

---

At
December 31, 2002 and 2001, the Company's retained earnings included $17,032,000 and $3,237,000, respectively, of accumulated undistributed earnings of Fairbanks (net of
goodwill amortization).

In
November 1998, the Company invested $19,900,000 to purchase a 19.9% interest in XLFA, a financial guaranty insurance subsidiary of XL (see Note 7). In
February 1999, the Company sold $4,900,000 of its interest back to XLFA, giving the Company a 15.0% interest in XLFA as of December 31, 1999. In December 2000, the Company
invested an additional $24,000,000 to maintain its 15.0% interest. The Company's investment in XLFA is accounted for using the equity method of accounting because the Company has significant influence
over XLFA's operations. Amounts recorded by the Company in connection with XLFA as of December 31, 2002, 2001 and 2000 are as follows (in thousands):

2002

2001

2000Investment in XLFA

$
52,206

$
49,726

$
43,721Equity in earnings from XLFA


9,145


8,356


3,090Dividends received from XLFA


6,665


1,492


859


At
December 31, 2002 and 2001, the Company's retained earnings included $13,206,000 and $10,726,000, respectively, of accumulated undistributed earnings of XLFA.

The
Company owns 29% of the equity of FSA Global, a Cayman Islands domiciled issuer of FSA-insured notes and other obligations sold in international markets (generally
referred to as medium term notes or "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. 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 FSA Global notes (taking into account, in some cases, dedicated third party liquidity). The matched funding structure
minimizes the market risks borne by FSA Global and FSA. FSA Global raises funds in U.S. dollars at LIBOR-based floating borrowing rates and invests its funds in obligations insured by FSA, maturing
prior to the maturity of the related FSA Global notes and paying a higher interest rate than the interest rate on the related FSA Global notes. Total assets for FSA Global at December 31, 2002
and 2001 were $9,182,028,000 (unaudited) and $3,561,344,000, respectively. Total liabilities at December 31, 2002 and 2001
were $9,188,967,000 (unaudited) and $3,565,255,000, respectively. The foregoing assets and liabilities include assets and matched liabilities that are "economically defeased" in lease financings in
which Company affiliates may play a number of financing roles. These economically defeased liabilities, and associated assets, are held in separate special purpose entities, FSA Global and Premier
International Funding Co. At December 31, 2002 and 2001, FSA Global's economically defeased obligations were $6,708,688,000 and $1,982,961,000, respectively. For the years ended
December 31, 2002 and 2001, total revenues for FSA Global were $285,897,000 (unaudited) and $151,135,000, respectively. For the years ended December 31, 2002 and 2001, total expenses for
FSA Global were $284,945,000 (unaudited) and $150,530,000, respectively. FSA Global's net income for 2002, 2001 and 2000 was $952,000 (unaudited), $605,000 and $383,000. FSA Global's net income is
determined net of premiums paid by FSA Global to FSA. For the years ended December 31, 2002 and 2001, FSA Global paid premiums to FSA of $7,707,000 and $7,502,000, respectively. All amounts
insured by FSA relating to FSA Global are included in the Company's outstanding exposure, included in the Notes to the Consolidated Financial Statements for December 31, 2002. As of
December 31, 2002, there were no case basis reserves required for any transactions related to FSA Global.

20. MINORITY INTEREST IN SUBSIDIARY

In November 1998, FSA International sold to XL $20,000,000 of preferred shares representing a minority interest in FSA International, which is a
Bermuda-based financial guaranty subsidiary of FSA (see Note 7). In December 1999, FSA International sold to XL an additional $10,000,000 of preferred shares to maintain its minority
ownership percentage. The preferred shares are Cumulative Participating Voting Preferred Shares, which in total have a minimum fixed dividend of $1,500,000 per annum. For the years ended
December 31, 2002, 2001 and 2000, the Company recognized minority interest of $6,684,000, $8,929,000 and $5,295,000, respectively.

73

---

21. GICs

The obligations under GICs may be called at various times prior to maturity based upon certain agreed-upon events. As of December 31, 2002, the
interest rates on these GICs were between 1.50% and 5.95%.

Principal
payments due under these GICs in each of the next five years ending December 31 and thereafter, based upon expected withdrawal dates, are as follows (in thousands):

Expected Withdrawal Date

Principal Amount2003

$
334,5052004


519,3032005


237,6262006


127,2922007


502,775Thereafter


712,608Total

$
2,434,109


22. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 133

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

FSA
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. The Company recorded $35,033,000, $15,385,000 and $1,760,000 in net earned premium under these agreements for the years ended December 31, 2002, 2001 and 2000,
respectively. The changes in fair value, which were losses of $50.2 million and a gain of $6.7 million for the years ended December 31, 2002 and 2001, respectively, were recorded
in net realized and unrealized gains (losses) on derivative instruments in the consolidated statements of operations and comprehensive income and in other assets or liabilities. The losses or gains
recognized by recording these contracts at fair value will be determined each quarter based upon market pricing of Super Triple-A (defined as having first-loss protection of
1.3 times the level required for a Triple-A rating) swap guarantees. The Company does not believe the fair value adjustments are an indication of potential claims under FSA's guarantees.

Derivative
instruments, which are primarily designated as fair-value hedges, are entered into to manage the interest rate exposure of the Company's GICs and GIC bond
portfolio and are recorded at fair value. These derivatives generally include interest rate futures and interest rate swap agreements, which are primarily utilized to convert the Company's
fixed-rate obligations on its GICs and GIC bond portfolio into floating-rate obligations. The gains and losses relating to these fair-value hedges are included in
guaranteed investment contract net interest income and 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. For the years ended December 31, 2002 and 2001, the
Company recorded a net loss of $1,402,000 and a net gain of $161,000, respectively, relating to the ineffectiveness of these hedges. For the years ended December 31, 2002 and 2001, the Company
recorded a net gain of $4,266,000 and $0, respectively, relating to failed hedges.

74

---

23. SECURITIZED LOANS

In 2002, FSA exercised certain rights available under its financial guaranty policies and indentures relating to loan-backed notes issued by FMAC Loan
Receivables Trust 1998-D and 2000-A (the Trusts). Those rights allowed FSA to accelerate the insured notes and pay claims under its insurance policy on an accelerated basis.
Refinancing vehicles reimbursed FSA in whole for its claims payments in exchange for assignments of certain of FSA's rights against the Trusts. The refinancing vehicles obtained their funds from the
proceeds of FSA-insured GICs issued in the ordinary course of business by CMS. FSA maintains significant reinsurance, first loss and quota share, on these transactions.

Since
the notes represent 100% of the debt capitalization of the Trusts and since FSA maintains all the risk of further asset decline 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.

Although
the securitized loans are included on FSA's balance sheet, the securitized loans continue to support FSA-insured transactions exclusively, subject to considerable
first loss and quota share reinsurance. In accordance with AICPA Practice Bulletin 6, "Amortization of Discounts on Certain Acquired Loans," the Company has recorded the securitized loans at cost, has
determined cash flows from the pools of securitized loans, net of reinsurance, and is recording income based upon the constant yield method. The cash flows on the securitized loans will be monitored
and the constant yield modified to reflect any change in the cash flow estimates.

As
a result of these transactions, the Company recorded $437.5 million of securitized loans and $6.3 million of other income related to those securitized loans during the
year ended December 31, 2002.

24. SEGMENT REPORTING

The Company operates in two business segments, financial guaranty and financial services. The financial guaranty segment is primarily in the business of providing
financial guaranty insurance on asset-backed and municipal obligations. Financial services includes the operations of the Company's asset management group, which issues GICs to municipalities and
other market participants. The GICs provide for the return of
principal and the payment of interest at a guaranteed rate. The following table is a summary of the financial information by segment as of and for the years ended December 31, 2002 and 2001:

|                           |               | For the Year Ended December 31, 2002
|-------------------------- | ------------- | ------------------------------------
|
|
|Revenues:                  |               |                                     
|                           | External      |                                     
|                           | Inter-segment |                                     
|Expenses:                  |               |                                     
|                           | External      |                                     
|                           | Inter-segment |                                     
|Income before income taxes |               |                                     
|Segment assets             |               |                                     

75

---

|                                  |  | For the Year Ended December 31, 2001
|--------------------------------- |  | ------------------------------------
|
|
|Revenues                          |  | $                                   
|Expenses                          |  |                                     
|Income (loss) before income taxes |  |                                     
|Segment assets                    |  |                                     

The
inter-segment assets are intercompany loans that are in the financial services investment portfolio. The inter-segment revenues relate to premiums charged by the financial guaranty
segment for insuring GICs and interest income and interest expense on the inter-segment loans.

25. RECENTLY ISSUED ACCOUNTING STANDARDS

In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities"
(FIN No. 46), which is an interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". FIN No. 46 addresses consolidation of VIEs which have one or
both of the following characteristics: (i) 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 (ii) 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. The provisions of FIN No. 46 will be effective immediately for VIEs created after January 31, 2003 and to VIEs in which an enterprise
obtains an interest after that date. For VIEs in which an enterprise holds a variable interest that it acquired prior to February 1, 2003, the interpretation is effective in the first fiscal
year or interim period beginning after June 15, 2003. Management believes that the implementation of FIN No. 46, on July 1, 2003, will cause the Company to consolidate for
financial reporting purposes, for the first time, FSA Global (see Note 19) and Canadian Global (see Note 9). FIN No. 46 requires that, upon consolidation, the Company shall initially
measure the VIEs' 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). Any differences upon consolidation on July 1, 2003 will be reflected as a cumulative effect of a change in accounting principle. The carrying amounts of assets,
liabilities and minority interest may change
significantly from December 31, 2002 to July 1, 2003 as a result of transactions entered into during that period. The Company will continue to analyze the effects of FIN No. 46,
considering the timing of its release and the complexity of practical application to the Company's transactions.

In
November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an Interpretation of FASB Statements No. 5, 57 and 107 and Rescission of FASB Interpretation No. 34 (FIN No. 45). FIN No. 45 relates to the
accounting for and disclosure of guarantees. FIN No. 45 excludes financial guarantee insurance contracts, including those accounted for as insurance contracts and those accounted for as
derivatives, from its initial recognition and measurement requirements. However, those contracts accounted for as derivatives are subject to its disclosure requirements. The disclosure requirements in
FIN No. 45 are consistent with those already provided by the Company.

76

---



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

None

77

---

Part III

Item 10. Directors and Executive Officers of the Registrant.

Directors

On May 24, 2002, the Company's shareholders appointed 12 directors to serve until the Company's next annual meeting of shareholders or until their earlier
resignation or removal. Effective in September 2002, two of those directors, John J. Byrne and Alain Delouis, resigned and the remaining directors elected Jacques Guerber a director of the
Company. Information about the directors is set forth below in this Item, under the caption "Directors and Executive Officers" in Item 12 and in Item 13.

|Dirk Bruneel
Age 52      |  | Director of the Company since November 2001. Mr. Bruneel has been a member of the Executive Committee of Dexia S.A. since July 2001, and is a director of a number of Dexia affiliated companies. He was a
member of the Board of Directors of Banque Artesia (a Belgian based bank which was acquired by Dexia S.A. in July 2001) from November 1997 until March 2002; BACOB Bank s.c. (the retail banking subsidiary of Banque Artesia) from
November 1993 until March 2002; and Dexia Bank from July 2001 through January 2002. Mr. Bruneel served as Chairman of the Management Committee of Banque Artesia 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. Mr. Bruneel was previously Vice President of the Board of the Belgian Banking
Association. He currently serves as a director of EHSAL, Erste Bank and Artesia Mortgage Capital Corporation, and as Treasurer ofVlaams Omroeporkest en Kamerkoor.
|------------------------ |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Robert P. Cochran
Age 53 |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                       
|Bruno Deletre
Age 41     |  | Director of the Company since September 2001. Mr. Deletre has been a member of the Executive Board 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 67  |  | 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.                                                                                                                                                                                                                                                                                                                                     
|                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

78

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|Jacques Guerber
Age 53  |  | 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 dés Dépôts et Consignations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|----------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|David O. Maxwell
Age 72 |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Séan W. McCarthy
Age 44 |  | 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 59  |  | Director of the Company since January 1990. Mr. Ozanne served as Vice Chairman of the Board of Directors of the Company from February 1998 until July 2000. Mr. Ozanne is 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 President of Fund American Enterprises, Inc. from March 1997 until December 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. He is a director of Acquisitor, PLC, and Proton Energy Systems, Inc., Vice Chairman of Fairbanks Capital Holding Corp. and Chairman of Peco, Inc.                                                                             
|Pierre Richard
Age 62   |  | 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 took over as 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 anOfficierof theLégion d'Honneurand theOrdre National du Mériteand as aCommandeurof theOrdre of Leopold II.
|                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|                        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

79

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|Roger K. Taylor
Age 51   |  | 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. 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
Fairbanks Capital Holding Corp.
|------------------------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Rembert von Lowis
Age 49 |  | 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.                                                                                                                              

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, and an additional annual fee of
$5,000 if chairperson of a Committee of the Board of Directors. 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 the Company's Deferred Compensation Plan and to participate in the "Director Share Purchase Program" described under that
caption in Item 11.

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 permanent members of the Management Committee.

|Name                 |  | Age |  | Position                                                                                
|-------------------- |  | --- |  | ----------------------------------------------------------------------------------------
|Russell B. Brewer II |  | 46  |  | Managing Director of FSA and the Company; Chief Underwriting Officer and Director of FSA
|Daniel C. Farrell    |  | 36  |  | Managing Director of FSA                                                                
|Joseph W. Simon      |  | 44  |  | Managing Director and Chief Financial Officer of the Company and FSA; Director of FSA   
|Bruce E. Stern       |  | 49  |  | Managing Director, General Counsel and Secretary of the Company and FSA; Director of FSA

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 Underwriting Officer of FSA since September 1990. 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.

80

---

Mr. Farrell
has been Managing Director of FSA in charge of FSA's Corporate Finance Department since December 2000 and a member of the Management Committee of the Company
since January 2002. Mr. Farrell joined FSA as an Associate in the Residential Mortgage Group in December 1990, and became a Managing Director of FSA in January 1995.

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.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16 of the Securities Exchange Act of 1934 (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 New York Stock Exchange (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.

81

---

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, 2002, 2001 and 2000.

|                                                                      |  |                |  | Annual Compensation |                         | Long Term
Compensation(1)
|--------------------------------------------------------------------- |  | -------------- |  | ------------------- | ----------------------- | -------------------------
|
|Robert P. Cochran
Chairman of the Board and Chief Executive Officer   |  | 2002
2001
2000 |  | $                   | 490,000
490,000
470,000 |                          
|Séan W. McCarthy
President and Chief Operating Officer                |  | 2002
2001
2000 |  |                     | 300,000
300,000
250,000 |                          
|Bruce E. Stern
Managing Director, General Counsel and Secretary       |  | 2002
2001
2000 |  |                     | 230,000
230,000
215,000 |                          
|Daniel C. Farrell
Managing Director                                   |  | 2002
2001
2000 |  |                     | 210,000
190,000
175,000 |                          
|Russell B. Brewer II
Managing Director and Chief Underwriting Officer |  | 2002
2001
2000 |  |                     | 230,000
230,000
215,000 |                          

---

Officer

2002

2001

2000Robert P. Cochran

$


$
1,813,646

$
5,580,821Séan W. McCarthy


37,823


20,709


715,166Bruce E. Stern





476,544


1,602,982Daniel C. Farrell


9,578





Russell B. Brewer II





654,057


1,430,161


82

---



Officer

2002
Pension Plan

SERP

2001
Pension Plan

SERP

2000
Pension Plan

SERPRobert P. Cochran

$
15,300

$
74,700

$
15,300

$
74,700

$
14,400

$
75,600Séan W. McCarthy


15,300


74,700


15,300


74,700


14,400


75,600Bruce E. Stern


15,300


59,400


15,300


58,050


14,400


44,550Daniel C. Farrell


15,300


72,000


15,300


69,300


14,400


50,400Russell B. Brewer II


15,300


59,400


15,300


58,050


14,400


44,550




Employment Agreements and Arrangements; Change in Control Provisions

In connection with the Merger, each of Messrs. Cochran and McCarthy entered into four-year employment agreements with the Company, effective
July 5, 2000, the date of the Merger. The employment agreements generally guarantee continuation of compensation and benefits through July 5, 2004. Compensation consists of
(i) base salary at the annual rate in effect immediately prior to the Merger, subject to increase at the Board's discretion; (ii) annual bonus equal to a minimum percentage of a defined
"bonus pool"; and (iii) annual grants of performance shares under the Company's 1993 Equity Participation Plan, as amended (the "Equity Plan"), equal to no less than 50% of the number of
performance shares granted to such executive officer in 2000. The bonus pool equals 7% of the after-tax growth in adjusted book value for the year, excluding realized and unrealized
gains/losses on investments and including a return on equity modifier consistent with the Company's practice in effect before the Merger. An additional reserve bonus pool made up of previously earned
but undistributed bonus pool allocations from prior years, equal to approximately $12 million after giving effect to 2002 bonuses (paid in the first quarter of 2003), may also be distributable.
Messrs. Cochran and McCarthy are entitled to receive an annual cash bonus equal to at least 5.6% and 4.25%, respectively, of the bonus pool and, if applicable, the reserve pool. The employment
agreements provide that an additional 2.02% of the bonus pool and, if applicable, the reserve pool, will be allocated among those two executive officers as determined by the Human Resources Committee.
The employment agreements also 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 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 twice his annual
base and average annual bonus; his outstanding performance shares will vest pro rata in proportion to the percentage of the applicable performance cycle during which he was employed by the Company;
and two-thirds of both his remaining unvested performance shares and the minimum annual performance shares which he is entitled to receive through July 5, 2004 will vest. Each
employment agreement provides 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, he will also be entitled to his pro-rata annual bonus through the date of termination, 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, and subsequently awarded performance shares will
be treated as provided in the Equity Plan. The employment agreements contain a non-compete provision extending through the four-year term.

The
Company's severance policy for senior management entitles Messrs. Farrell, Stern and Brewer to 12 months of compensation, in each case if terminated without cause and
based upon 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 Plan provides for accelerated vesting and payment of equity bonus shares, performance shares and stock options awarded there under upon the occurrence of certain change in
control transactions involving the

83

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Company.
These provisions are generally applicable to all participants in the Equity Plan. Each of the named executive officers holds performance shares awarded under the Equity Plan.

The
Equity Plan provides 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 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.

Director Share Purchase Program

In the fourth quarter of 2000, the Company entered into an agreement with Dexia Holdings, Inc. ("DHI") and Dexia Public Finance Bank (now Dexia
Crédit Local) establishing a program (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 S.A. (or an affiliate thereof) up to $10 million of restricted shares ("Restricted Shares") of the Company's Common
Stock at an initial price of $78.766 per share; provided that (i) Restricted Shares must be held for the lesser of four years or the participant's tenure as a director of the Company;
(ii) Restricted Shares may be put to Dexia Crédit Local at any time or from time to time following the required holding period for cash; and (iii) purchases of shares
after inception of the program are at a price equal to the purchase price for shares put to Dexia Crédit Local described below. Directors may purchase such shares either directly or
through deemed investments under the Company's Deferred Compensation Plan ("DCP") or Supplemental Executive Retirement Plan ("SERP"). Each deemed investment election with respect to these shares is
irrevocable. The Director Share Purchase Program enables the Company to purchase from DHI, 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 DHI for generally a minimum of six months. The purchase price for each Restricted Share 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 Plan.
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.

During
2002, one of the Company's directors, Mr. Ozanne, made additional investments in phantom shares under this program. Mr. Ozanne purchased approximately 150, 164, 158
and 150 phantom shares on February 14, 2002, May 23, 2002, September 5, 2002 and November 14, 2002, respectively, at purchase prices per share determined under the formula
described above of $101.38, $104.86, $109.10 and $115.22,
respectively. In July 2002, the deferral period in respect of 3,437 phantom shares expired for another director, Mr. Downey, and the Company satisfied its obligation to pay out those
shares in kind by issuing 3,437 treasury shares of common stock to Mr. Downey. 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. Such investments, and outstanding investments made by the Company's directors, are described under the caption "Directors and Executive Officers" in
Item 12.

Performance Shares

Performance shares are awarded under the Equity Plan. The Equity Plan authorizes 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. Each performance share represents the economic value of up to two shares of Common Stock, 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.

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, 2002 (which awards were
made in January or February 2003), (b) the

84

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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.

LONG-TERM INCENTIVE PLANSAWARDS IN 2002(1)

|                     |  |        |  |    |   | Estimated Future Payouts(3)
|-------------------- |  | ------ |  | -- | - | ---------------------------
|
|Robert P. Cochran    |  | 38,000 |  | (2 | ) | 0                          
|Séan W. McCarthy     |  | 25,000 |  | (2 | ) | 0                          
|Bruce E. Stern       |  | 10,000 |  | (2 | ) | 0                          
|Daniel C. Farrell    |  | 10,000 |  | (2 | ) | 0                          
|Russell B. Brewer II |  | 10,000 |  | (2 | ) | 0                          

---

Compensation Committee Interlocks and Insider Participation

The Human Resources Committee consisted of Messrs. Maxwell (Chairperson), Byrne (until he resigned as a director in September 2002), Cochran,
Deletre (since May 2002), Downey and Richard during 2002. Except for Mr. Cochran, none of such persons is currently or has ever been an officer or employee of the Company or any
subsidiary of the Company. Mr. Byrne is Chairman of White Mountains Insurance Group Ltd. ("White Mountains"), and served as that company's Chief Executive Officer until January 1,
2003. White Mountains was a major shareholder of the Company prior to the Merger. Mr. Cochran, Chairman and Chief Executive Officer of the Company, is a director of White Mountains, the
Chairman of its human resources committee and a member of its compensation committee. Mr. Downey, a director of the Company, is a Senior Director of Goldman, Sachs & Co. Goldman Sachs
was an underwriter of the Company's issuance in November 2002 of $230 million principal amount of 6.25% Notes due November 1, 2102. Mr. Richard is the Group Chief Executive
and Chairman of the Executive Committee of Dexia S.A. and Mr. Deletre is a member of the Executive Board of Dexia Crédit Local. Mr. Ozanne is Vice Chairman of Fairbanks
Capital Holdings Corp. ("Fairbanks"), a servicer of residential mortgage loans, including a number of residential mortgage loan portfolios supporting transactions insured by FSA. In
August 2002, the Company contributed an additional $13.4 million to Fairbanks, increasing its equity ownership in that company to

85

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29.8%.
Executive officers of the Company have invested in White Mountains and two other companies sponsored by White Mountains, Montpelier Re Holdings Ltd. and Olympus Re Holdings, Ltd.

As
described above under the caption "Director Share Purchase Program", 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 Deferred Compensation Plan or Supplemental Executive Retirement Plan.

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, 2003 as to each person known by the
Company to beneficially own, within the meaning of the Securities Exchange Act of 1934 (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 |  | 32,840,449 shares(1)(2)                   |  | 98.9             | %(2)
|                                       |  | Boulevard Pachéco 44
B-1000 Brussels, Belgium                                 |  |                                           |  |                  |     

---

86

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Directors and Executive Officers

The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock at March 15, 2003 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. The table also provides information regarding economic ownership. 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



281,625Bruno Deletre(2)



Robert N. Downey

17,887

29,259Jacques Guerber



Séan W. McCarthy



134,385David O. Maxwell

5,213

19,299James H. Ozanne



24,576Pierre Richard(2)



Roger K. Taylor



154,822Rembert von Lowis(2)



Bruce E. Stern



40,000Daniel C. Farrell



36,667Russell B. Brewer II



40,000All executive officers and directors as a group (15 persons)

23,100

770,633


---

Officer

Performance SharesRobert P. Cochran

154,667Séan W. McCarthy

108,333Bruce E. Stern

40,000Daniel C. Farrell

36,667Russell B. Brewer II

40,000




87

---

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 S.A., at March 15, 2003, 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 0.1% for each executive officer and director listed, individually and as a group.

Directors and
Executive Officers(1)

Amount and Nature of Beneficial OwnershipDirk Bruneel

21,590Robert P. Cochran

282,250Bruno Deletre

Robert N. Downey

Jacques Guerber

750Séan W. McCarthy

223,600David O. Maxwell

James H. Ozanne

Pierre Richard

29,000Roger K. Taylor

124,690Rembert von Lowis

5,120Bruce E. Stern

91,450Daniel C. Farrell

106,710Russell B. Brewer II

90,960All executive officers and directors as a group (15 persons)

976,120


---

Officer

Leveraged SharesRobert P. Cochran

280,750Séan W. McCarthy

222,100Bruce E. Stern

85,990Daniel C. Farrell

106,710Russell B. Brewer II

89,460


88

---

Securities Available Under Equity Compensation Plans

The following table sets forth information as of December 31, 2002 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                                                                  |  | Equity bonus awards (no longer granted by the Company): 9,984,780
  
All other awards: 3,112,263                                               
|Equity compensation plans not approved by security holders(2) |  | 0                                                                                               |  | Not applicable                                                                  |  | 1,073,905                                                                                                                                      
|Total                                                         |  | 0                                                                                               |  | Not applicable                                                                  |  | 14,170,948                                                                                                                                     

---

89

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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 above under the caption "Director Share
Purchase Program" in Item 11.

Other Relationships

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

90

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Item 14. Controls and Procedures

Within the 90-day period prior to the filing of this report, the Company carried out an evaluation, under the supervision and with the participation
of management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in
Rule 13a-14(c) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and
operation of these disclosure controls and procedures were effective. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation.

91

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Part IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.



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

|Schedule |  | Title                                                                                                                                                                                      
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|II       |  | Condensed Financial Information of Registrant for the Years Ended December 31, 2002, 2001 and 2000.                                                                                        
|         |  | The report of the Registrant's independent auditors with respect to the above listed financial statement schedule is set forth on page 47 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.

92

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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 Credit 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.)
|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         |     | Indenture dated as of September 15, 1997 (as supplemented, the "Senior QUIDS Indenture") between the Company and First Union National Bank, as Trustee (the "Senior Debt Trustee"). (Previously filed as Exhibit 2 to the Company's Current
Report on Form 8-K (Commission File No. 1-12644) dated September 15, 1997 (the "September 1997 Form 8-K"), and incorporated herein by reference.)   
|4.1         | (A) | First Supplemental Indenture dated as of November 13, 1998, between the Company and the Senior Debt Trustee. (Previously filed as Exhibit 6 to the Company's Current Report on Form 8-K (Commission File No. 1-12644) dated
November 6, 1998 (the "November 1998 Form 8-K"), and incorporated herein by reference.)                                                                             
|4.1         | (B) | Form of 6.950% Senior Quarterly Income Debt Securities due 2098. (Previously filed as Exhibit 2 to the November 1998 Form 8-K, and incorporated herein by reference.)                                                                                                                                                                                                                           
|4.1         | (C) | Officers' Certificate pursuant to Sections 2.01 and 2.03 of the Senior QUIDS Indenture. (Previously filed as Exhibit 5 to the November 1998 Form 8-K, and incorporated herein by reference.)                                                                                                                                                                                                    
|4.1         | (D) | 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.)                                                                              
|            |     |                                                                                                                                                                                                                                                                                                                                                                                                 

93

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|     |     |                                                                                                                                                                                                                                                                                                                                                                                                                                          
|---- | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|4.1  | (E) | 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  | (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 December 2001 Form 8-K, and incorporated herein by reference.)                                                                                                                                                                                                                              
|4.1  | (G) | 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  | (H) | 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.)                                                                                                                                                                                                                              
|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.)
|10.2 |     | Facility Agreement dated as of August 30, 1994, among FSA, Canadian Global Funding Corporation and Hambros Bank Limited. (Previously filed as Exhibit 2 to the Company's Quarterly Report on Form 10-Q (Commission File No. 1-12644)
for the quarterly period ended September 30, 1994, and incorporated herein by reference.)                                                                                                           
|10.3 |     | 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.)                
|10.4 | *  | Supplemental Executive Retirement Plan (amended and restated as of November 14, 2002).                                                                                                                                                                                                                                                                                                                                                   
|10.5 |    | 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.)                                                                                                            
|10.6 | *  | Deferred Compensation Plan (amended and restated as of November 14, 2002).                                                                                                                                                                                                                                                                                                                                                               
|10.7 |    | Severance Policy for Senior Management (amended and restated as of May 17, 2001). (Previously filed as Exhibit No. 10.2 to the June 30, 2001 10-Q, and incorporated herein by reference.)                                                                                                                                                                                                                                                
|10.8 |    | 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                                                                                                                                                                                                                  
|     |     |                                                                                                                                                                                                                                                                                                                                                                                                                                          
|     |     |                                                                                                                                                                                                                                                                                                                                                                                                                                          

94

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|      |   | (Commission File No. 1-12644) for the fiscal year ended December 31, 2000 (the "December 31, 2000 10-K"), and incorporated herein by reference.)                                                          
|----- | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.9  |  | Employment Agreement dated as of March 14, 2000 by and between the Company and Robert P. Cochran. (Previously filed as Exhibit 10.10 to the December 31, 2000 10-K, and incorporated herein by reference.)
|10.10 |  | Employment Agreement dated as of March 14, 2000 by and between the Company and Séan W. McCarthy. (Previously filed as Exhibit 10.12 to the December 31, 2000 10-K, and incorporated herein by reference.) 
|21    | * | List of Subsidiaries.                                                                                                                                                                                     
|23    | * | Consent of PricewaterhouseCoopers LLP.                                                                                                                                                                    
|24    | * | Powers of Attorney.                                                                                                                                                                                       
|99.1  | * | Financial Security Assurance Inc. and Subsidiaries 2002 Consolidated Financial Statements and Report of Independent Accountants.                                                                          
|99.2  | * | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350                                                                                                                               
|99.3  | * | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350                                                                                                                               
|      |   |                                                                                                                                                                                                           

---

The Company filed a Current Report on Form 8-K dated November 6, 2002, with the Securities and Exchange Commission on
November 25, 2002, which incorporated by reference the documents included as Exhibits thereto into the Registration Statement relating to the Company's 6.25% Notes due 2102.

95

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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. (Registrant)                              
| |  | -----------------------------------------------------------------------------------------
| |  | By:                                                                                      
| |  | Name: Robert P. Cochran
Title: Chairman and Chief Executive Officer
Dated: March 28, 2003

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 28, 2003
|/s/SÉAN W. MCCARTHY*Séan W. McCarthy   |  | President, Chief Operating Officer and Director                              |  | March 28, 2003
|/s/JOSEPH W. SIMON*Joseph W. Simon     |  | Managing Director and Chief Financial Officer (Principal Financial Officer)  |  | March 28, 2003
|/s/JEFFREY S. JOSEPH*Jeffrey S. Joseph |  | Managing Director and Controller (Principal Accounting Officer)              |  | March 28, 2003
|/s/DIRK BRUNEEL*Dirk Bruneel           |  | Director                                                                     |  | March 28, 2003
|/s/BRUNO DELETRE*Bruno Deletre         |  | Director                                                                     |  | March 28, 2003
|/s/ROBERT N. DOWNEY*Robert N. Downey   |  | Director                                                                     |  | March 28, 2003
|/s/JACQUES GUERBER*Jacques Guerber     |  | Director                                                                     |  | March 28, 2003
|/s/DAVID O. MAXWELL*David O. Maxwell   |  | Director                                                                     |  | March 28, 2003
|/s/JAMES H. OZANNE*James H. Ozanne     |  | Director                                                                     |  | March 28, 2003
|/s/PIERRE RICHARD*Pierre Richard       |  | Vice Chairman and Director                                                   |  | March 28, 2003
|/s/ROGER K. TAYLOR*Roger K. Taylor     |  | Director                                                                     |  | March 28, 2003
|                                       |  |                                                                              |  |               

96

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|/s/REMBERT VON LOWIS*Rembert von Lowis |  | Director |  | March 28, 2003
|-------------------------------------- |  | -------- |  | --------------

---

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

97

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CERTIFICATIONS

I, Robert P. Cochran, certify that:

Date:
March 28, 2003

|/s/ROBERT P. COCHRANName: Robert P. Cochran
Title: Chief Executive Officer |  | 
|-------------------------------------------------------------------------- |  | 

98

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I,
Joseph W. Simon, certify that:

Date:
March 28, 2003

|/s/JOSEPH W. SIMONName: Joseph W. Simon
Title: Chief Financial Officer |  | 
|---------------------------------------------------------------------- |  | 

99

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Schedule II    Condensed Financial Information of Registrant

Condensed Balance Sheets
(Dollars in thousands)

|                                           |                                                            | December 31,
|------------------------------------------ | ---------------------------------------------------------- | ------------
|
|Assets:                                    |                                                            |             
|                                           | Bonds at market value (amortized cost $17,164 and $24,961) |             
|                                           | Short-term investments                                     |             
|                                           | Cash                                                       |             
|                                           | Investment in subsidiaries, at equity in net assets        |             
|                                           | Notes receivable from subsidiary                           |             
|                                           | Deferred compensation asset                                |             
|                                           | 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 Statements of Income
(Dollars in thousands)

|                                                   |  | Year Ended December 31, |        
|-------------------------------------------------- |  | ----------------------- | -------
|
|Investment income                                  |  | $                       | 8,161  
|Net realized gains (losses)                        |  |                         | 805    
|Other income (loss)                                |  |                         | 38     
|Interest and amortization expense                  |  |                         | (28,098
|Salaries and related expenses                      |  |                         | 5      
|Equity-based compensation                          |  |                         |        
|Commissions                                        |  |                         | (3,300 
|Other expenses                                     |  |                         | (1,686 
|Net unrealized losses on derivative instruments    |  |                         | (2,013 
|                                                   |  |                         |        
|                                                   |  |                         | (26,088
|Equity in undistributed net income of subsidiaries |  |                         | 196,720
|                                                   |  |                         |        
|Income before income taxes                         |  |                         | 170,632
|Income tax benefit                                 |  |                         | 10,443 
|                                                   |  |                         |        
|Net income                                         |  | $                       | 181,075
|                                                   |  |                         |        

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 Financial Statements and Supplementary Data.

100

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Condensed Statements of Cash Flows
(Dollars in thousands)

|                                                                           |                                                   | Year Ended December 31,                              |        
|-------------------------------------------------------------------------- | ------------------------------------------------- | ---------------------------------------------------- | -------
|
|Cash flows from operating activities:                                      |                                                   |                                                      |        
|                                                                           | Other operating expenses recovered, net           |                                                      | $      
|                                                                           | Net investment income received                    |                                                      |        
|                                                                           | Federal income taxes received                     |                                                      |        
|                                                                           | Interest paid                                     |                                                      |        
|                                                                           | Other                                             |                                                      |        
|                                                                           |                                                   |                                                      |        
|                                                                           |                                                   | Net cash provided by (used for) operating activities |        
|                                                                           |                                                   |                                                      |        
|Cash flows from investing activities:                                      |                                                   |                                                      |        
|                                                                           | Proceeds from sales of bonds                      |                                                      |        
|                                                                           | Proceeds from sales of equity investments         |                                                      |        
|                                                                           | Purchases of bonds                                |                                                      |        
|                                                                           | Purchases of equity investments                   |                                                      |        
|                                                                           | Purchases of property and equipment               |                                                      |        
|                                                                           | Investment in subsidiaries                        |                                                      |        
|                                                                           | Net decrease (increase) in short-term investments |                                                      |        
|                                                                           | Other investments                                 |                                                      |        
|                                                                           |                                                   |                                                      |        
|                                                                           |                                                   | Net cash provided by (used for) investing activities |        
|                                                                           |                                                   |                                                      |        
|Cash flows from financing activities (b):                                  |                                                   |                                                      |        
|                                                                           | Issuance of notes payable                         |                                                      |        
|                                                                           | Repayment of notes payable                        |                                                      |        
|                                                                           | Surplus notes purchased, net                      |                                                      |        
|                                                                           | Dividends paid                                    |                                                      |        
|                                                                           | Purchase of common stock                          |                                                      |        
|                                                                           | Sale of treasury stock(a)                         |                                                      |        
|                                                                           | Settlement of forward shares                      |                                                      |        
|                                                                           | Other                                             |                                                      |        
|                                                                           |                                                   |                                                      |        
|                                                                           |                                                   | Net cash provided by financing activities            |        
|                                                                           |                                                   |                                                      |        
|Net increase (decrease) in cash                                            |                                                   |                                                      | 1,331  
|Cash at beginning of year                                                  |                                                   |                                                      | 421    
|                                                                           |                                                   |                                                      |        
|Cash at end of year                                                        |                                                   | $                                                    | 1,752  
|                                                                           |                                                   |                                                      |        
|Reconciliation of net income to net cash provided by operating activities: |                                                   |                                                      |        
|Net income                                                                 |                                                   | $                                                    | 181,075
|                                                                           | 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        |                                                      |        
|                                                                           | Deferred equity compensation                      |                                                      |        
|                                                                           | Depreciation and accretion of bond discount       |                                                      |        
|                                                                           | Change in other assets and liabilities            |                                                      |        
|                                                                           |                                                   |                                                      |        
|Cash provided by (used for) operating activities                           |                                                   | $                                                    | 22,566 
|                                                                           |                                                   |                                                      |        

---

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 Financial Statements and Supplementary Data.

101

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







102

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Exhibit Index

|Exhibit No. |  | Exhibit                                                                                                                        
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------
|10.4        |  | Supplemental Executive Retirement Plan (amended and restated as of November 14, 2002)                                          
|10.6        |  | Deferred Compensation Plan (amended and restated as of November 14, 2002)                                                      
|21          |  | List of Subsidiaries                                                                                                           
|23          |  | Consent of PricewaterhouseCoopers LLP                                                                                          
|24          |  | Powers of Attorney                                                                                                             
|99.1        |  | Financial Security Assurance Inc. and Subsidiaries 2002 Consolidated Financial Statements and Report of Independent Accountants
|99.2        |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350                                                    
|99.3        |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350                                                    

All
other Exhibits to Form 10-K are incorporated by reference, as described in Item 15 of Form 10-K.

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